Europe’s competitiveness is stalling: how to unleash investment to do better

Europe’s competitiveness is in dire straits – putting Europe’s prosperity and place in the world at risk and jeopardising its long-term ability to fund the net zero transition and its social model.

Large European firms invest 40 percent less in R&D than their US peers and grow a third more slowly. In ten critical technologies, Europe is trailing the United States or China, according to McKinsey Global Institute (MGI) analysis. Notably, in the generative AI value chain, Europe’s market share is less than five percent in most segments.

Investment is the pulse and lifeblood of competitiveness – and there is a factor two per capita gap relative to the U.S. in the most productive forms, i.e. into intellectual property and equipment and machinery. Bridging this must take priority. MGI has found that investment has accounted for 70 to 80 percent of productivity growth since the turn of the century. Companies or markets that are less competitive don’t attract as much investment. Without such investment, there is no growth, putting Europe’s growth, debt sustainability, prosperity, social model and place in the world at risk. Can Europe afford to invest double its current investment?

Public investment in net terms, that is after depreciation, accounts for just one percent of total public expenditure, and even this level is fragile, likely to be cut when budgets are tight. Even if investment doubled, it would merely mean reallocating one percent of public spending. It could also help to apply the same accounting rules in the public sector as is common in private firms, specifically by recognising investment as a productive asset on the balance sheet that loses value and thus costs money over time of use, rather than hitting budget deficits one-off at the time the investment is made.

But most investment will need to come from the private sector, where funding is less of an issue than framework conditions and expectations of attractive returns. As long as corporations in Europe generate four percentage points lower returns on capital than those in the U.S., it is hard to imagine European investment to double and reach U.S. levels. Prerequisites would include changes from energy cost to the regulatory environment. Simpler cross-border and even in-market consolidation could be welcome in that regard. While the discussion has focused so far on potential negative implications on price and other elements of consumer welfare, the long-term implications for consumers and workers of under-investment come to the fore too rarely.

In the past, Europe has mastered a model of stability and “industrial excellence”. But the world has changed, and Europe must adapt. The coming decades will increasingly be about scale and speed in technology and technology-enablement. This requires new approaches. In the U.S., the so-called “magnificent seven” giant technology firms put up as much R&D funding as half of all of Europe’s public and private R&D spend combined. To step up, a public-private approach will be required. One way could be to deploy at scale EU-wide publication innovation procurement to leapfrog in technology areas where Europe has strengths, such as quantum computing, solid state batteries, or AI in healthcare. More risk capital will also be needed, as venture capital assets under management are only a quarter of those in the U.S. Consolidating pension funds and enabling them to allocate more of their assets to fund high-growth firms could make a difference.

For firms both old and new to rise to global competition, they will need to scale up, fast. That requires completing the single market and harmonising rules — admittedly a long-term project. More immediately, Europe could concentrate on devising a 28^th regime of common investment-friendly business rules. This framework would need to be bold and broad, covering areas from labour to taxation to permitting.  To reduce policy competition with national rules, it could be made applicable only to innovative firms that need to scale up fast.

In essence, to leave a real mark on competitiveness, European decision makers might focus on one simple question for every decision they discuss: will it unleash investment?

This article is a contribution from a member or partner organisation of Friends of Europe. The views expressed in this #CriticalThinking article reflect those of the author(s) and not of Friends of Europe.