Europe is falling behind, can it pick up the pace when it comes to innovation?

Europe’s decline rel­at­ive to the United States and China is a real­ity, par­tic­u­larly regard­ing dis­rupt­ive innov­a­tion and arti­fi­cial intel­li­gence. It is not that Europe lacks ideas, research­ers or sci­entif­ic cap­ab­il­it­ies. On the con­trary, a sig­ni­fic­ant pro­por­tion of the research lead­ing to dis­rupt­ive innov­a­tions is car­ried out on our con­tin­ent. Rather, the prob­lem lies in the dif­fi­culty of trans­form­ing these innov­a­tions into glob­al com­pan­ies cap­able of grow­ing rap­idly and com­pet­ing with the Amer­ic­an or Chinese giants. It is there­fore less a prob­lem of cre­at­ing start-ups than a dif­fi­culty in scal­ing up. Since the late 1980s, Europe has gradu­ally lost ground to the United States in terms of GDP per cap­ita, pro­ductiv­ity and dis­rupt­ive innovations.

After 1945, European growth was largely based on a catch-up mod­el; a cycle of growth had begun with the recon­struc­tion of cap­it­al des­troyed by the war. It con­tin­ued through the imit­a­tion of Amer­ic­an innov­a­tions asso­ci­ated with the Second Indus­tri­al Revolu­tion, such as elec­tri­city with its many applic­a­tions, and intern­al com­bus­tion engines, which had been rolled out across the Atlantic a gen­er­a­tion earli­er, as early as the 1920s and 1930s.

But when the glob­al eco­nomy entered a new phase of growth, in which the main driver is innov­a­tion at the tech­no­lo­gic­al fron­ti­er, Europe failed to change its mod­el. It remained strong in cer­tain sec­tors, such as aerospace, nuc­le­ar power, phar­ma­ceut­ic­als and infra­struc­ture, but it missed the boat when it came to inform­a­tion tech­no­logy and then bio­tech­no­logy. It is often con­fined to incre­ment­al, medi­um-tech innov­a­tion. When it comes to dis­rupt­ive innov­a­tion, the United States has left us behind. In addi­tion, China is now emer­ging, driv­en by far-reach­ing sci­entif­ic and indus­tri­al ambi­tions that are now yield­ing spec­tac­u­lar res­ults. Yet the research papers under­pin­ning these dis­rupt­ive innov­a­tions ori­gin­ate largely from European uni­ver­sit­ies and institutes.

Why is this poten­tial not being real­ised? The primary reas­on is the lack of a genu­ine European mar­ket. Des­pite the offi­cial exist­ence of the single mar­ket, nation­al reg­u­la­tions con­tin­ue to frag­ment the eco­nom­ic area. For an innov­at­ive com­pany, this frag­ment­a­tion lim­its the size of the access­ible mar­ket from the out­set. Yet dis­rupt­ive innov­a­tions require a large domest­ic mar­ket to devel­op rap­idly. Added to this is the lack of a truly integ­rated European cap­it­al mar­ket, which hinders access to fin­ance, par­tic­u­larly ven­ture capital.

Indeed, the weak­ness of the ven­ture cap­it­al sec­tor is the second reas­on that we are lag­ging behind. The United States has a very power­ful fin­an­cial eco­sys­tem, sup­por­ted by insti­tu­tion­al investors, pen­sion funds and a strong risk-tak­ing cul­ture. In Europe, these mech­an­isms are inad­equate. European start-ups may emerge, but they struggle to grow due to a lack of suit­able fund­ing. They often end up being acquired or expand­ing else­where, par­tic­u­larly in the United States. Sweden is an inter­est­ing excep­tion, as it has man­aged to devel­op pen­sion funds des­pite a pen­sion sys­tem that is not based on capitalisation.

A third reas­on is the lack of long-term fund­ing for research. Dis­rupt­ive innov­a­tion requires the free­dom to fail, as well as patient fund­ing. How­ever, many schemes, such as France’s Nation­al Research Agency, fund pro­jects over three to five years, which forces research­ers to spend more time on admin­is­trat­ive paper­work rather than focus­ing on their research. The LABEX pro­grammes, fun­ded over nine or ten years, are seen as a pos­it­ive exper­i­ence, hav­ing stim­u­lated innov­a­tion with­in the labor­at­or­ies con­cerned. The ERC (European Research Coun­cil), which funds high-risk explor­at­ory research pro­jects based on cri­ter­ia of sci­entif­ic excel­lence, is an achieve­ment on which to build. This type of fund­ing should be strengthened by real­loc­at­ing part of the resources cur­rently devoted to less effect­ive schemes, such as, in France, cer­tain uses of the research tax credit.

Com­pared with China and the United States, Europe also faces a major prob­lem: it was slow to embrace indus­tri­al policy, and it alloc­ates only lim­ited resources to it. The European Uni­on is often por­trayed as a reg­u­lat­ory giant but a budget­ary dwarf. This is even more evid­ent when one con­siders invest­ment expendit­ure. How­ever, the dif­fi­culty in invest­ing goes hand in hand with an insti­tu­tion­al cul­ture whose guid­ing prin­ciple remains “free and undis­tor­ted com­pet­i­tion”. For a long time, the EU restric­ted sec­tor-spe­cif­ic aid and curbed the indus­tri­al policies of Mem­ber States that saw the value in them. In the name of com­pet­i­tion, it pre­ven­ted the emer­gence of glob­al giants. Yet, leav­ing aside China, which has made this the corner­stone of its devel­op­ment, the United States has had no such qualms. It has tools such as DARPA and BARDA, which fund stra­tegic pro­jects by pit­ting sev­er­al teams against one anoth­er. This mod­el com­bines pub­lic guid­ance, com­pet­i­tion, exper­i­ment­a­tion and free­dom of action, bring­ing togeth­er clearly defined pri­or­it­ies and open pro­grammes that allow for a bot­tom-up approach. It has con­trib­uted to major innov­a­tions such as the inter­net and GPS. Europe needs to cre­ate com­par­able struc­tures, par­tic­u­larly in defence, arti­fi­cial intel­li­gence, green energy and biotechnology.

Com­pet­i­tion is a good thing, but it must be approached dynam­ic­ally. The epis­ode sur­round­ing the rejec­tion of the Alstom–Siemens mer­ger illus­trates an overly stat­ic view of com­pet­i­tion, focused on imme­di­ate mar­ket shares rather than on mar­ket con­test­abil­ity and the capa­city for innov­a­tion. A dom­in­ant firm is not neces­sar­ily prob­lem­at­ic if the mar­ket remains con­test­able and oth­er com­pet­it­ors can join. In this case, com­pet­it­ors do exist: the Chinese high-speed trains. We must there­fore coordin­ate indus­tri­al policy and com­pet­i­tion policy, rather than pit­ting them against one another.

Finally, we have a ser­i­ous reg­u­lat­ory prob­lem in Europe. Here again, it is not a ques­tion of dereg­u­lat­ing everything. But we reg­u­late too much, which cre­ates bar­ri­ers to entry that bene­fit estab­lished play­ers. Yet tal­ent is mobile, and small organ­isa­tions can relo­cate abroad. An ambi­tious start-up that can­not cap­it­al­ise on its poten­tial in Europe will relo­cate to Boston or Aus­tin, where it will find both a vast mar­ket and less restrict­ive reg­u­la­tion. It will also find cap­it­al there. Amer­ic­an investors make no secret of it: there is too much red tape in the EU. Those who invest in our start-ups prefer to move them across the Atlantic, where they will also find it easi­er to secure a prof­it­able “exit”.

Europe’s eco­nom­ic decline is there­fore linked to its abil­ity to gen­er­ate future growth. This abil­ity is being hampered. The decline is all too often denied, even though the Draghi report of Septem­ber 2024 on com­pet­it­ive­ness and the future of the European Uni­on sparked a wel­come debate. This lack of growth is a cru­cial prob­lem for our abil­ity to fund the social mod­el of which we are so proud.

Europe does, how­ever, have sig­ni­fic­ant strengths. It boasts excel­lent research­ers, engin­eers and uni­ver­sit­ies. It also retains – and this must be emphas­ised – con­sid­er­able appeal linked to its val­ues: demo­cracy, aca­dem­ic free­dom, the rule of law, the social mod­el and qual­ity of life. At a time when the United States appears less open, par­tic­u­larly to for­eign research­ers, Europe can once again become an attract­ive des­tin­a­tion. This soft power can serve as a stra­tegic lever, provided it is backed by fund­ing, infra­struc­ture and appro­pri­ate regulation.

Arti­fi­cial intel­li­gence rep­res­ents a major oppor­tun­ity in this regard. Admit­tedly, Europe does not have the same fin­an­cial resources as the United States, but it does have world-class research­ers, high-qual­ity data in sec­tors such as health and edu­ca­tion, and the capa­city to embody an eth­ic­al and socially respons­ible AI. The aim here is not to copy the Amer­ic­an mod­el, but to devel­op AI that is aligned with European val­ues. This does, how­ever, require avoid­ing excess­ive reg­u­la­tion, which could dis­cour­age new entrants and favour the large, estab­lished players.

To ensure that innov­a­tion is not lim­ited to large plat­forms, Europe must improve access to data, sup­port open source, and cre­ate data centres access­ible to start-ups. Indus­tri­al policy can strengthen com­pet­i­tion in this area by giv­ing new play­ers the means to enter the market.

This is where a well-thought-out bal­ance between com­pet­i­tion and indus­tri­al policy can make all the dif­fer­ence. Because suc­cess in AI requires CAPEX: faced with US play­ers backed by power­ful fin­an­cial investors, Europe must find ways to invest in com­put­ing power. This may involve pub­lic funds, but mobil­ising private funds is a sound policy when pub­lic money is in short sup­ply. Europe must there­fore devel­op ven­ture cap­it­al and enable house­hold sav­ings, pos­sibly via insti­tu­tion­al investors who are the main cus­todi­ans of such sav­ings, to be chan­nelled towards areas of future growth. Mario Draghi him­self recom­mends devel­op­ing secur­it­isa­tion mech­an­isms, and it should be remembered that he had to man­age the con­sequences of the 2008 fin­an­cial crisis, which was caused by excess­ive secur­it­isa­tion. Here again, reg­u­la­tion is neces­sary, but too much reg­u­la­tion stifles growth.

Finally, AI requires tal­ent. European gov­ern­ments must facil­it­ate hybrid career paths between uni­ver­sit­ies and busi­nesses; oth­er­wise, the best and bright­est will turn their backs on aca­demia, for how can one res­ist stra­to­spher­ic salar­ies and the thrill of tak­ing part in spec­tac­u­lar entre­pren­eur­i­al ventures?

AI will des­troy some jobs, but it will also cre­ate oth­ers, par­tic­u­larly because it boosts pro­ductiv­ity, busi­ness com­pet­it­ive­ness and the capa­city to gen­er­ate new ideas. The net bal­ance is uncer­tain, and my col­league Daron Acemo­glu and I have debated this issue, but to date the avail­able data does not yet show any mass job losses. The real chal­lenge will be to man­age these trans­itions. Here, our social mod­el can become an asset, par­tic­u­larly if it takes the form of the “flex­icur­ity” prac­tised in Den­mark, which oth­er European coun­tries have begun to emu­late high levels of com­pens­a­tion for a lim­ited peri­od, train­ing, and sup­port in find­ing a new job. Facil­it­at­ing the restruc­tur­ing of the labour mar­ket is a far bet­ter policy than hinder­ing it.

AI will des­troy some jobs, but it will also cre­ate oth­ers, par­tic­u­larly because it boosts pro­ductiv­ity, busi­ness com­pet­it­ive­ness and the capa­city to gen­er­ate new ideas.

Edu­ca­tion there­fore becomes cent­ral, as a good sys­tem of lifelong learn­ing requires a sol­id aca­dem­ic found­a­tion. Schools will be one of the pil­lars of the European response. In an eco­nomy trans­formed by AI, all chil­dren must mas­ter the fun­da­ment­al skills: read­ing, writ­ing, arith­met­ic, reas­on­ing and con­cen­tra­tion. The demo­graph­ic trans­ition presents an oppor­tun­ity to do bet­ter, and although it is a tempta­tion for many gov­ern­ments, we must res­ist the urge to cut edu­ca­tion budgets. On the con­trary, we can aim for class sizes of 15 pupils in primary schools, a strength­en­ing of learn­ing, bridges between voca­tion­al and gen­er­al edu­ca­tion, and a great­er emphas­is on soft skills: inde­pend­ence, ini­ti­at­ive, cooper­a­tion and adaptability.

The budget­ary issue deserves to be revis­ited here. No eco­nom­ist ser­i­ously denies the need for fisc­al dis­cip­line, but, as Mario Draghi poin­ted out when he was Prime Min­is­ter of Italy, with­in this frame­work of fisc­al dis­cip­line, a dis­tinc­tion can be made between oper­at­ing expendit­ure and invest­ment expendit­ure. Europe must be able to bor­row to fin­ance growth-enhan­cing invest­ments, as it did dur­ing the Cov­id crisis. In return, Mem­ber States must demon­strate their com­mit­ment by keep­ing cur­rent expendit­ure under con­trol. In France, where this issue has been par­tic­u­larly acute in recent years, there are sev­er­al poten­tial areas for sav­ings: abus­ive tax loop­holes, poorly eval­u­ated schemes, inef­fi­cient pub­lic spend­ing, and the research tax cred­it used by com­pan­ies that do not actu­ally need it.

Reform must be based on a cul­ture of eval­u­ation. This does not mean mak­ing sweep­ing cuts by blindly scrap­ping exist­ing schemes but rather identi­fy­ing which ones work and which do not. Fund­ing should be redir­ec­ted towards the most effect­ive instru­ments for innov­a­tion, such as long-term research, uni­ver­sit­ies, LABEX pro­grammes, tech­no­lo­gic­al infra­struc­ture and schemes that facil­it­ate scal­ing up. Fine-tun­ing is both pos­sible and neces­sary. In any case, it is more cru­cial than ever to invest in research. Gov­ern­ments tend to treat it as a budget­ary adjust­ment vari­able, but this is a ser­i­ous mistake.

Europe can recov­er, but this requires a col­lect­ive will com­par­able to that seen dur­ing major peri­ods of recon­struc­tion or stra­tegic invest­ment. With the war in Ukraine, the Rus­si­an threat, uncer­tainty in the US and the rise of pop­u­lism, we are at a cru­cial junc­ture in our col­lect­ive his­tory. If Europe does not equip itself with the means to act, there is a risk that the indus­tri­al and tech­no­lo­gic­al recov­ery agenda will fail. But if cer­tain lead­ing coun­tries decide to move for­ward togeth­er, ambi­tious ini­ti­at­ives remain pos­sible, par­tic­u­larly in a field such as defence. This could, moreover, include the United King­dom, which is mov­ing closer to the European Uni­on, as well as Mark Carney’s Canada, whose impas­sioned speech at Dav­os is still fresh in our minds.

Europe is cur­rently lag­ging behind in dis­rupt­ive innov­a­tion, but it is not doomed. It pos­sesses con­sid­er­able sci­entif­ic, human, social and insti­tu­tion­al cap­it­al. To regain its status as a power­house of innov­a­tion, it must com­plete its single mar­ket, devel­op ven­ture cap­it­al, fund long-term research, build a genu­ine indus­tri­al policy, invest in AI, strengthen edu­ca­tion and man­age the trans­itions in a socially respons­ible man­ner. The chal­lenge is not merely eco­nom­ic: it is also about pre­serving a European mod­el based on demo­cracy, the rule of law, social pro­tec­tion and freedom.