Research and development and the resulting innovations are of central importance for the competitiveness of economies and thus for economic prosperity. That’s why it’s worrying that Europe and Germany are losing ground in this area to the USA, and now also China. How do you recognize this decline? It can be seen both on the input side, i.e. the expenditure on research and development, and in the results of these investments, which are reflected in patents, company start-ups and ultimately in the overall economic productivity development. More than 20 years ago, as part of the 2000 resolution Lisbon Strategy, the EU set out to increase the competitiveness of the European economy. In order to achieve this, the share of overall economic spending on research and development should increase to 3 percent of gross domestic product (GDP) by 2010. The goal was missed by a wide margin. Today, at 2.2 percent of GDP, they are hardly higher than they were back then. In the United States, however, spending on research and development amounts to 3.5 percent of the country’s GDP. In absolute figures, spending in the USA at 730 billion euros is more than twice as high as in the EU at 322 billion euros. There are significant differences in Europe: there is little investment, especially in southern European economies such as Italy and Spain; there the rates are around 1.5 percent. Germany is doing better at 3.1 percent. However, the amount of spending on research and development (R&D) is only one aspect. Their composition is also important. The first thing that stands out here is that the share of government spending on R&D in economic output is similar in the EU and the USA. The difference arises primarily from the fact that European companies invest less in research and development. At 1.2 percent of GDP, private investment in the EU is only about half as high as that in the USA (2.3 percent). Between high technology and medium technology How does this gap come about? It arises primarily because research-intensive US companies are active in other areas. It is customary to distinguish between “high technology areas” and “medium technology areas” in technological development. High technology includes, for example, the development of software and hardware for the digital industry, biotechnology or aerospace. In contrast, the development of cars and industrial machines, chemicals or telecommunications systems is classified as medium technology. High-tech areas play a much larger role in the United States. In the European Union, companies invest roughly the same amount in R&D in high-tech and mid-tech industries – around 45 percent of total spending each. In Germany, the share of mid-tech industries is 57 percent, even higher than the EU average; the high-tech share is only 36 percent. US companies, on the other hand, focus their research and development primarily on high-tech industries. They account for 85 percent of private sector spending on research and development in the United States. Classification of various areas as high or medium technology is undoubtedly debatable. The distinction can be difficult, partly because digital innovations are playing an increasingly important role in the automotive industry, for example. However, German car companies show considerable weaknesses, especially in the IT area. What is clear is that companies in high-tech sectors have grown much faster in recent decades. This has led to research spending also increasing more quickly. In the EU they have roughly doubled in the past two decades, but in the USA they have quadrupled.Mercedes, Siemens and VW with the highest research spendingThe dynamics in the USA can also be seen when you look at which companies spend the most and whether and how this group is changing. The three companies with the highest spending on research and development in the EU in 2003 were Mercedes, Siemens and VW. In the USA at that time it was Ford, Pfizer and General Motors. In both cases, the auto industry dominated. In 2022, VW and Mercedes were still in the top group in the EU, only Bosch has replaced Siemens. The dominance of the auto industry had increased in Europe (and Germany). In the USA, however, this industry is now secondary. In 2022, Amazon, Alphabet and Meta led the way in spending on R&D. If, instead of spending on research and development, you look at international patent applications that meet certain quality standards due to the high costs involved, a similar picture emerges. Europe is a leader in the automotive industry or in special machine construction. But these belong to the mid-tech sectors, which only accounted for 6.7 percent of all international patents in 2023, and the trend continues to fall. At 35 percent, high-tech sectors have a significantly larger and growing share of patents. The USA dominates here, while China is catching up and Europe is being left behind. It fits into the picture that the high investments in rapidly growing high-tech areas are also accompanied by an increasing economic gap between the USA and the EU. This can be seen dramatically in the fact that among the globally leading, newly created technology companies, none come from Europe. The gap is also clear when one looks at the development of labor productivity. By the mid-1990s, the EU states had caught up with the USA. However, this trend has since reversed. The EU is falling behind the United States again. Although labor productivity is influenced by many factors, innovations play an important role in productivity development.More on the topicIs the specialization of Europe and especially Germany in medium-sized technologies really a disadvantage? One could counter this by saying that it is an international division of labor and specialization in which everyone involved concentrates on what they do best. This is not entirely convincing for two reasons: Firstly, the framework conditions for research and development are significantly influenced by government action. Secondly, there are also significant path dependencies in private research and development. This can be clearly seen in the software sector. US high-tech companies are much more profitable. The difference in average profit margins between high and medium technology companies in the US is 7 percentage points, while in the EU it is only 3 percentage points. When it comes to software, the difference is even greater. This may explain why so much more capital is flowing into the US high-tech sector. One reason for the lower profit margins in the European high-tech sectors must certainly be found in the fragmentation of the markets and the higher level of regulation, especially in the software sector. Undoubtedly, the high profits of US technology companies are at least partly the result of market power and monopoly or oligopoly positions, that arise from network effects. In terms of technology policy, however, this results in the problem that high profits drive the financing of research and development in the high-tech sector in the USA. As a result, the market dominance of these companies continues to grow. This leads to a self-reinforcing process in which the EU falls further and further behind. For these reasons, the current situation cannot be viewed solely as the result of efficient market processes. But this does not change the fact that the EU has been left behind and a huge effort would be needed to bring European companies back to success in these sectors. This is also shown by the experience of the European flagship company in the field of artificial intelligence, Mistral, which has entered into a cooperation with Microsoft.Improving conditions for groundbreaking innovationsOne could also argue that the classification of the sectors as mid-tech or high-tech is questionable because it suggests that High-tech sectors are necessarily more promising than the mid-tech sectors. It is hardly possible to predict today in which areas European economies will be able to generate particularly high added value in the future. Nevertheless, it should be taken into account that the high-tech areas have been showing significantly higher growth rates for a long time and that the volume of research and development spending there is expanding more quickly. The decline in investments in research and development by the large EU states documented here is from this perspective at least risky. Last but not least, it should be borne in mind that Germany in particular could lose competitive advantages in its core competence, the automotive industry, due to the change towards electric drives and networked mobility concepts. A recent ranking by the automotive research institute CAM came to the conclusion that among the 10 best-selling electric cars worldwide, none come from Germany. What follows from the finding that Europe is in a kind of medium-technology trap and is increasingly losing touch with high technologies? At first glance, it seems obvious to demand that more government resources be channeled into the computer or software industry. However, directing resources specifically into fields in which European companies are already largely left behind in international competition offers little chance of success. It is more promising to improve the conditions for groundbreaking innovations across all sectors without narrow sectoral definition. This requires changes in government funding for research and development, but also a comprehensive concept to strengthen the innovative forces in Europe. American innovation agencies as a role model The American innovation agencies ARPA (Advanced Research Project Agencies) are considered a role model worldwide when it comes to groundbreaking technological innovations . The best known of these is DARPA, which focuses on defense projects and has an annual budget of around 4 billion euros. Other ARPA agencies promote fundamental innovations in energy and health. The Federal Agency for Leap Innovation (SPRIND) was recently founded in Germany. It pursues the same purpose, but is very poorly funded. At EU level, the European Innovation Council has existed since 2021, which, like ARPA, should support groundbreaking innovations. Of course, it doesn’t make sense to simply copy the US model ARPA – the conditions for innovation on both sides of the Atlantic are too different. Nevertheless, EU innovation policy must be measured by whether it achieves the goal of promoting groundbreaking innovations. These are projects that are still far from being ready for the market and are therefore not privately financed. There are major weaknesses here. The European Innovation Council not only has too few, but also too few highly qualified staff to be able to supervise projects from all sectors. The decision-making structures should be reformed by reducing the influence of the EU Commission and giving top scientists more competencies. In addition, the European Innovation Council’s programs combine innovation goals with other economic policy concerns, especially the promotion of medium-sized companies. The involvement of actors from poorer member states in research and development by requiring broad transnational cooperation is also well-intentioned, but it dilutes the focus on groundbreaking innovations and impairs the effectiveness of the funds used. Make better use of existing funds The existing EU programs should instead focus consistently on breakthrough innovations be aligned. Projects should be funded regardless of whether they are applied for by large or small companies or research institutions. Collaborations should be voluntary and not forced as a prerequisite for funding. The existing funds, at least more than 1 billion euros per year, could be used much better. However, the funds made available at EU level are only part of the state’s support for innovation. National innovation policies should also be reviewed and geared more towards disruptive innovations. In order to achieve noticeable progress, it is not enough to simply focus on state support for breakthrough innovations. What is needed is a comprehensive economic policy agenda to strengthen innovation. Private capital markets must be developed so that more venture capital flows to start-ups. Tax law must not hinder the financing process, for example by excessively restricting loss compensation. Labor market regulation should enable newly founded companies to quickly increase and reduce staff. Last but not least, it is crucial to reduce the still significant barriers to cross-border economic activity in the EU internal market in order to offer new companies better growth opportunities.The authorsDaniel Gros (69) is Professor of Economics and Director of the Institute for European Policymaking at Bocconi- University in Milan. He was an advisor to the Delors Committee, which developed the plans for the European Monetary Union. He also advises the EU Parliament and various central banks. In his research, Gros, who comes from Wiesbaden, deals with monetary policy, foreign trade and general macroeconomics. Clemens Fuest (55) is President of the Ifo Institute, Director of the Center for Economic Studies at the Ludwig Maximilians University in Munich and at the LMU Professor of Economics. Fuest is a sought-after political consultant. But he also sees his task as a scientist in communicating findings to the general public in order to enable critical debates. As a liberal economist, he always promotes free-market approaches. Jean Tirole (70) is an economics professor and co-founder of the Toulouse School of Economics (TSE) and the Institute for Advanced Study in Toulouse (IAST). Tirole comes from Troyes, France. His research focuses on industrial economics, regulation, game theory, banking and currency crises. He is the most cited economist in Europe and has received many awards, including the 2014 Nobel Prize in Economics.
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