Draghi Review Must Deliver a New Start for Europe’s Underperforming Tech Sector

James Watson is a former Chief Economist at BusinessEurope, Senior Economic Adviser to the UK government, and Commission economist.

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By Brussels standards, commented Politico, it was the ‘smash hit of the season’. The prospect of meeting 70 leaders from ‘basic industry sectors’ had brought European Commission President Ursula von der Leyen to BASF’s enormous Antwerp chemical works in February, to receive their declaration calling for an ‘industrial deal’.  With EU elections looming in the Spring, the business leaders could leave with confidence that industrial competitiveness was finally back on the agenda.

But global financial markets had a very different focus. Chip producer Nvidia was about to release its Q4 2023 results, a key indicator of the rapidity with which tech companies were investing in their AI capability. The results exceeded expectations, with Nvidia’s revenue up over 260% from a year previous. With Q2 growth similarly exceptional, by June, Nvidia had become the world’s most valuable company; its valuation of over 3$ trillion exceeding the valuation of stock markets in France, Germany and the UK, according to Deutsche Bank research.

With Mario Draghi’s report on the future of European Competitiveness, due in the coming weeks, expected to help set the direction of economic policy in the new political cycle, these are crucial times for long-term EU prosperity. How the former ECB President will balance the demands of the EU’s traditional industrial power houses such as Germany, France and Italy, against those, Member States, particularly in Scandinavia and the Baltics, with a greater focus on emerging technological sectors, will be a key question.

Whilst most Brussels policy makers are aware that Europe has a technological gap with both the US and China, the rapidly increasing magnitude of the gap, and the consequences it will have for both the EU’s  growth and security, if continuing to be left unchecked, seem vastly underestimated.

ICT producers and services companies together account for 44% of global R&D, according to the Commission’s 2023 R&D Scoreboard, with the US tech giants Alphabet, Meta, Microsoft and Apple occupying the top 4 global spots for company R&D, followed by China’s Huawei. And with recent company releases suggesting 30% average increase in R&D between 2021 and 2022 by Alphabet and Meta, it should be clear that the dominance of the tech sector in global R&D is gathering steam.

In contrast, the chemicals sector accounts for just 2% of global R&D, with a further 5% coming from industrials (such as metals). Thus, whilst traditional industries will continue to provide crucial jobs and economic activity in many communities, their ability to apply new technologies will be a key factor for a successful transition to a greener economy, we nevertheless risk overestimating their scope to drive growth and innovation on broader scale.

Further evidence of the importance of the technology sectors to EU competitiveness can be found in the productivity data. ECB analysis shows that productivity growth in the ICT sector was stronger than other sectors between 1996 and 2017, in both the EU and the US. But the vastly superior performance of the US ICT sector, with cumulative growth over 320% compared to around 80% in the EU, when combined with the greater relative size of the sector in the US, accounts for much of the productivity gap between the two regions in recent years.

Draghi’s speech in April at the conference on the European Pillar of Social Rights, set out a strong narrative of how ‘other regions are no longer playing by the rules and are actively devising policies to enhance their competitive position’. His suggestion that the EU, lacks a strategy to ‘shield our traditional industries from an unlevel global playing field caused by asymmetries in regulations, subsidies and trade policies’, could be seen as preparing the ground for a new era of EU subsidies and protectionism.

But the EU will need to think carefully how it defines its strategic dependency, and the extent to which it seeks to protect industries. As the IMF has argued, support to specific sectors is only likely to deliver productivity and welfare gains under specific conditions; targeted sectors must generate measurable social benefits, such as lower carbon emissions or knowledge spillovers, policies must not discriminate against foreign firms, and governments must have the implementation capacity. Ultimately, as IFO’s Clements Fuest has suggested in relation to German industry, with much of the EU needing to adapt to a changed energy price, following the end of access to cheap Russian gas, some migration of energy-intensive industries may be inevitable.

Leaders must also look much broader than their present focus on semiconductor production, when they consider the technological capability necessary for so-called strategic autonomy.  As Olivier Coste has argued in his insightful book, ‘Europe, Tech and War’, and as we are seeing in Ukraine, whilst power in the first half of the 20^th century was based on steel production, in the coming years, our capabilities around electronic and artificial intelligence, drones and satellites will all be crucial.

The EU would do well to adopt many of the broad ideas set out in the Antwerp declaration, particularly around addressing regulatory incoherence, unnecessary complexity in legislation and over reporting. Moreover, as the declaration also suggests, its overall competitiveness would benefit from a stronger EU energy strategy, making use of EU funds to deliver cross-border infrastructure to help deliver, in the words of the declaration, ‘abundant and affordable low carbon renewable and nuclear energy’. These and other ideas to deepen the single market, and in particular, to strengthen the capital markets union, were given a boost by Enrico Letta’s recent report.

But simply delivering on past promises will not be enough to ensure the step change needed to boost Europe’s underwhelming technology sector.

For example, Coste also makes a convincing case that labour regulations are making it all but impossible for companies to invest in technological projects, which are by nature high-risk. Whereas US based companies are able to start and shut down project teams almost at will (as we saw when large US tech companies laid off workers in 2023), he calculates the cost of time taken for consultations, as well as redundancy payments add up to €200,000 per engineer. Whilst Europe can compete in areas of incremental innovation where consumer markets are more mature and projects less risky (e.g. 4G to 5G telecoms), for tech projects which on average, have a success rate of just 20%, the numbers simply don’t add up to invest in most EU countries.

Moreover, across the economy, companies’ ability to maintain global competitiveness will be increasingly dependent upon their success in adopting productivity enhancing AI. But with even the most optimistic AI advocates recognising the labour market displacement such investment gives rise to, and history suggesting organised labour rarely accepts such change quietly, we need to see a proper reflection on the ability of Europe’s model of social partnership to deliver such radical transformation.

It is time for Europe to get real about the consequences of losing further ground in the technology sector. It will not be easy, but nobody can rival Super Mario’s stature within the EU to provide the jolt to leaders that is needed to get policy moving.