Long-term competitiveness and innovation can preserve the best of Europe

#CriticalThinking

Picture of Solveigh Hieronimus
Solveigh Hieronimus

Senior Partner at McKinsey & Company, Co-Lead of McKinsey’s global Center for Government (MCG) and Member of the McKinsey Global Institute Council

In her 2022 State of the Union speech, European Commission President Ursula von der Leyen highlighted the need for an enabling-business environment and a workforce with the right skills as two of the keys to preserving Europe’s social market economy. She called for the obstacles that hold small companies back to be removed.

The focus on business and skills was welcome. New McKinsey Global Institute (MGI) research, published in its ‘Securing Europe’s competitiveness: Addressing its technology gap’ report, suggests that this focus needs to be sustained if the slow-motion crisis of corporate competitiveness is to be addressed.

Europe has many high-performing companies but, on average, large firms with €1bn of revenue or more lag behind competitors in other major regions. Between 2014 and 2019, these European corporations had 20% lower returns on capital, grew revenue 40% slower and spent 40% less on research and development (R&D) than their competitors in the United States.

Why? A large part of the answer is that companies are underperforming their counterparts in two sectors—information and communications technology (ICT) and pharmaceuticals—that rely on cutting-edge technology and superlative skills.

The facts are clearly a wake-up call for Europe and Europe’s leadership appears to have heeded that call

When considering frontier technologies that are permeating through every sector, the gap is broad-based. Of the ten analysed in the 2022 MGI report, Europe is falling behind on eight. For instance, the top ten major companies investing in quantum computing are in the US or China, not in Europe. In artificial intelligence (AI), investment by US corporations is six times that of their European counterparts.

In 5G, Europe has strong suppliers but lags on deployment. In clean tech, a European stronghold, the region remains ahead on patents, venture capital funding and world-class installed capacity in mature technologies. But even there, China intervened to take the lead in clean-tech production in nearly all areas and the US leads on most breakthrough technologies, including nuclear fusion.

The facts are clearly a wake-up call for Europe and Europe’s leadership appears to have heeded that call. The broad array of initiatives launched by the European Union—including the €95bn Horizon Europe programme, the Important Projects of Common European Interest framework, the Digital Markets Act and the Path to the Digital Decade policy programme to name a few—are testament to that.

But given the significant ground that Europe’s companies need to make up to be competitive, are all these initiatives, both underway and planned, big enough not only to match similar programmes in other regions but exceed them to enable catch-up? It is doubtful. The US federal budget for R&D in 2021 was $165bn, more than ten times larger than Horizon Europe’s €14bn a year.

2023 will be the European Year of Skills

As the Commission president noted, businesses need an enabling environment and large-scale measures are needed to overcome current barriers. European business deals with the fragmentation of the European market day in and day out. That is why MGI suggested the idea of a ‘28th regime’ as a common standard that high-growth firms could opt in to and operate in all European countries. The Commission’s proposal for a single set of tax rules for doing business in Europe—Business in Europe: Framework for Income Taxation (BEFIT)—shares the same spirit.

Another challenge for European companies is Europe’s smaller and less established technology ecosystems and firms. And here we come again to the issue of skills. The Commission president proclaimed that 2023 will be the European Year of Skills.

Europe has about the same number of STEM graduates as the US as a share of their respective populations, although both shares are lower than in China. But Europe is not attracting more of the talent it needs from outside. Take immigrant inventors—Europe draws about 35% of the pool against the US figure of 60%—partly because of its more limited skills-based immigration. The number of highly skilled workers who secured EU blue cards in 2018 was nearly 80% lower than the number of people given employment-based immigrant visas each year in the US.

Could Europe consider developing fast-track regulatory approval and decision-making processes?

Broadly, European companies lack scale and are hampered by relatively slow decision-making. Scale and speed are both vital in an increasingly tech-driven world. Bold ideas should be on the table. Could Europe, for instance, move to joint procurement in innovation-related areas, such as defence and healthcare, to promote cross-border competition and scale? Today, Europe pools only 0.2% of its total public procurement at the European level, compared with 45% at the US federal level. Could Europe consider developing fast-track regulatory approval and decision-making processes, as happened in the case of COVID-19 vaccine approval?

The stakes are high. Even amid war in Europe and a severe cost-of-living crisis, leaders need to find time to focus on long-term competitiveness and innovation. Europe has world-competitive industries, but they could be at risk. Take automotive manufacturing as one instance. Europe still has two of the world’s top three players but is far behind the US on fully autonomous vehicles. US manufacturers account for close to 70% of all kilometres travelled by L4 fully-autonomous vehicles.

Today, Europe is a world leader in sustainability and inclusion. But if the competitiveness of European businesses falters, growth could suffer and put the best of Europe at risk, too. Energy autonomy and security have understandably been the focus of policymakers, but technological performance and autonomy are important for long-term security, prosperity and preservation, as President von der Leyen said in her 2022 State of the Union speech, “the enduring values of our social market economy”.


This article is a contribution from a member or partner organisation of Friends of Europe. The views expressed in this #CriticalThinking article reflect those of the author(s) and not of Friends of Europe.

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