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Europe in the age of industrial policy

Sep 26,2023 - Last updated at Sep 26,2023

MILAN — The European Union, like much of the rest of the world, is facing powerful economic headwinds. But whereas other major economies, such as China and the United States, are well-positioned to use industrial policies to help counter the challenges they face, the EU faces significant structural impediments on this front.

As it stands, EU economic growth is slow and decelerating, with some of the bloc’s economies doing worse than others. It does not help that the drivers of export growth are faltering, partly because of increased competition from China, which is moving rapidly into major industrial sectors like electric vehicles.

Moreover, while Europe’s commitment to leading the world on climate action and the clean-energy transition might eventually result in a competitive advantage, it is now acting as an economic impediment, and will continue to do so in the medium term, not least because carbon-intensive industrial sectors dominate exports. The Ukraine war has exacerbated this problem, not only by raising energy costs, but also, and even more so, by forcing the EU rapidly to diversify away from Russian fossil fuels, a very expensive process. As a result, carbon prices in Europe are significantly higher than in other regions.

Yet, another problem lies in Europe’s technology sectors, which are underdeveloped relative to those in the US and China. Mega-platforms, cloud computing, supercomputing and the development of advanced artificial intelligence are largely missing from the European economic and tech landscape. The consequences are far-reaching: these are high-growth sectors and important drivers of the structural change and productivity gains upon which an economy’s long-term well-being depends.

To make progress on tech, scale matters. For example, it takes a huge amount of computing power to train the most advanced generative-AI models. While it is possible that advances in AI technology will reduce the requirements in this area, the idea that limited computing power would not hamper progress is a bad bet. In any case, mega-platforms are currently the only entities with the required computing power (with the possible exception of the US federal government).

And it is the US federal government, not US states, that dominates investment in science and technology. This is particularly notable if one considers that California’s economy, which totaled $3.6 trillion in 2022, is larger than every national economy in the EU except Germany’s (worth roughly $4 trillion). No US state, not even California, could afford the 2022 CHIPS and Science Act, which supports semiconductor research, development, manufacturing and workforce development.

The US government recognises that, in a federal system, decentralisation is a recipe for underinvestment. It also leads to inefficiency, since state-level investment inevitably targets local actors, whereas federal investment is distributed based on competitive merit in the wider economy. In today’s context, where anything short of large-scale structural transformation implies relative stagnation, the costs of decentralisation are particularly high. This is true not only for tech, but also for national security and defence.

Herein lies the problem for Europe. While China and the US take advantage of scale to pursue industrial policies that include large-scale investment in critical sectors, the EU struggles to follow suit, owing to its decentralised fiscal policies and rules limiting government subsidies to industry.

The EU’s 2021 Recovery and Resilience Facility (RRF), a 723 billion euros programme aimed at mitigating the worst effects of the COVID-19 pandemic and advancing structural change, growth, and stability in the digital age, was a step in the right direction. But it had serious flaws.

Imagine if, in the US, all investment under the CHIPS and Science Act and the (misleadingly titled) Inflation Reduction Act was distributed to states in proportion to their size, to be deployed in accordance with pre-approved proposals, which all 50 states had been required to submit before any funding was disbursed. This would clearly be inefficient, yet it is essentially the approach taken by the RRF.

The point is not to criticise the RRF, which was established as a response to an immediate set of common challenges and proved to be far more constructive than the fiscal response to the 2008 global financial crisis and the European debt crisis that followed. Rather, it is to highlight the constraints associated with long-term European public investment.

Today, a new European investment program is urgently needed; but, unlike the RRF, it must be neither limited nor temporary. If Europe is to achieve growth and dynamism in the twenty-first century, federal investments must be expanded and made permanent. They should be funded through the issuance of EU sovereign debt, and administered centrally.

In a recent commentary, former European Central Bank President and former Prime Minister of Italy Mario Draghi argues that the prospects for fiscal union in Europe are improving, because “the nature of the needed fiscal integration” has changed considerably since the euro’s creation. Instead of federal fiscal “stabilisation”, Europe needs to mobilise “vast investments”, in defence, the green transition and digitisation, in a “short time frame”. Though this does not demand full fiscal centralisation, no federal structure would achieve that, anyway, it does mean that Europe must find a way to federalise critical investment in public goods that produce shared benefits.

This would greatly enhance the competitiveness and dynamism of European economies, enabling them to avoid prolonged stagnation. More concretely, it would help to ensure that the EU’s talented people, especially the young, have the opportunities they need to reach their potential.

 

Michael Spence, a Nobel laureate in economics, is emeritus professor of Economics and a former dean of the Graduate School of Business at Stanford University. Copyright: Project Syndicate, 2023. www.project-syndicate.org

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