Draghi report on Europe’s competitiveness falls short

Daniel Gros is director of the Institute for European Policymaking at Bocconi University.

How to improve European competitiveness?

According to former Central Bank President Mario Draghi’s long-awaited assessment, Europe can address its relative decline via a long list of economic reforms and a huge investment boost to be financed — at least partially — by common debt. And now that the report is out, it’s up to the new European Commission to drive this agenda forward.

Starting from the transatlantic divide in productivity — due to the weakness of the EU’s high-tech industry — Draghi’s report recognizes that European enterprises are caught in a “middle-tech trap.” A term coined here, at the Institute for European Policymaking at Bocconi, this means that most large EU companies are in middle-tech sectors and remain languishing there because they don’t want to leave the field they know. The current travails of the German automotive sector, for example, clearly illustrates how this is a losing strategy.

The report also shows that while the European economy has actually performed just as well as the U.S. outside of high-tech sectors, information technology, and communications, radical innovation is much weaker here, and has thus resulted in very few highly valued start-ups — so-called unicorns.

And so, in response, Draghi proposes a number of small but significant steps to strengthen innovation — like the creation of a European equivalent to the U.S. Defense Advanced Research Project Agency, which has been credited with fostering key innovations like the internet.

However, most of the report isn’t really about fostering innovation or the emergence of new industries. And where it is, it falls short.

Rather than innovation, Draghi focuses on the defense of existing industries against Chinese competition. And though he does propose spending huge sums — it’s not on new high-tech sectors.

The industrial policy — or “industrial vision” as he calls it — centers on the green economy with its “joint decarbonization and competitiveness plan.” But this is unlikely to work. Achieving the EU’s ambitious climate targets requires lowering the cost of known technologies like solar panels, wind turbines and batteries, however, the EU is unlikely to ever beat China at this game.

It thus makes sense that Draghi recommends abandoning such sectors where China’s cost advantage is too big — even if due to subsidies.

He does, however, consider the automotive industry, and potentially many other clean-tech sectors, too important to expose to unfettered Chinese competition. So, first, Draghi recommends tariffs to defend domestic producers, then — if China starts to invest in Europe — moving on to measures to enforce a transfer of technology.

This is the exact approach used by China and that the EU has always criticized. Moreover, protecting clean tech at home is unlikely to generate a competitive industry, as the scale economies can only be reaped on the global market where there are no protections for EU producers.

This also applies to the headline figure of €800 billion in additional annual investment that Draghi believes is required. The overall figure is poorly documented, with just one short table (relegated to page 282 of part two) showing that €450 billion — or over one half of the total — should be earmarked for the energy transition, and the remainder for digital, defense and innovation. And while supporting the energy transition is necessary, a large part of the remaining financing need actually comes from the residential sector, which is rather low tech.

Furthermore, even though there’s an implicit call to spend €300 billion annually on digital and innovation in this table, there’s absolutely no indication as to what kind of projects or programs should be financed. Apart from scattered allusions to the need for subsidies, the only concrete indication is a throwaway line from earlier in the report, stating the funds for the European Research Council should be doubled. However, this would cost €3 billion, not €300 billion.

Overall, Draghi’s report has been well received in the Brussels bubble. But that’s because when somebody recommends spending €800 billion, nobody’s looking at the fine print.

So far, most discussions have revolved around who would favor common debt and who would be against it — and in this regard the initial reactions from various capitals were predictable. But the question of what exactly the common debt should finance, and how it would foster innovation has been sidelined — especially as there’s so little material on this in the report.

Having asked for the report in the first place, the Commission got what it expected. Some of its recommendations even appear in the mission letters that Commission President Ursula von der Leyen addressed to the commissioner candidates — especially on competition and trade policy.

And for a geopolitical Commission, it’s of course greatly attractive to obtain more latitude for its decisions on mergers and state aid rather than pursuing the unpopular task of constantly saying no to member states and large companies that want to dominate certain markets.

However, whether this approach will actually foster European competitiveness remains to be seen.