Europe at a Crossroads

Former Italian Prime Minister and former President of the European Central Bank Mario Draghi’s recently released report on the future of European competitiveness (the Report) delivers a sobering assessment of Europe’s declining economic position. Once the global powerhouse, Europe now lags behind the United States and China in areas critical to long-term growth, like innovation, digitalization, and business scalability. Indeed, as the United States and China continue to outpace Europe amidst new technological transformations like artificial intelligence, the Report attempts to provide a policy framework to get Europe on track. However, while the Report accurately captures how Europe’s productivity gap stems from a lack of innovation facilitated by flawed competition policy, the solutions it puts forward represent a mixed bag toward achieving the twin goals of spurring European innovation and countering the techno-economic challenge posed by China.

Europe’s Productivity Gap

According to the Report, “a wide gap in GDP has opened up between the EU and the US, driven mainly by a more pronounced slowdown in productivity growth in Europe.” Specifically, while “EU labor productivity converged from 22% of the US level in 1945 to 95% in 1995…labour productivity growth has subsequently slowed by more than in the US and fallen back below 80% of the US level.” Indeed, not only has this decline in productivity growth come at the expense of European living standards, as “real disposable income has grown almost twice as much in the US as in the EU since 2000,” but also Europe’s global position. That is, in the words of current Italian Prime Minister Giorgia Meloni, “[i]n 1990 the EU of 12 states made up 26.5pc of world GDP. Today the EU of 27 states makes up 16.1pc, while the US is still at 26pc. We were a big weight in the world but that is no longer the case.”

Innovation and Growth

What are the causes of declining productivity growth in Europe compared to the United States? Here, the Report explicitly confirms what many have long suspected:

The main reason EU productivity diverged from the US in the mid-1990s was Europe’s failure to capitalise on the first digital revolution led by the internet – both in terms of generating new tech companies and diffusing digital tech into the economy. In fact, if we exclude the tech sector, EU productivity growth over the past twenty years would be broadly at par with the US.

This conclusion is consistent with what has long been the conventional wisdom regarding the relationship between innovation and economic growth. As ITIF’s President Rob Atkinson has explained, “[m]any studies that attempt to account for the various sources of growth in productivity and per capita income have found that technological change (i.e., innovation) plays the key role.” And, as the Draghi Report emphasizes, Europe is already well behind in the new and emerging technologies with “70% of foundational AI models have been developed in the US since 2017 and just three US ‘hyperscalers’ account for over 65% of the global as well as of the European cloud market,” and none of the ten leading quantum computing firms based in the EU, in contrast with five in the US and four in China.

Competition and Regulation

But why has innovation lagged in Europe? Echoing French President Macron’s remarks in a speech at the Sorbonne earlier this year that Europe must “take responsibility for the evolution of competition policy” and specifically the “ordo-liberal model of competition,” the Draghi report addresses not only the barriers to innovation posed by bureaucracy and regulation, but also the “question of whether vigorous competition policy conflicts with European companies need for sufficient scale to compete with Chinese and American superstar companies.” The Report notes that “the lack of innovation in Europe is sometimes blamed on competition enforcement,” especially regarding merger enforcement. Specifically, the Report highlights the importance of Schumpeterian scale-driven dynamic competition toward promoting the investment incentives that advance innovation, which, as ITIF has made clear, “captures the essence of the American technology success story.”

Rethinking Fair Competition

The Draghi Report is undoubtedly a major step in the right direction. But unfortunately, its recommendations for competition policy remain a mixed bag. First, the Report doubles down on the EU’s traditional focus on “fair competition” and the protection of “European consumers and businesses,” and only seeks to incorporate “innovation and future competition” into this framework. To do so, the Report argues that “stronger competition will in theory generally…foster innovation,” which aligns with the Arrowian view that—contrary to Schumpeter—deconcentrated market structures spur innovation. However, as ITIF has argued, that is a mistaken approach:

…numerous studies across many economies around the world continue to confirm that the relationship between concentration and innovation often takes the form of an inverted-U, where markets characterized by many firms demonstrate less innovation than markets with a few firms, and markets with a few firms exhibit more innovation than those characterized by monopoly.

Mergers and Agreements

The recognition of the importance of ensuring that competition law promotes Schumpeterian dynamism is most clearly evinced in the Report’s recommendations regarding concerted practices like mergers and joint development agreements. For example, the Report calls for updated merger guidelines that provide an “innovation defence” which “merging parties can present to prove that their merger increases the ability and incentive to innovate.” Similarly, the Report notes that “horizontal cooperation agreements and concerted practices are sometimes necessary to achieve R&D investment” and calls for a “streamlined process that groups of EU industries can follow to work together to reach scale when it would benefit consumers.”

Unilateral Conduct

In contrast to concerted action, in the area of single firm behavior and exclusionary conduct, the Draghi Report seems deferential to the status quo. That is, the Report calls for “[i]ncentivising the adoption of open access, interoperability, and adherence to EU standards through State aid and other competition tools,” and specifically states that “[i]mportant advances in promoting open access and interoperability in digital markets have been achieved through the DMA.” Indeed, the Report recommends not just “strong enforcement of the DMA provisions” but even “new requirements involving open access and interoperability.” However, not mentioned by the Report are the already demonstrable harmful effects caused by the DMA on European consumers, businesses, and innovation.

Conclusion

To again quote Prime Minister Meloni, the Draghi Report is confronted by a reality where “America innovates, China replicates, Europe regulates.” Indeed, the Report is clear that:

[t]he EU’s competitiveness is currently being squeezed from two sides. On the one side, EU companies are facing weaker foreign demand – especially from China – and rising competitive pressures from Chinese companies.… On the other side, Europe’s position in the advanced technologies that will drive future growth is declining.

In the face of these twin challenges, ITIF has argued that Europe should pursue not just a competition policy that prioritizes innovation and Schumpeterian competition, but also Atlanticism and, in particular, a new “G2” with the United States to counter China. Without question, the Draghi Report is an influential wake-up call for European policymakers as to how ordoliberal and structural competition policy can stifle innovation and ultimately harm European productivity growth and competitiveness. However, while the Report’s recommendations surrounding agreements and mergers generally further the goal of a pro-innovation competition framework, its doubling down on the DMA and the consequent targeting of America’s leading digital firms risks stifling innovation as well as creating unnecessary tensions in the vital U.S.-EU relationship that is necessary for the West to prevail amidst a rising China.