Perspective on Risk - Sept. 16, 2024 (Draghi Report)
The Draghi Report is out, so I thought I would give you a summary, tell you what, if anything, the early commentary has been, and try and slot my reaction to the Report into my Big Three Forces framework.
For those who aren’t familiar with the framework, my most recent past commentary can be found at these links:
Perspective on Risk - Aug. 22, 2024 (Big Three Forces; 1 of 2)
Perspective on Risk - Aug. 22, 2024 (Big Three Forces, 2 of 2)
My initial reaction is that the Report is very much in line with this framework (with the addition of climate change that we discussed previously).
Draghi Report On “The Future Of European Competitiveness”
Is there anything more European than Mario Draghi writing a 400 page report on how to boost productivity? (Tracy Alloway)
EU competitiveness: Looking ahead (European Commission)
Europe has been worrying about slowing growth since the start of this century. Various strategies to raise growth rates have come and gone, but the trend has remained unchanged.
… the foundations on which we built are now being shaken.
The previous global paradigm is fading. The era of rapid world trade growth looks to have passed, with EU companies facing both greater competition from abroad and lower access to overseas markets. …
Technological change is accelerating rapidly. Europe largely missed out on the digital revolution led by the internet and the productivity gains it brought: in fact, the productivity gap between the EU and the US is largely explained by the tech sector. …
Yet, Europe’s need for growth is rising.
The EU is entering the first period in its recent history in which growth will not be supported by rising populations. By 2040, the workforce is projected to shrink by close to 2 million workers each year. …
This is an existential challenge.
Three areas for action to reignite growth
Europe must profoundly refocus its collective efforts on closing the innovation gap with the US and China, especially in advanced technologies. …
The second area for action is a joint plan for decarbonisation and competitiveness. …
The third area for action is increasing security and reducing dependencies …
What is standing in the way?
First, Europe is lacking focus. We articulate common objectives, but we do not back them by setting clear priorities or following up with joined-up policy actions.
Second, Europe is wasting its common resources. We have large collective spending power, but we dilute it across multiple different national and EU instruments.
Third, Europe does not coordinate where it matters. Industrial strategies today – as seen in the US and China – combine multiple policies, ranging from fiscal policies to encourage domestic production, to trade policies to penalise anti-competitive behaviour, to foreign economic policies to secure supply chains. In the EU context, linking policies in this way requires a high degree of coordination between national and EU efforts. But owing to its slow and disaggregated policymaking process, the EU is less able to produce such a response. Europe’s decision-making rules have not substantially evolved as the EU has enlarged and as the global environment we face has become more hostile and complex. Decisions are typically made issue-by-issue with multiple veto players along the way.
First, while Europe must advance with its Capital Markets Union, the private sector will not be able to bear the lion’s share of financing investment without public sector support. Second, the more willing the EU is to reform itself to generate an increase in productivity, the more fiscal space will increase, and the easier it will be for the public sector to provide this support.
Draghi Through The Three Lens Framework
As the next step, I thought it worthwhile to slot his specific recommendations into the Venn diagram. For the most part, it slots very well.
In some ways, putting the Global Race For Green Tech at the heart of the Venn diagram solves my quandary about how to integrate climate change into the framework - it is currently at the heart of things.
There are three aspects that do not fit well into the Venn diagram as they represent some European-specific challenges. These are:
1. Energy and Decarbonization Costs
The Draghi Report frequently highlights the competitive disadvantage Europe faces due to higher energy prices compared to global peers, especially the U.S. The challenges of price volatility and energy security, exacerbated by the energy crisis following Russia’s invasion of Ukraine, are critical concerns.
2. Governance and Regulatory Reform
One of Draghi's concerns is that Europe’s fragmented regulatory environment—particularly across member states—creates barriers to scaling innovation and maintaining competitiveness. Regulatory hurdles, like lengthy permitting processes for renewable energy projects, are more aligned with governance reform than the categories in the Venn diagram.
Europe’s approach to state aid and subsidies, especially compared to the U.S. (e.g., the Inflation Reduction Act), doesn’t fit well into the Venn diagram. This is more of a policy coordination issue, where Draghi stresses the need for a unified approach to subsidies to avoid creating market distortions within the EU.
3. EU Internal Market Dynamics
Some of Draghi’s recommendations, like harmonizing taxation and lowering energy costs within the EU, focus on improving the efficiency of the internal market itself. This is less about external globalization dynamics and more about ensuring Europe’s internal cohesion across different industries and member states.
Globalization is running into incomplete European integration. Europe needs the scale and consistent rules to compete with China and the US. The heart of Draghi is further European governance reform, which seems highly unlikely in the short term with German economic weakness and French political disfunction.
What’s missing from the Report?
Immigration
Although the report touches on the aging European population and workforce challenges, it lacks a detailed strategy on how immigration can be effectively leveraged to address demographic decline. Europe’s ability to compete globally will depend on its ability to attract and retain skilled workers, especially in technology and STEM fields. A robust, forward-looking immigration policy that targets high-skill labor and talent could help Europe address both its demographic and skill gaps.
American Protectionism
The Report mentions the protectionist US Inflation Reduction Act, but does not address the potential for declining integration with the US more directly. Trade strategy with the US and China feels neglected.
Innovation
The Report acknowledges that Europe has fallen behind and needs to improve its environment for innovation, but gives few concrete proposals.
Reactions & Analysis
I haven’t seen much critical review of the Report. Most discussions are regurgitations of the Report itself, rather than critical analysis (maybe I’m doing the same?).
Tooze
Chartbook 317 Draghi's view of Europe (1): Investment, R&D & the US-EU comparison
The reports - Part A with the general argument and Part B with the more technical sectoral arguments - are fascinating and dense reading. In this newsletter I am excerpting some of the more striking graphs, focusing only on the questions of investment and R&D and specifically in comparison with the USA. There is much more to say about China and the many sectoral analyses in Part B.
Draghi’s report makes a compelling case that investment is too low and Europe’s innovation system is failing to turn Europe’s considerable scientific resources into global industrial leadership and business success.
The handling of the Eurozone crisis was an unmitigated disaster. The scarring of the European banking system has since helped to reduce the dynamism of credit. The Draghi report makes yet another call for the completion of the capital markets union.
… why is Europe’s brand of capitalist political economy so undynamic, or, as I put it back in January: “how has Europe become a “failed project of state-capitalist relations”?
Comparing the top-three corporate R&D spenders in the USA and the EU at three moments over the last twenty five years, gives us a stark overview of the differences between the US and European economies. Over the last twenty years in the USA, leadership in R&D has shifted dramatically from autos and pharma - the industries of the “second industrial revolution” (apologies to David Edgerton) - towards tech.
Since the Eurozone crisis it has been clear that relations between big business and EU governance are profoundly dysfunctional. In the 2010s conservative strategies of macroeconomic governance backfired disastrously. The Draghi report rams home the point that the EU for all the sophistication of its governance no longer provides European capital with the platform to face global competition at the scale of the US or China.
Chatham House
Mario Draghi’s competitiveness report sets a political test for the EU (Chatham House)
The overall strategy requires urgent, massive, concrete, joint efforts by EU countries, including enormous financial commitments. To boost growth and productivity gains, Draghi considers the bloc needs both public and private investments of €750-800 billion (£630-675 billion) per year, that is up to 5 per cent of the EU’s total GDP. As much as €450 billion of this would go toward the energy transition. As a comparison, 1-2 per cent of GDP was spent annually during the Marshall Plan (1948-1951).
But Draghi’s strategy does not just come down to money. It advocates a new stance towards cooperation by coordinating policies, cutting red tape and better respecting the principle of subsidiarity so that the EU remains focused on areas where it most adds value.
The strategy also advocates reforming competition law to facilitate mergers of European corporations. In 2019, the European Commission prohibited Siemens’ proposed acquisition of Alstom in the high-speed train sector. But Draghi argues that economic security should be considered when reviewing mergers, as fierce Chinese competition calls for bigger European industrial champions.
Atlantic Counsel
Five questions (and expert answers) about Draghi’s new report on European competitiveness (Atlantic Counsel)
What is the report’s most significant recommendation?
Draghi deserves credit for not ducking the question of regulation. EU regulation is necessary to make the single market work, and while it is often applied worldwide by firms out of convenience, it is also employed as a guarantee that a good or a service meets an acceptable standard. The problem is that the exports of EU firms have derived little to no competitive advantage in hailing from the market that exported the regulation. The report calls for more responsive and parsimonious regulators, capable of anticipating where technology may go.
Much will be made of Draghi’s carefully-calibrated comments on common debt issuance. The report goes as far as it can to argue that this would be a useful component to get investment to the level it needs to be at (an extra $885 billion a year). But it stops short of saying this is mandatory. Doing this would have made the report an easier target for fiscal hawks, such as the German finance minister.
—Charles Lichfield
The most significant recommendations concern reforming European energy markets. The high price of energy makes Europe uncompetitive and threatens European industries, but inefficiencies in Europe’s energy markets could improve with some of the smart recommendations from this report. Eliminating some of the intermediaries would have an immediate impact on energy prices, bringing cheers from consumers, businesses, and governments.
—Penny Naas
OddLots Podcast
Lots More With Isabella Weber on Draghi's EU Competitiveness Report (Bloomberg)
Good OddLots podcast. Spotify link