The Strategist

Draghi report: EU faces existential threat without reforms and investment

As the world's most competitive economy to date, the European Union has a problem: its main competitors, China and the US, no longer want to play the game. In his report "The future of European competitiveness", Mario Draghi, a grandee of EU politics who, as former head of the European Central Bank, is credited with saving the euro, analyses Europe's economic vulnerability and advises the EU to take massive steps towards reform - a summary.

Date
Auteur
Dominique Stutz, LGT
Temps de lecture
10 minutes

Mario Draghi
© Shutterstock

For decades, Europe has faced a creeping erosion of its competitiveness. The economic decline is not a sudden development, but the result of a sustained decline in productivity that has been observed since the turn of the millennium. For most of this period, however, the slowdown in economic growth was not perceived as dramatic. After all, Europe's export industry was still able to gain market share in fast-growing parts of the world - especially in Asia, more women were entering the labour market, unemployment had fallen after the crises of 2008 to 2012 and Europe had benefited for a long time from a favourable global environment. But the era of free global trade and rapid growth seems to be over. The EU now faces stronger and new competitors, less access to global trade and the loss of its main energy supplier, Russia.

A key factor highlighted in Draghi's report is Europe's lack of innovation. While new tech giants are constantly emerging in the US and China, Europe remains stuck in traditional industries with no significant start-ups that could revolutionise the market. A striking example: no EU company with a market capitalisation of more than euro 100 billion has been created from scratch in the last 50 years, while all six US companies with a valuation of more than euro 1 trillion have been created in the same period.

According to the former ECB chief and former Italian prime minister, the EU must change radically if it is to continue to guarantee its fundamental values of prosperity, justice, freedom, peace and democracy in a sustainable environment through growth and productivity and thus preserve its raison d'être. The solution, according to Draghi, is a new industrial strategy that should increase public and private investment by 800 billion euro - or 4.7% of total euro area GDP - per year and thus boost growth. At the heart of his policy recommendations and their financing is the idea of joint EU-bonds.

Three main areas for action to reinvigorate growth

The report structures its recommendations around three main areas: innovation, decarbonisation and security. It argues that these areas are inextricably linked, as technological innovation can only succeed if it is built on a sustainable and secure economic foundation.

1. Closing the innovation gap

Nowhere is Europe lagging behind more than in the technology sector. While the US and China are leading the way in the digital sector, Europe is lagging behind. For example, of the world's top 50 technology companies, only four are European. The report highlights the urgent need for Europe to catch up in future technologies such as artificial intelligence (AI) and quantum computing.

There is no lack of ideas or ambition in Europe or the EU. But innovation at the next level is being held back by inconsistent and restrictive regulation. Against this backdrop, almost 30% of unicorn start-ups founded in Europe and later valued at more than USD 1 billion have moved their headquarters abroad - the vast majority to the US. The report highlights the need for Europe to better fund its tech start-ups and provide them with an environment in which they can grow. One way of doing this is to harmonise EU capital markets so that European companies are no longer forced to look to the US for investors.

The funding of research and innovation in the EU is highly fragmented: While the US manages much of its innovation spending centrally at the federal level, in the EU only around a tenth of research and innovation spending is coordinated at the Union level, leading to an inefficient allocation of resources. In addition, EU companies specialise in mature technologies and spent euro 270 billion less on research and innovation in 2021 than their US counterparts. The top 3 investors in research and innovation in Europe over the last 20 years were automotive companies. This was also the case in the US in the early 2000s, along with pharmaceuticals. Today, however, the top 3 investors in the US are all in the technology sector.

2. Decarbonisation as an opportunity and a challenge

Decarbonisation and competitiveness must go hand in hand - this is one of the key messages of the report. Europe's energy crisis, exacerbated by the loss of Russian gas supplies, has shown that dependence on fossil fuels is unsustainable. Although energy prices have come down from their highs, they remain two to three times higher than in the US. Global decarbonisation is a growth opportunity for the EU industry. The EU is a world leader in clean technologies such as wind turbines, electrolysers and low-carbon fuels, and more than a fifth of the world's clean and sustainable technologies are developed here.

In the short term, the report suggests reducing energy prices through targeted reforms and expanding renewable energy. In the long term, the EU should strengthen its leadership in green technologies, in particular by investing in wind power, electrolysers and sustainable fuels. However, competition from China, which dominates through massive subsidies and control over raw materials, is intensifying. An uncoordinated approach in the EU could leave Europe behind.

3. Security and reduction of dependencies

The third pillar of the strategy concerns Europe's economic and geopolitical security. Here the report makes a worrying diagnosis: Europe is heavily dependent on other countries, especially China, in many strategic areas - from critical raw materials to digital technologies. These dependencies are more risky in an increasingly multipolar world, as recent geopolitical crises have shown.

The foreign trade strategy should aim not only to conclude new trade agreements, but also to secure the supply of critical raw materials, for example by building up stocks and promoting recycling technologies. In the technology sector, Europe must also reduce its dependence on Asian chip suppliers and develop its own semiconductor production - a project that the EU Chips Act is intended to promote.

Peace is Europe's first and foremost objective. Physical security threats are on the rise. While the EU as a whole is the second largest military spender in the world, it also has a fragmented defence industry. For example, Europe operates twelve different types of battle tanks, while the US produces only one.

Proposals that can be implemented quickly

Most of the proposals are not intended to be aspirations, but are designed for the various key sectors to be quickly implementable. In the automotive sector, for example, it is stressed that Europe can only maintain its leading role if it accelerates the transition to electromobility while strengthening the circular economy. The role of IPCEIs (Important Projects of Common European Interest) in promoting transnational projects is highlighted. Another example of his proposals from the technology sector is how the EU can catch up in the field of semiconductors: In the short term, European companies should be given more support for research and development, while in the medium term the production of high-end semiconductors must be established in the EU to reduce dependence on Asian producers.

A common way forward

In many areas, EU member states are already acting individually and industrial policy is on the rise. But it is clear that Europe is falling short of what could be achieved by acting as a community, says Draghi. A coordinated strategy combining innovation, sustainability and security could help Europe catch up. According to Draghi, it will be crucial for EU member states to pool their efforts and move forward together, rather than going it alone at national level, in order to avoid wasting common resources.

Thought experiments

In our view, Draghi's analysis and above all his proposals will first have to face the icy political - and typically European bureaucratic and fiscal - reality. Even if the implementation of the proposals should be positive for European assets in the longer term, it would be speculative at this stage to base investment decisions on this report. In our view, it is unlikely that EU-bonds will be issued on a large scale. Until the plans are finalised at the political level, we prefer to take a closer look at key fundamentals such as European consumption, foreign trade or manufacturing performance when making investment decisions.

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