Mario Draghi’s economic vision in analysis

Europe has a growth and competitiveness problem. This is why it is falling behind the USA and China. The EU must pull itself together to make a coordinated and expensive effort, is the tenor of a 393-page report that a group led by the former head of the European Central Bank and Italian Prime Minister Mario Draghi submitted to the EU Commission last week. The report makes numerous suggestions on how the problem should be addressed with comprehensive economic, industrial and security policy measures at the EU level.

Draghi’s approach ignores a fundamental structural problem of the EU. There are huge differences between the various states in terms of both prosperity and competitiveness, which have nothing to do with Brussels.

The purchasing power adjusted wealth per capita in Denmark is about the same as in the USA. Although it has a different economic structure, Denmark has been able to keep pace with developments in the USA over the past three decades. Sweden has caught up significantly. Italy has fallen further and further behind.

This is particularly evident in productivity. In Northern and Central Europe, productivity has grown at a similar rate to the USA. It is not primarily the EU as a whole that has problems, but Southern Europe, particularly Italy and the less developed countries in Eastern Europe.

Yet Italy is the country that has not overcome its contradictions between the once dynamic north and the backward south, its growth-inhibiting and cumbersome bureaucracy, its inefficient political structures and its very slow legal system, despite enormous support from Brussels.

The collapse of the motorway bridge in Genoa was symbolic of the structural problems. The bridge has since been rebuilt. But even the many billions of the EU’s so-called reconstruction program after the corona pandemic, financed for the first time by joint EU debt, have done little to change Italy’s fundamental problems. Rome is struggling to invest the funds sensibly.

It is therefore difficult to see why another large industrial master plan from Brussels should be able to solve this problem. Countries like Italy must primarily help themselves.

The tech companies make the difference

However, Draghi’s report makes an interesting point when he highlights the different economic structures in Europe and the US. Europe’s economy is generally more dominated by small, national companies, which are more often financed by banks. Large corporations that invest heavily and develop new products are found in Europe primarily in traditional industries and the health sector.

In the US, there are more large companies and more new companies entering the market. Companies in the US are increasingly financing themselves through the capital market. Europe’s companies are innovative, but of the 147 unicorns (startups valued at more than one billion dollars on the stock exchange) founded in the EU between 2008 and 2021, 40 have moved their headquarters abroad – the majority of them to the US. However, the Draghi report also concedes that this was probably not primarily due to a lack of capital, but because the larger domestic market in the US promises easier and faster growth, which is then also easier to finance.

The USA is home to the big tech companies. They have helped the country to achieve a growth spurt. The Draghi report even comes to the conclusion that the growing productivity gap between the EU and the USA can be explained almost entirely by the different developments in the information and communications technology (ICT) sector.

This is also indicated by the research of the “Crux of Capitalism” project by Simon Evenett at the University of St. Gallen. This determines the economic value that companies create, defined as operating profit after depreciation plus extraordinary expenses minus average capital costs. As the list of the 25 most profitable companies in the USA and Europe shows, these are dominated to a surprisingly large extent by American ICT companies. In Europe, on the other hand, it is mainly pharmaceutical and car companies that make it into the league of superstar companies.

Sometimes it takes more size

The ICT sector is characterized by digitization with high fixed costs, significant economies of scale and network effects. And artificial intelligence needs access to large amounts of data that can be processed electronically. This makes the development of new products even more expensive. Draghi is therefore probably right when he insists that the advantages of the large EU internal market should be better exploited. Strict data protection laws prevent easy, cross-company use of data. Due to the many different national technical specifications and licensing practices, there are still many relatively small telecom companies in the EU that are strongly national in nature.

A solution could be an EU-28 license, which would facilitate access to all countries, accelerate consolidation and at least make it easier for Europe to get its ICT superstar companies (and transnational banks).

More transnational coordination, consolidation and size would also be necessary in the European arms industry, which is still heavily over-regulated and characterized by competition between national states.

However, the need for deeper cooperation and consolidation raises questions of competition law. The EU internal market is so successful and important because it is competitive and distortions of competition through state aid are limited. However, an overly narrow definition of market power and prohibited agreements can prevent European suppliers from achieving the necessary size to be able to compete with American or Chinese market leaders.

Draghi’s report therefore advocates a more dynamic approach to competition policy. In addition to the immediate price effect, the assessment should focus on whether a merger will promote innovation or rather slow it down by preventing new competitors from entering the market.

Finally, Draghi’s report criticises a lack of focus in research in the EU. Instead, he advocates large international research programmes on key issues and technologies, which should be coordinated by renowned researchers rather than bureaucrats, following the American model.

Overall, there are six areas where there is reasonable scope for improvement at EU level:

The challenge is therefore for the nation states, which, like Italy, must overcome their own structural problems. Where more action at EU level makes sense, this should be done by re-prioritizing financial resources, just as it must happen in national budgets. The pivotal point should be the liberalized internal market and research and competition policy.

Europe’s strength is its diversity. By far its greatest economic achievement is open competition in the liberalized EU internal market. This is what we need to focus on – so that Europe’s south can become stronger again and no longer have to fear the USA and China.