Only creative destruction will boost European competitiveness

ParisAlthough debates about Europe’s dwindling growth prospects have been ongoing since at least the beginning of the century, the 2020s have lent them a new urgency. Russia’s invasion of Ukraine not only exposed a dangerous dependence on imported energy, but the change of government in the United States has forced Europeans to rethink how they will ensure their future prosperity, security, and sovereignty. Furthermore, with the United States and China leading the way in AI—widely considered the next mainstream technology, on par with the internet—Europe’s lack of dynamism has become an emergency. The problem is not just the commonly cited gap between the per capita incomes of the European Union and the United States. It is that Europe has long lagged technologically, with few globally recognized leaders in the digital platform economy, AI, the new space race, and other sectors that will be critical to competitiveness and security in the 21st century. Deeply dependent on advanced technologies manufactured elsewhere and unable to generate the growth needed to fund its strategic objectives and future liabilities, Europe is a textbook example of why creative destruction—the elimination of less productive firms as a result of the emergence of innovative new entrants—is important. Ignored, moderately reduced growth prospects are just the beginning of the problems. Despite its success as a trading and regulatory powerhouse, Europe will remain vulnerable unless it can foster innovation at the same pace and scale as the United States, China, and other countries. Given that AI has the potential to generate new knowledge and ideas, as well as perform a wide range of traditional productive services or functions, it could be a doubly potent engine of creative destruction that ultimately drives long-term growth. Frontier innovation matters the closer an economy gets to the technological frontier. However, while increasing investment in R&D is necessary to generate cutting-edge innovation, it is not enough. As highlighted in the report by former European Central Bank President and Italian Prime Minister Mario Draghi for the European Commission, The future of European competitivenessThe continent will remain stuck in incremental, mid-technology innovation unless it makes significant progress on three main fronts: removing all barriers to a fully integrated market for goods and services; creating a suitable financial ecosystem to encourage long-term risk-taking by companies, starting with venture capital and institutional investors (pension funds, investment funds); and promoting a pro-innovation and pro-competition industrial policy in key areas such as the energy transition, defense and space (including AI), and biotechnologies. Europe has not only avoided industrial policy under the guise of implementing a competition policy, but has also emphasized competition among established companies within Europe, paying little attention to the entry of new players and competition from outside Europe, starting with the United States and China. The entry of innovative startups from the rest of the world into the market is, in fact, the essence of the creative destruction that Europe needs to grow faster. In the early 2000s, Giuseppe Nicoletti and Stefano Scarpetta of the OECD demonstrated that while turnover (the replacement of older, less efficient firms with newer, more innovative ones) had played a significant role in productivity growth in the United States, most of the productivity gains in Europe can be attributed to this fundamental difference. More generally, Europe needs to update its economic doctrine, which has made it a regulatory behemoth and a budgetary dwarf. First, in implementing the Maastricht Treaty limits on budget deficits, policymakers should no longer equate growth-promoting investments with various recurring public spending programs (such as pensions and social benefits). Furthermore, they should allow for well-managed industrial policies, particularly those designed to promote competition and innovation. Finally, eurozone countries should be able to borrow collectively to invest in new technological revolutions, provided that member states demonstrate discipline in managing their public spending frameworks.

Fostering creative destruction and revolutionary innovation in Europe will also require complementary policies that help workers redeploy from backward to more advanced sectors, and compensate the short-term losers of structural reforms. That is why I have advocated for a model of flexicurity In the Danish style, where the state covers the wages of displaced workers while they seek retraining and reintegration into the workforce. An AI-driven industrial revolution demands no less.

It was a European, Joseph Schumpeter, who recognized the centrality of creative destruction to economic development. Europeans today must accept it, but also make it inclusive and socially acceptable if they are to prosper in the coming years and decades.

Copyright: Project Syndicate, 2025.