Why Europe is embracing the new American growth model

The bloc’s politics were shaken up last week when Mario Draghi, the former European Central Bank president credited with saving the eurozone in 2012, released a long-awaited report on how to stem economic stagnation, exacerbated by competition from Chinese exports and the end of cheap Russian energy.

His demand for more joint debt has already been met with opposition from Germany, which is not a new controversy.

But that is a political distraction. The report’s key point is that “the EU should aim to match the US example in terms of productivity growth and innovation,” pointing out that no listed European company has emerged in the past 50 years valued at more than €100 billion ($111 billion). In America, Apple, Microsoft, Nvidia, Amazon, Alphabet and Meta all exceed $1 trillion.

But what does it mean to get closer to the US? Draghi has stressed the importance of the technology sector, saying it has been responsible for almost all of the US productivity outperformance over the past 20 years. He says “Europe cannot afford to remain trapped” in old industries.

This “vertical” emphasis on a single sector is a big departure from the post-1980s status quo, which encouraged free markets, entrepreneurship, and “horizontal” policies designed to strengthen the entire European economy, such as training the workforce and building infrastructure. This view is enshrined in the very foundation of the European Union, the 1992 Maastricht Treaty.

Why the United States is more productive is an old question. It was asked in 1928 by Allyn Young, the American president of the London School of Economics. In a speech, he denied that the gap was due to better management of American companies. “The largest domestic market in the world,” he argued, meant that “methods of production are economical and profitable in America, which would not be profitable elsewhere.” Over time, this led to the emergence of the most complex industries there.

The implication is that companies will only make large productivity-enhancing investments if they are in growth sectors where it makes sense. That is why Europe has a gap in investment rates outside construction with the US: its three biggest R&D spenders in recent times have consistently been petrol-powered car companies. In the US, by contrast, the big R&D spenders in the 2000s were car and pharmaceutical companies, then in the 2010s software and hardware, and more recently in digital applications.

However, countries cannot easily enter these more complex sectors because increasing economies of scale create a natural barrier to any entrepreneurial competitors.

Indeed, in today’s winner-take-all world, entrenched trade imbalances and agglomeration within a few metropolitan areas cannot be fully explained by comparative advantage or even the impact of diverging exchange rates and capital flows.

Nor can the history of any nation that has ever tried to catch up economically. Despite its laissez-faire credentials, during its own catch-up phase with Britain in the 19th century, the US was an ardent user of industrial protectionism. More recent successes, such as Japan and South Korea, have relied heavily on privileged sectors and export markets.

The United States championed multilateral free trade in the second half of the 20th century, and had ample incentive to do so until recently. Its Silicon Valley companies, born in part from earlier military investments, have harnessed network economies to become global champions.

But America began to change its tune as China emerged as a direct competitor. Industrial subsidies and a huge domestic market are now helping the Asian nation flood global markets with electric vehicles, solar panels and other advanced technologies that are beyond the reach of lower-end Western competitors.

The response came first through Donald Trump’s tariffs and then President Biden’s Chips and Science Act and Inflation Reduction Act, which poured federal money into the country’s semiconductor, electric vehicle and clean energy industries. Despite growing pains, as Intel’s woes show, they led to a boom in manufacturing construction.

Yet the EU has failed to respond in an equally decisive manner, paralysed by unstable governance, German corporate interests in China and Russia, and a glaring belief in its own free-market propaganda.

Draghi’s image as the ultimate technocrat gives him a chance to change that while avoiding a destructively protectionist turn. To do so, the 400-page document proposes a trade policy based on “case studies” of what will boost productivity growth, and an industrial strategy based on picking sectors rather than specific winners.

In semiconductors, he points to foundries focused on European strengths such as automotive and networking equipment as ripe for subsidies. In the space economy, he promotes targeted preference policies to scale up domestic firms. In solar, he suggests challenging Chinese trade practices and overcapacity, but also warns that too harsh a crackdown could threaten the bloc’s trade surplus in wind technology.

There is a precedent: in the early 1990s, Airbus was an unprofitable joint venture of various European countries. Thanks to government support and a well-focused commercial strategy, it is now the world’s largest aircraft manufacturer.

The so-called Washington Consensus of the late 20th century preached free trade and laissez-faire economic management. Today, being Team USA means targeted protectionism and aggressive subsidies for high-tech sectors.

Write to Jon Sindreu at [email protected]