Innovation and Competitiveness: at What Price?

The report on The Future of European Competitiveness presented by Mario Draghi provides a clarion call for economic reforms to stop Europe’s relative decline.  This short comment cannot do justice to the report with over 300 pages of supporting material.  We will concentrate just on two key messages regarding innovation and investment.

 

The starting point of the report is the weakness of innovation in the EU, and the report lays out the well-known lamentable state of Europe’s high-tech industries. Draghi recognizes that European enterprises are caught in a ‘middle tech trap’, a term coined by a joint report of the Institute for European Policymaking at Bocconi with other institutes in France and Germany. Most large EU companies are in the middle tech sectors and remain there because this is the field they know.  Radical, breakthrough innovation is much weaker in Europe.

 

Draghi proposes a number of small, but significant steps that should strengthen innovation, like the creation of a European equivalent to the US Defense Advanced Research Project Agency (DARPA) that has been credited with fostering key innovations like the internet.

 

However, EU companies are relatively strong in cleantech innovation. The report thus concentrates on the threat to the EU clean tech industry from China. It recommends, rightly, and courageously, abandoning sectors like solar panel manufacturing, where the Chinese cost advantage is too big – even if that advantage was due to subsidies.

But it considers the automotive industry too important to be exposed to unfettered Chinese competition.  It recommends a mixture of tariffs and measures to ensure that Chinese investment in this sector leads to a transfer of technology.  The report says:

 

“The latter can be achieved by requiring foreign companies that want to produce in Europe to enter into joint ventures with local companies.” This is exactly the approach China has used for a long time and which the EU has always criticized.

 

After discussing these and other challenges like decarbonization and high energy prices, the report concludes that: “a minimum annual additional investment of EUR 750 to 800 billion is needed, based on the latest Commission estimates, corresponding to 4.4-4.7% of EU GDP in 2023”. This part has attracted the most attention, but it is also the least convincing.

 

Even the 300 pages of supporting material provide little explanation of how the Commission arrived at this magnitude. Why this amount would be needed in addition to the existing investment, and what concrete projects should be financed.  The report does not say directly that the 800 billion euro annually should be financed by the EU through common debt, only that private financing will not be sufficient, and that common public debt would be desirable.  But the message that has caught on is naturally the figure as can be seen in the headline of the Financial Times. 

 

Moreover, it is very much debatable whether Europe needs more investment as opposed to investment in different sectors. A recent report by IEP Bocconi shows that investment in the EU is higher as a share of GDP than in the US.  It thus does not make sense to call for a large increase in investment without specifying what kind of investment is missing.  

 

The main EU-US difference is expenditure on research and development (R&D), which is much stronger in the US because US high-tech companies spend so much more. 

 

It would of course be ideal if European enterprises were to increase their investments in high tech by hundreds of billions of euros. But there is no indication in the report how this could be achieved.  More public support for research and development which is advocated in the part of innovation would certainly be useful.  But EU financing for R&D amounts to about 10 billion annually, even doubling it would do little to cover the gap in private R&D spending.  In this crucial aspect, there is little connection between the parts of the report dealing with Europe’s innovation lag and the call for huge increases in investment.

 

The Bocconi investment report also shows that the return on investment is higher in the US, again not indicating a need for more investment in the EU.  

 

The low return in the EU might be due to inefficiencies in the bank-centric nature of EU capital markets (plural because each Member State has a separate one). The calls for a capital market union and to foster more equity investment are thus well taken. But the benefit would be in terms of the quality of investment, rather than its quantity.

 

It is a pity that the 800 billion euro figure is likely to distract attention from the many other important ideas and proposals of the landmark report. But much progress could be achieved if its concrete ideas on fostering innovation without requiring huge sums were to be adopted.