Lagging behind in tech: will the EU ever be competitive?

Source: Flickr

The technology gap between Europe and other world regions is growing, with European spending on technology research and development being only a fifth of North American spending. This raises questions about EU competitiveness in the technology sector, as well as about the areas where becoming more competitive is desirable in the first place.

“There is no longer any political sovereignty without technological sovereignty” echoed Bruno Le Maire, the French Minister of Economics, at the EU Digital Sovereignty Conference in 2022. The European Union has long lagged behind the US and China in developing technologies in areas other than sustainable energy and materials, a reflection of its dependency on EU-based firms to carry out their research and development unaided. Companies like Swedenʼs Spotify, the Netherlandsʼ Unity and Romaniaʼs UiPath have all scaled up outside of Europe, bringing with them entire value chains that contribute to foreign economies. In 2022, European startups raised $95,7 billion, relative to the $241,5 billion generated by US firms. This comes as a result of Europe’s lower public and private investment in R&D, as well as an environment that only supports new firms in their first stages of financing. Europe’s later-stage growth funding is only 10% of the United States, indicating that more mature tech firms have less opportunity for growth in the EU. Innovative companies with large growth opportunities acquire funds primarily through venture capital firms (VCs), both of which the EU has less relative to its Asian and North American counterparts. As the size of these VCs impacts how much these technology firms can grow, European-based companies start looking outward, raising the issue of European technological sovereignty in the future. 

The World Economic Forum estimates that 70% of the new value created in the global economy over the next 10 years will be digitally enabled. As technology becomes more intertwined with businesses in every sector, remaining competitive now means developing and adopting transversal technologies. Next-level process automation, cloud computing, and cybersecurity architecture are all examples of tech that spreads across sectors, with a wide range of applications; while AI is used in healthcare to develop new diagnostic tools and treatments, in finance and retail AI is used to automate repetitive tasks. Europe lacks in the production, innovation and adoption of these technologies, indicating that modest funding is not the sole barrier to their employment. For example, the lack of a definition for technology infrastructure in European legislation has slowed down firmsʼ adoption of relevant instruments to test their technologies.  

As the technology sector permeates all other industries via transversal tech, areas where Europe is currently competitive may also become vulnerable to slow growth. For example, Infrastructure-as-a-Service is a subscription-based service that provides server capacity through the cloud to firms that aim to bypass the costs of purchasing and managing physical servers and the entire data centre infrastructure. Too few IaaS providers in the EU will impact the operational efficiency and costs of European retail businesses. The low amount of European firms in tech lends itself to the region’s less developed risk-capital funding. The fact that 35% of the funding raised by European VCs in 2020 came from government agencies raises questions about Europeʼs private pools of capital. One of these agencies is the European Investment Fund, which recently launched European Tech Champions Initiative to adress this gap. The €3.75 billion fund invests in other funds, such as mutual funds, pension funds, insurance companies, or university endowments, which then provide money to large-scale VCs to invest in high-tech companies in their late-stage growth phase as well. However, given pension funds and insurance companies have been the most prolific in the US market, the EU also has to weigh in on whether to reduce the restrictions and capital requirements it imposes on these asset managers to leave more space for investment. Member States can also consider supporting private agencies such as the JEDI, the European Advanced Research Projects Agency, which backs R&D programs for breakthrough technologies through targeted competitions.  

Uncoordinated research poses itself as another key challenge towards bridging the gap. Research and industry have contrasting opinions regarding the distribution of Horizon Europe funds. Because of its broad scope, the project allocates money thinly towards multiple areas, covering different levels of technology readiness levels. TRLs define a framework for estimating the maturity of a particular technology in its R&D phase. Currently, projects that are closer to reaching the market are prioritised, to the detriment of the exploration of basic principles and technology concepts that the EU is renowned for. This partly explains why the EU is now lagging in high R&D intensity sectors (technology hardware, software services, etc.) as the majority of R&D investment in the EU is mostly implemented in low to medium R&D sectors. Moreover, the transformation of scientific research into commercial opportunities is slower in the EU, reflecting that much of the funding for academic research tends to be independent of how it is then applied. For example, R&D in next-generation materials is lower in Europe than in other major regions, and there is less collaboration between universities and the private sector. However, university spin-offs can be more skilfully leveraged to mature ideas explored in theory at universities towards the market, as Europe pioneered one of the first tech transfer offices in the world. Belgiumʼs KU Leuven R&D centre has helped the university spin-off more than 124 companies since its founding.

Fragmentation in funding and regulation is another EU characteristic that blocks a cohesive development of a larger European technology sector. As Member Statesʼ tech ecosystems are at different stages in their development, their stakeholders require region-specific regulation that focuses on their priorities. Countries in the Baltic, Nordic and Central Europe show great potential in the start-up scene, with examples ranging from Estoniaʼs 4 unicorns per million citizens statistic to Polandʼs hosting of the largest Intel R&D facility. Helsinki, Stockholm, and Tallinn also present higher growth rates per capital invested in start-ups compared to London, Berlin, and Paris, which illustrates the latter’s need for regulation that focuses more on the large companies transition to digital technologies. Given that firms in Western Europe thus bear different economic risks to those in smaller countries, it is important that everyone involved feels heard in the decisions on new tech policy.

From a funding perspective, 55% of all grants from Horizon 2020 went to the UK, Germany, France, and the Netherlands. Moreover, only France, Germany, Italy, and Sweden have participated in more than two Important Projects of Common European Interest (IPCEI). Whilst Central and Eastern Europe can still attract foreign funding because of their flourishing tech scene, there are still regions in the EU where tech start-up density is low, if it exists at all. The Commission notes that some local innovation clusters lack the incentives, experience, and resources to engage more actively with researchers and founders. However, countries like Estonia, Portugal, and Malta have set model policies that the EU can learn from, especially in the deep tech industry.

Another deterrent to company growth and risk-taking is a difficult regulatory environment.  While the EU Single Market has eliminated an unprecedented amount of trade barriers, the EU is still composed of Member States with different standards for taxes, regulation, labour rules, and administrative processes. This discourages firms from scaling up in other countries and seeking cross-border partnerships. Even if achieving full harmonisation is the long-term goal, the EU can still accelerate progress toward the capital markets union and the banking union. From an executive and employee equity compensation perspective, current regulation deters risk-taking because most employees have no stake in the companyʼs future. Only 5% of the private sector workforce in Europe has a type of employee ownership, compared with 20% in the US. This is because dealing with employee-owned shares in Europe is made highly complex by administrative formalities and the tax burdens that come with their ownership.

Energy is another sector where more integration could benefit renewables and hydrogen tech development. Current infrastructure bottlenecks and an inefficiently utilised cross-border grid capacity narrow the geographical scope of green energy start-ups. Cross-border interconnectors link national energy grids together, through which intra-European electricity is traded. These are the backbone of the European Interconnected Network, which can only achieve its potential if its whole capacity is harnessed. The proposed Artificial Intelligence regulation is also perceived as a slow-down to innovation by 50% of European AI startups, and 16% are even considering stopping developing AI or relocating outside the EU.

Low investment in transversal technologies, uncoordinated research, fragmented funding and a complex regulatory landscape present significant barriers to a wider deployment of tech R&D. However, the EU has implemented various measures to address these issues and foster stable growth. Horizon Europe is the EUʼs key research funding program, with a €95 billion budget for 2021-2027 aimed at supporting scientific knowledge and technologies. It provides grants and financing opportunities to universities directly, or through councils such as the European Innovation Council. The European Institute of Innovation and Technologyʼs budget funds disruptive innovation projects that may be too risky for private investors to uptake, with 70% of it allocated towards SMEs. The Important Projects of Common European Interest (IPCEIs) also pool private, EU, and national state funds for major cross-border infrastructure projects whose risk would be too high to assume by one region alone. A second IPCEI has recently been approved in Microelectronics, which contributes to the technological advancement of communications (5G and 6G), AI, and quantum computing.

The recently adopted Strategic Technologies for Europe Platform (STEP) plans to channel up to €160 billion in investments through initiatives such as the “Sovereignty Seal”, which would be awarded to projects that scored high during the selection process of the Commissionʼs funding programs. This certifies project quality and helps its promotion on the “Sovereignty Portal”, where investors meet with project leaders. The EU's strategy for start-ups, the European Innovation Agenda, helps Member States direct €10 billion to interregional innovation projects, as well as retain talent through intern schemes and a new framework for employee stock options. As traditional regulations often deter firms from testing out new technology, it also focuses on fostering no-stake experimental spaces through regulatory sandboxes and public procurement. The European Chips Act also entered into force this past September, intending to increase the EUʼs market share in semiconductor production from 10% to 20%. As the EU has a lower chance of becoming a leader in net chip production, its strategy is to focus R&D towards other necessary technologies for chip manufacturing. This is a way to gain a competitive advantage in the industry. For example, the Dutch company ASMLʼs intensive research into photolithography machines helped Europe become a leader in this essential component of chip printing.

The EU thus tries to build on its strengths – high data regulation, pioneering deep tech standards, and being a leader in the automotive and green energy sectors – to become more competitive. Through this, it aims not to spend as much as the US or China to achieve its targets, as the European objectives also incapsulate the ways in which locally produced technology impacts its citizens. The implications of accelerating the deployment of disruptive technologies have mostly pointed towards cautiousness. However, the EU may have to grapple with not only a loss in competitiveness in the technology sector in the future, but also with an aggravatingly declining productivity in all other sectors.