Improving Europe’s digital and innovation performance and strengthening the Transatlantic alliance
/ By Fredrik Erixon, Director, European Centre for International Political Economy (ECIPE)
This article was originally published as part of the 2021 edition of Bled Strategic Times, the official gazette of the Bled Strategic Forum (BSF) international conference. You can access the full version of this and other BSF publications by visiting our official website.
Europe’s digital challenge is both about economic performance and geopolitics, but all too often the task to raise Europe’s digital leadership gets simplified to the point that policies aim in the wrong direction. Lately, there has been a lot of talk about Europe’s dependency on the United States and others for advanced digital technologies, and several national capitals — along with Brussels — have developed regulations and industrial strategies to wean us off American technological leadership. Europe’s new themes are digital sovereignty and autonomy.
But Europe’s digital problem is not dependency on others: policymakers can complain all they like over Big Tech and that Europe has no big platform that could rival Google, Amazon, Facebook and Apple. All that makes little sense when the main economic problem with Europe’s digital performance is that far too few businesses, individuals and governments actually adopt the advanced technologies and services that are on offer. Europe’s lagging digital performance is not chiefly about creation — that too few digital giants carry a European passport. It is about lagging use and the slow uptake of modern technology. The economic power of innovation is not about invention, but adaptation.
There may be cultural explanations behind many countries in Europe trailing behind global technology leaders. Unlike many countries in East Asia, several European countries have been slow to move towards digital services like alternative payments because they fear an intrusion in their privacy. When Europe now develops new regulation of Artificial Intelligence, it starts from a defensive position — thinking that more regulation is better than less regulation. Even if it is unclear exactly what it is that should be regulated, Europe seems to be set to develop a permission-based approach to AI. In the US and many parts of Asia, the regulatory approach is more allowing and less burdensome.
However, the main obstacles in Europe to having digital technologies flowing through society at a faster clip are economic and not cultural. Various forms of sectoral and professional regulations, and other barriers to trade, prevent a smooth expansion across borders or between different sectors. We have a Digital Single Market — but in name only. Especially many services sectors — for instance, business services like legal and accounting service or professional services like engineering and architectural services — are all to protected along national borders and make it hard for consumers to access digitally enabled services provision from abroad. As a result, the digital intensity of European Union firms is lower than in comparable countries, like Singapore, Japan and Australia.
Business restrictive policies also prevent big entrepreneurial success in Europe. Fragmented markets and burdensome regulations push digital entrepreneurs to build or grow their enterprises in other parts of the world. For Europe, the issue is also about financial policy: are the capital market conditions good enough to motivate expansion from Europe? Notably, EU countries are already struggling to keep up with venture capital funding of digital entrepreneurship — and the gap between the EU and the US becomes wider in later-stage financing than in early-stage financing. Since 1995, it has been estimated that the US has invested 1.2 trillion US dollars in venture capital for startups, while the similar figure in Europe is 200 billion US dollars — a six-times difference. It is true that Europe has been catching up a bit with the US in recent years, but the gap remains stark. Moreover, the gap becomes even more significant in later-stage financing of growth. Europe has particularly been catching up in the financing of the growth phases of firms. In later stages, however, Europe is far more reliant on venture capital from the US and Asia. Generally, the type of later-stage funding that is the more common route for European firms is an initial public offering — that is, to go public.
The regulatory environment affects the scale-up phase in different ways. First, capital markets regulation in Europe — especially the regulation of large institutions like pension funds — makes it more difficult to generate a rapid increase in the pool of capital available to late-stage venture capital investment. Second, market restrictions (especially in services) are generally higher in Europe than in other developed economies like Australia and the United States — and those restrictions push up barriers to entry. Importantly, these competition-decreasing market regulations have a distinct effect on business churn rates and is one explanation to why it’s more difficult to grow and scale-up entrepreneurial projects and new business models in Europe.
The geopolitical consequence of a high-regulation environment is that other countries are reducing their dependence on the European market: it is no longer particularly attractive to be in the economic and technological slipstream of Europe. There are many geopolitical consequences that emerge from digitalization — and from new innovation more broadly — but perhaps the most neglected one is that Europe’s ability to shape economic outcomes globally is diminished by burdensome regulations and relatively poor economic performance. General economic conditions in the world already forces Europe to struggle with economic gravity: as other parts of the world grow richer, Europe’s share of global innovation, trade and economic output will shrink. By 2024, estimates the European Commission, 85 per cent of all global growth will happen outside the European Union.
The United States is confronting a similar scenario of relative economic decline — albeit not at the same speed as the EU — and there are good reasons for Brussels to seek closer ties with Washington, DC. There is, to start with, a geopolitical argument for it: the US remains an indispensable ally for security and peace in Europe. Moreover, Europe would benefit if the Biden administration took a less protectionist direction and started to engage with the world in trade policy, and closer Transatlantic ties could be a step in that direction. But perhaps the most important reason for closer relation with the US is that it would be a power multiplier: with America engaged and the two parties aligned, the EU can better reach its ambitions in international and economic affairs. Just like Europe, America’s commitment to an open global economy is partly challenged by unfair terms of global competition: America too is worried about being dependent on other countries for critical technologies. It is more concerned than Europe about systemic competition from China. China hasn’t made up its mind if its strategic interests are better served by a collapsing or reinvigorated liberal trade order. As a consequence, the US is in some doubt if it is in its strategic interest to revive the liberal trade order. A stronger Transatlantic relation could help push America closer to the European view.
Moreover, if Europe is true to its ambitions of arresting climate change and spurring digitalisation, it will need the support of the United States. The climate change agenda is already unleashing geopolitical tensions that Europe alone cannot manage: they will only grow bigger as Europe and others wean themselves of energy sources, goods and production technology that are carbon-intensive. Furthermore, as a good part of Europe struggles with demographic challenges and shrinking labour forces and have created an inhospitable regulatory climate for innovation and entrepreneurship in digital sectors, Europe will become a lot more dependent on foreign digital creation and diffusion. Closer relations with the US will provide Europe with a better choice of access to digital technologies and businesses.
Europe’s influence on the world order depends on many factors, but two of the most important ones are its capacity to shape a new alliance with the US and other like-minded countries and improve its digital and innovation performance.