On Draghi competition thoughts - Part 6 - Productivity Differences

 

The Draghi report provides a set of policy idea that will support stronger growth and productivity, yet the problem of EU productivity is not a recent phenomenon but a problem that has existed for decades after the productivity catch-up miracle of post-WWII. This problem is well-documented in "The Lack of European Productivity Growth: Causes and Lessons for the US", "Labour productivity growth in the euro area and the United States: short and long-term developments", "Keeping Up with the US: Why Europe’s Productivity Is Falling Behind", and "Productivity growth in Europe: low, uneven and slowing". For the period of 1996-2109, US labor productivity per hour increased at 2.1% while EU productivity was only 1% per year. The cumulative effect is huge. 

There are large differences in productivity across the EU, but the overall level is still consistent with Japan and the UK. It may not be that EU is doing something wrong, it is, but that the US is doing something right. This means that there is opportunity to copy US policies but there is also a problem that the EU is not able to differentiate itself versus other parts of the world.   

One of the key differences between the US and EU is that in the EU there is less investment in new technologies and low levels of spending on R&D and R&D spending that is focused on auto manufacturing and less on new technologies. 

On Draghi competition thoughts - Part 5 - EU and US investment differences

The EIB Investment Survey for 2024 provides some interesting differences between the US and EU.  I highlight some of the survey results that caught my eye for trying to explain the difference in the economic and financial environment between the two. First, there is higher level of uncertainty in the EU associated with the Ukraine-Russia War. Second, the cost of energy is a major obstacle in the EU unlike the US. Third, the availability of finance is a much greater concern in the EU.  

What is surprising is the fragmentation of requirements and standards in the EU. It is not really a single market in the same way as the US. This generates a significant amount of costs for any business that is trying to grow and innovate in the EU. 

 

The amount of time and effort to meet regulatory requirements in some EU countries is staggering. While the number does not seem out of line for the EU versus the US, the variation is surprisingly high. 

The regulatory burden for small firms is especially high. These are the firms that are expected to be innovators and drivers of future growth. It is likely that small firms in the US have to spend more time and effort on regulatory issues relative to large firms, yet there is not the problem of dealing with intra-EU regulatory problems.

On Draghi competition thoughts - Part 4 - Growth Differentials

 

While there has been much discussion about EU competitiveness since the Draghi report was released in late September, it is important to remember that the shocks since the Great Financial Crisis. For example, we can look at the growth between the US and EU surrounding the pandemic and see the strong difference in economic behavior. 

The US saw a negative pandemic shock, but the real GDP jumped back quickly to trend. The EU also came back to trend albeit in a more muted fashion given the slow GDP prior to the pandemic. What is truly noticeable is the slow gain in productivity but again this is from a slow trend prior to the pandemic. See "An Investigation into the Economic Slowdown in the Euro Area". 

Much of the difference in growth and productivity has to do with the composition of the EU economy relative to the US. First, there is a heavier emphasis on manufacturing which has been hurt by the slowdown and impacted by higher interest rates. Second, the EU has been hurt by the strong energy shock from the spike in natural gas prices from the war between Ukraine and Russia. Third, the EU is more sensitive to trade with China. This differential may not be an innovation problem but an economic composition problem.

Experience does not always make you a better decision-maker

 

“In times of rapid change, experience could be your worst enemy.” - J. Paul Getty

Most people believe that more experience is better than less experience. Hire the older portfolio manager or trader and you will do better. This has strong logic and makes sense; however, experience can be harmful if you learn the wrong lessons, or the lessons of the past do not apply to the future.

Experience depends on the learning environment and how you learn. If the past repeats itself, then experience matters because you will see the same problem with the same answer. A static world is good for the experienced manager. On the other hand, if the link with the past changes, then experience will work against the manager.  What worked in the past may not apply in the new environment. Learning from the past will be a hinderance and the less experienced manager may do better.

If experience supports how to deal with change, then it is helpful. If experience wants to replicate the past to find answers, it will fail and create bigger problems. 

On Draghi competition thoughts - Part 3 - Global hubs

 

The Global Innovation Hubs Index 2024 from Nature shows four cities in the EU considered as global innovation hubs: Paris, Munich, Amsterdam and Dublin but there is strong convergence to the developed high-income hubs from Asian cities. These hubs are clustered into four development patterns, innovation economy-oriented cities, research innovation-oriented cities, combined research and innovation ecosystems, and cities of balance development.  While many hubs have held their positions longer-term, there have been significant changes with the AI revolution. 

The development or switching of rankings is associated with infrastructure development including the ability to increases global capital and labor flow. Hub cities constantly need capital and an inflow of new labor talent to maintain their edge.

Again, the EU shows consistency with their hubs, but there is an increasing global competition.

On Draghi competition thoughts - Part 2 - Global innovation

 

Global innovation country rankings from the world Intellectual Property Organization in the top 15 – Sweden, Finland, Netherlands, Germany, Denmark, and France with Ireland the only EU country that dropped out of the top 15. See WIPO Global Innovation Index 2024. The innovation rankings are stable for the high-income group but show wider dispersion and more dynamic change for lower income groups. Based on the innovation index there does not seem to be an EU innovation problem based on significant fall in country rankings. GII score is tied closely with GDP per capita; however, there are strong country performers that innovate above their income level. What is important is the output to input score which tells us something about innovation efficiency. This relative score difference is high for many EU countries. Nevertheless, the innovation pillars do show strong dispersion even for highly innovation countries. It is hard to argue that EU is failing with the innovation scorecard.

On Draghi competition thoughts - Part 1 - Higher education

I have been thinking about the Draghi report on competition in the EU. He makes a strong case for specific policy proposals. One area of focus is higher education. Our universities are where many of the innovations of the future will first be hatched, yet the EU is falling behind the rest of the world.  The US is also falling given the rankings of the top 200 universities. The big winner is China which has seen a strong increase in the number of top universities. 

We do not believe that education alone is the driver for innovation, but it provides a strong base. Education is a necessary but not a sufficient condition for innovation and innovation may not translate to competition. Enclosed is a table of data from ARTU, the aggregate ranking of top universities, that is a meta-ranking from a wider set of surveys. These top universities can also be tied to R&D spending. The EU has fewer top universities and R&D spending is less, but the real problem is the fragmentation of education in the EU. Both the US and China have integrate systems while the EU is still focused on country level education and not the EU in total.