In an increasingly digital world, technological prowess has become synonymous with economic might and geopolitical influence. As the United States cements its position as the world's dominant financial and technological power, and China rises as a global manufacturing hegemon, Europe finds itself at a crossroads, grappling with a pressing question: What is its economic leverage in this new landscape?
This question lies at the heart of a recent report by former European Central Bank President Mario Draghi, which paints a sobering picture of the European Union's economic future. Draghi argues that the EU faces significant economic challenges that could soon render the bloc irrelevant on the global economic stage. While this assessment may seem alarmist at first glance, a closer examination of economic data from the US, China, and Europe reveals that Draghi's analysis is indeed on point.
The Root Causes of Europe's Tech Lag
Structural Challenges
The causes of Europe's economic woes are deeply rooted in structural issues. Two key factors determine long-term economic prospects: demographics and productivity growth. Unfortunately, the EU is underperforming in both areas.
Demographic Decline
Europe's demographic outlook is particularly concerning. Due to persistently low fertility rates, the EU's workforce is projected to shrink by approximately 2 million workers annually by 2040. This demographic decline will have far-reaching consequences, particularly in financing the growing costs of public healthcare and pensions as the population ages.
Lagging Productivity
Productivity growth in the EU has been lackluster, averaging a modest 0.7 percent per year since 2015. This figure is less than half the US rate and a mere fraction of China's reported growth. To put this into perspective, Draghi's report notes, "In 1995, U.S. and EU productivity was broadly similar. Today, Europe's productivity is about 20 percent below America's".
The Innovation Gap
While economists have long debated the various factors contributing to Europe's sluggish productivity, one stands out as a primary driver of the growing productivity gap between the US and EU economies: insufficient investment in research and development (R&D).
The disparity in R&D spending is stark. In 2022, US R&D expenses totaled $886 billion, or 3.4 percent of GDP. In contrast, EU spending amounted to just $382 billion, or 2.3 percent of GDP. This significant difference in investment is giving the United States and China the means to succeed in the global transition toward high-tech, digitalized economies, while the EU lags behind.
The Consequences of Underinvestment
The repercussions of Europe's underinvestment in technology and innovation are far-reaching and multifaceted.
Brain Drain and Startup Exodus
One of the most visible consequences is the exodus of European talent and startups to more favorable ecosystems. As Draghi's report highlights, "Of the 147 unicorns (start-ups whose value stands above $1 billion) that have emerged in the EU since 2008, about one-third eventually relocated abroad, mostly to the United States, often because they could not find sufficient financing in Europe to grow their operations".
Falling Behind in Frontier Technologies
Europe's underinvestment is particularly evident in frontier technologies such as artificial intelligence (AI) and quantum computing. The data is alarming: "More than 80 percent of global AI funding goes to U.S. or Chinese firms compared with just 7 percent to EU businesses". Similarly, in quantum computing, seven of the top ten global firms are US-based, two are Chinese, and one is Japanese – none are European.
Proposed Solutions and Challenges
Draghi's Call for Massive Investment
Recognizing the severity of the situation, Draghi's report calls for a financial "electroshock" to boost R&D spending. His team of economists estimates that the EU needs to invest an additional 750 to 800 billion euros annually to close the gap with the United States and prevent falling further behind its competitors.
However, this proposed investment push faces significant hurdles. The private sector alone cannot shoulder such enormous costs, and public funding on this scale would require unprecedented levels of EU cooperation and joint borrowing.
Alternative Approaches
While Draghi's call for massive investment may go unheeded, the EU still has options to boost innovation spending without incurring additional costs. Two key areas for improvement are:
Addressing fragmented public funding across EU member states and sectors
Tackling the relative scarcity of private venture capital in Europe
Unified Funding Strategy
To combat fragmentation, the EU could create a centralized structure to identify and fund priority sectors. This approach would involve transferring responsibility to EU institutions to determine which sectors should receive public R&D funding, fostering a more coherent EU financing landscape.
Attracting Global Venture Capital
By streamlining regulations and creating a more favorable environment for startups, the EU could become more attractive to global venture capital funds. Since 2013, approximately five times more venture capital has flowed into US startups compared to European ones. Closing this gap is crucial for nurturing homegrown innovation.
The Stakes and the Path Forward
The consequences of inaction are severe. Without a significant overhaul of EU innovation financing, Europe risks falling further behind the United States and China in the global race for economic power, technological prowess, and geopolitical relevance. Moreover, sustaining Europe's generous social model will become increasingly challenging without robust economic growth.
As Agathe Demarais, a columnist at Foreign Policy, aptly puts it, "Tackling Europe's productivity gap should be at the top of the to-do list of the new European Commission". While the proposed massive investment boost may not materialize, the EU still has avenues to enhance productivity growth and maintain its relevance on the global economic stage.
The path forward requires a multifaceted approach:
- Streamlining regulations to create a more business-friendly environment
- Fostering closer collaboration between academia and industry
- Investing in education and skills development to build a workforce ready for the digital age
- Encouraging risk-taking and entrepreneurship through targeted incentives and support programs
Europe stands at a critical juncture in the global tech race. While the challenges are significant, they are not insurmountable. By addressing structural issues, increasing R&D investment, and creating a more unified and agile approach to innovation, the EU can close the gap with its competitors and secure its place in the digital future.
The time for action is now. As the global economy continues to evolve at a rapid pace, Europe must adapt and innovate to thrive. By leveraging its strengths – a highly educated workforce, strong institutions, and a rich history of scientific achievement – and addressing its weaknesses, the EU can reposition itself as a formidable player in the global tech landscape.
The race is far from over, but Europe must pick up the pace to avoid being left behind in the dust of technological progress.
