Can Europe create an innovation economy?

PARIS – In the three decades after World War II, Western Europe caught up with the United States in terms of per capita GDP. But since the mid-1990s, this trend has reversed, with the US growing twice as fast as Europe.

What happened? The explanation is simple: During the Trente Glorieuses (the 30 years until 1975), Western European policies favored a model of growth based on imitation and accumulation. These countries were playing catch-up, and the process was facilitated by unlimited access to fossil fuels (until the first oil shock of 1973-74); the US Marshall Plan, which helped Western Europeans reconstitute their capital stock; and educational systems favoring the absorption of new technologies from the US.

But there comes a time when the growth potential of imitation and accumulation exhausts itself. Once you have gotten sufficiently close to the technological frontier, innovation necessarily becomes the main engine of growth. That has certainly been the case in the US, where the information-technology revolution, and now the artificial-intelligence revolution, developed quite spectacularly. In Europe, however, policymakers failed to adopt the institutions and policies to promote disruptive innovation.

As a result, Europe’s private-sector investment in research and development is only half that of the US. This is primarily due to a composition effect. Europe’s R&D is concentrated in the mid-tech range, which absorbs more than 50% of private R&D, with the automotive industry accounting for roughly one-third, even though it generates few breakthrough innovations. By contrast, 85% of private R&D in the US is in more R&D-intensive and higher-return (incidentally) areas such as biotech, software, hardware, and AI.

Private R&D in Europe also suffers from EU fragmentation. Across 27 member states, there are 27 different labor laws, sets of procurement rules (very little public procurement is centralized at the EU level, unlike federal procurement in the US), securities regulators, electricity and pharmaceutical regulators, and so forth.

Moreover, European startups suffer from the absence of a true capital-market union. Europe has nothing comparable to the Nasdaq; it lacks America’s dense network of venture capitalists to finance new innovative projects; and, save for a few national exceptions (Sweden, Denmark, and the Netherlands), its institutional investors (pension funds and mutual funds) are less willing to take the risks associated with radical innovation. While European household savings are plentiful, they are mostly channeled to low-risk projects or public securities.

European public-sector support for innovation also leaves much to be desired. In the US, public R&D funding is concentrated at the federal level, whereas public funding in the EU happens mostly at the member-state level. As is well known, the EU is a regulatory giant, but a budgetary dwarf (with a total budget of around 1% of the bloc’s GDP). Given the scale of today’s challenges, which require economy-wide green and digital transitions, this is a huge handicap.

Moreover, as far as public institutions are concerned, nothing in Europe resembles America’s Advanced Research Project Agencies. By delegating decision-making and project management to top scientists, the ARPAs have helped the US government continuously stimulate disruptive innovation in strategic sectors. Among the famous successes associated with this strategy are GPS, the internet (derived from Arpanet), and the COVID-19 mRNA vaccines.

The mRNA vaccines are a shining example of “competition-friendly industrial policy.” When COVID-19 emerged, the Biomedical Advanced Research and Development Authority (BARDA) concentrated its funding on three technologies, with two projects (one US, one European) per technology. All six ended up being approved by the US Food and Drug Administration and the European Medicines Authority in record time. Interestingly, the two main winners, the US firm Moderna and the German firm BioNTech, were small biotechs, and only one project originated from a pre-pandemic global leader in vaccines (a Sanofi-GSK partnership).

This example offers a template for a successful European industrial policy. The US model delegates scientific decision-making to top scientists, does not pretend to know which technologies will work, and offers no incumbency advantage. Such features make it a promising remedy to many of the serious deficiencies in the European innovation ecosystem that former European Central Bank President Mario Draghi highlighted in his recent report on EU competitiveness.

Draghi proposes massive public and private investments in fundamental research and disruptive technologies, as well as reforms to EU governance aimed at streamlining decision-making, loosening regulatory constraints, and putting scientists and entrepreneurs in charge.

Europe urgently needs to create the conditions for promising new innovators to emerge. Absent any change in its economic doctrine – under which regulation largely prevails over investment – Europe runs the risk of suffering an irremediable decline. The Draghi report shows the way out of this economic death spiral. But first, its message on governance must be fully absorbed.

Philippe Aghion is a professor at the College de France, INSEAD, and the London School of Economics.

Mathias Dewatripont is Professor of Economics at the Université Libre de Bruxelles (I3h and Solvay Brussels School).

Jean Tirole, a Nobel laureate in economics, is a professor at the Toulouse School of Economics.