Too Much Bureaucracy, Too Little Investment

“Insanity is doing the same thing over and over again and expecting different results”. Whether or not Albert Einstein ever uttered the phrase, it neatly captures Europe’s economic debate. To break the cycle of economic stagnation and low investment, the EU needs a decisive break from the status quo. A reduction in corporation tax offers the most effective lever to reverse Europe’s economic underperformance.

Europe’s investment shortfall is hardly a new concern. Mario Draghi placed it at the heart of the competitiveness debate. The connection between investment and competitiveness is clear: a lack of investment acts as a brake on innovation, condemning the continent to mediocre productivity and economic growth.

Across the Atlantic, the American economy is enjoying an investment boom, driven by the surge in artificial intelligence and the infrastructure that makes it possible – cloud computing, semiconductors and software. Yet this is not a recent phenomenon. Between 2005 and 2022, the cumulative investment gap between the five leading US technology firms and the twelve largest European players in telecommunications and cloud infrastructure exceeded $1.36 trillion. In 2023 alone, America’s services sector spent four times as much on R&D, relative to GDP, as its counterpart in the EU.

How can Europe regain its economic footing? The prescription in the Draghi Report is more public investment. He estimates that the EU requires an additional €800 billion in annual investment, equivalent to increasing the bloc’s investment share of GDP by around 5 percentage points per year.

However, before policymakers hatch up plans to issue fresh common debt, it is prudent to evaluate the current exercise of joint borrowing: the NextGenerationEU (NGEU). Although the funds run until 2026, there are already some studies evaluating its effectiveness. The European Central Bank (ECB) estimates that between 2021 and 2023, the Recovery and Resilience Facility (RRF) – the NGEU’s centrepiece – increased the euro-area GDP by 0.1 to 0.2 per cent, short of the 0.5 per cent originally anticipated.

The ECB identified the factors behind this shortfall. Some were (more or less) exogenous, such as the erosion of real purchasing power caused by the inflation shock of 2022–2023. Others, however, are symptomatic of the EU’s deeper economic malaise: a scattered strategic focus and, crucially, the public sector’s limited capacity to execute the programme.

NGEU has scored some good successes, particularly in infrastructure. However, as the ECB’s analysis lays bare, the aggregate impact has been worse than expected. Too often, projects have yielded mediocre or low economic impacts, or public funds have simply displaced private investment that would have happened regardless. In other cases, rigid eligibility criteria have skewed incentives, nudging companies towards investments and technologies that qualify for public subsidies rather than those best suited to the companies’ interests.

Behind the debate on public investment lies a more fundamental question. Why is public investment needed to stimulate private investment? What prevents EU companies from deploying this capital themselves? The headwinds are familiar: economic uncertainty, and high energy, financial and regulatory costs. Together, these factors erode the expected return on capital. While European governments should undertake policies to reduce these costs, such reforms will take years, and success is far from guaranteed.

A far more direct route to increase EU investment is to cut corporation tax. It is hardly a secret that profit drives capital allocation. The greater the after-tax return, the stronger the incentive to produce more, and producing more requires more capital. By lowering the corporate tax bill – either through the headline rate or the tax base – governments can instantly lift corporate profits and the yield on future investment projects.

The risk is, however, that such a reduction in corporation tax ends up flowing into dividends rather than funding new projects. To prevent this drift, the most reliable approach is to expand – and simplify – tax allowances for new equipment and technology. Such incentives already exist in many European countries. Yet their complexity renders them ineffective and dilutes their impact. The good news is that policymakers don’t need not reinvent the wheel; they must simply steer it better. That means radical simplification: offering clear, accessible incentives that allow investments in tangible and intangible capital to be deducted from the corporate bottom line.

This approach offers clear advantages. Empowering firms to decide for themselves where to invest would be far more efficient. Capital would flow to the locations, products and research that markets identify as genuinely strategic, rather than to those pre-selected by administrative criteria. Crucially, this model cuts the public middleman, eliminating the bureaucratic constraint that has hampered the NGEU funds.

Nor does this policy shift need to be expensive. Tax incentives can be designed to ensure that the forgone revenue matches the sums the state would have otherwise spent on direct subsidies for companies. Replacing public grants with tax relief could keep the net cost to the public purse unchanged. The upside could be a virtuous circle of higher investment and lower bureaucracy – a double dividend that Europe’s economy sorely needs.