Addressing the European know-how hole

This report builds on an MGI article from Might 2022, “Securing Europe’s future past vitality: Addressing its company and know-how hole.”

Europe as it’s as we speak has been solid in instances of disaster. The European Union (EU) was created in response to the ravages of World Warfare II. The autumn of the Berlin Wall marked the beginning of a interval of financial catching up by economies in Central and Jap Europe. The 2008 monetary disaster and the eurozone disaster that adopted led to extra monetary cooperation amongst European nations. The COVID-19 pandemic then triggered the next stage of fiscal coordination via the NextGeneration EU fund.

Most just lately, the Russian invasion of Ukraine not solely is a humanitarian disaster however has uncovered a spread of fragilities, from meals safety and vitality to protection. The warfare has accentuated the fact that resilience will depend on a powerful financial system with strategic autonomy in these important areas that has lengthy been taken as a right.

Know-how is pivotal, too. Until Europe catches up with different main areas on key applied sciences, will probably be weak throughout all sectors on development and competitiveness—compromising the area’s comparatively strong file on sustainability and inclusion—in addition to safety and strategic energy, hindering long-term resilience. Given seismic occasions inside its personal continent, a strong Europe is arguably wanted greater than ever. But to make {that a} actuality would require the area to deal with a slow-motion competitiveness disaster that has quietly been unfolding for twenty years, centered on its company and know-how hole with different main areas. That’s the subject of this text. Confronting this hole would require leaders to point out the identical resolve and collaboration as they initially displayed of their response to the warfare in Ukraine.

Though Europe has many high-performing corporations, in mixture European corporations underperform relative to these in different main areas: they’re rising extra slowly, creating decrease returns, and investing much less in R&D than their US counterparts. This largely displays the truth that Europe missed the boat on the final know-how revolution, lagging behind on worth and development in data and communications know-how (ICT) and on different disruptive improvements.

ICT and different tech sectors have spawned a spread of transversal applied sciences, that are spreading horizontally throughout sectors and figuring out aggressive dynamics. This analysis seems at ten transversal applied sciences and finds that Europe leads on solely two of the ten. If Europe isn’t profitable in competing in these applied sciences, it might additionally lose its strongholds in conventional industries. To present only one instance, Europe has been a pacesetter in automotive however might change into a laggard in autonomous driving.

The stakes are excessive. We estimate that company worth added of €2 trillion to €4 trillion a 12 months could possibly be at stake by 2040—worth that might generate wages, employment, funding, and financial development to the broader advantage of society. To place the estimated worth at stake into perspective, that may be equal to 30 to 70 % of Europe’s forecast GDP development between 2019 and 2040, or one proportion level of development a 12 months; six instances the gross quantity wanted in Europe to attain net-zero emissions by 2050; and about 90 % of all present European social expenditure, or €500 month-to-month common earnings for every European citizen.

Until tackled, this disaster will handicap Europe on many dimensions, together with development, inclusion, and sustainability, and its strategic autonomy and voice on this planet.





Europe can proceed to construct on its strengths. Its socioeconomic mannequin has served nicely up to now. But when corporations are to play on the scale and pace wanted to compete in a world wherein know-how disruption is spreading all over the place, usually with winner-takes-most dynamics, a reevaluation of long-held beliefs and trade-offs could also be wanted. An built-in bundle of initiatives might create an atmosphere that allows them to take action—within the course of serving to to make sure that as we speak’s prime quality of life for a lot of of Europe’s residents is preserved for the long run.

Europe has traditionally had a powerful file on sustainability and inclusion, with a blended image on development

Persevering with to raised the lives of all Europeans over the lengthy haul requires sustainability, inclusion, and development. The three reinforce—or can undermine—each other; it isn’t a query of or, however and.





The place does Europe stand? (See sidebar, “Europe: Geographic scope of analysis”).

Europe is a pacesetter on sustainability and inclusion, a minimum of in Northern and continental Europe, our evaluation reveals (Exhibit 1). When Europe works, it really works nicely. Nevertheless, the area’s efficiency on development is much less robust. As in the US, per capita GDP development was sluggish over the previous twenty years. The per capita GDP of Europe as we speak is 30 % beneath that of the US. That hole had been narrowing however is now not doing so.

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On sustainability, Europe has 2.4 instances decrease CO₂ emissions per capita than the US, and 1.8 instances decrease CO₂ emissions per unit of GDP.





Each emissions per capita and emissions per unit of GDP have decreased quicker in Europe than in the US since 1990. Europe has additionally pledged to attain web zero carbon emissions earlier than different areas.

On inclusion, Europe leads on most dimensions, together with equality, social progress, and life satisfaction. Revenue inequality as measured by the Gini index is simply 30.





It’s 41 in the US. On social mobility, all prime ten nations within the Social Mobility Index printed by the World Financial Discussion board are European.





Europe total has the best life expectancy on this planet: the EU-27 common is 80 years (80.3 for the EU-30); it’s 79 in the US and 77 in China.

On development and prosperity, Europe tracked different superior economies’ sluggish development of per capita GDP at a compound annual fee of 1.2 %, just like 1.1 % in the US, between 2000 and 2019. Nevertheless, the US has been rising in whole GDP phrases at 1.9 % a 12 months, in contrast with Europe at 1.4 % yearly, reflecting larger inhabitants development. Europe’s per capita GDP remains to be some 30 % decrease than that of the US. Forty % of this hole is because of consciously totally different labor selections (as an illustration, earlier retirement ages and extra trip and parental go away). An extra 30 % is pushed by persistently giant divides between totally different areas of Europe. Nonetheless, alongside the earnings distribution, earnings are larger in the US for the primary 9 deciles, whereas solely the underside 10 % of Europeans have larger earnings than these in the US.

Company Europe is falling behind as tech weak point permeates sectors

Company Europe’s long-standing weak point in tech is ever extra evident in as we speak’s figures. This hole has lengthy been thought of a results of specialization and aggressive benefit elsewhere—that Europe is robust in different sectors reminiscent of chemical compounds, supplies, and style, as an illustration—that means that the weak point is due to this fact not one thing to fret about. Nevertheless, that is now not true. Know-how is now permeating all sectors through transversal applied sciences reminiscent of synthetic intelligence (AI), the Bio Revolution, and the cloud.

Europe’s clear and well-known weak point in tech is the supply of a big and rising company efficiency problem

Knowledge present that Europe’s company efficiency is underwhelming in mixture. To grasp variations in company efficiency, we used McKinsey’s Company Efficiency and Analytics Software (CPAT) to look at a pattern of greater than 2,000 US and European corporations with income of greater than $1 billion. 

Between 2014 and 2019, giant European corporations had been 20 % much less worthwhile (measured by return on invested capital, or ROIC), grew revenues 40 % extra slowly, invested 8 % much less (capital expenditure relative to the inventory of invested capital), and spent 40 % much less on R&D than different corporations within the pattern.

A lot of the variations are observable in technology-creating industries, particularly ICT and prescribed drugs.





Collectively, these sectors account for 90 % of the ROIC hole, 80 % of the funding hole, 60 % of the expansion hole, and 75 % of the R&D hole (Exhibit 2).

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As know-how permeates all sectors and company scale benefits and winner-take-most dynamics enhance, Europe’s present strategy is now not tenable

ICT was once a sector; now it’s all over the place. The know-how base in-built ICT has spawned a spread of transversal applied sciences which can be spreading horizontally throughout most vertical sectors. Worth creation is shifting to those horizontal areas, with winner-take-most dynamics and community results in know-how creation and scale benefits in know-how adoption. The World Financial Discussion board estimates that 70 % of the brand new worth created in the entire financial system over the subsequent ten years will likely be digitally enabled, a momentum additional accelerated by the COVID-19 pandemic (Exhibit 3).

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Europe’s lack of scale in transversal applied sciences jeopardizes its place in almost all sectors, together with present strongholds like automotive and luxurious items

The truth that Europe didn’t maintain tempo with the US within the first know-how wave centered on the web and software program now implies that Europe is in a weakened place in transversal applied sciences throughout sectors. Our evaluation seems at ten such transversal applied sciences on which Europe’s future efficiency and prosperity hinge. Europe leads on solely two of the ten (Exhibit 4).

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To present only a few examples, in quantum computing, 50 % of the highest ten main tech corporations investing on this transversal know-how are in the US, 40 % in China, and none in within the EU. In 5G, a key ingredient of the way forward for connectivity, China captures almost 60 % of exterior funding, with the US at 27 % and Europe at 11 %. In AI, the US captured 40 % of exterior funding in 2015–20. Europe captured 12 % and Asia (together with China) 32 %. In biotech, Europe has a powerful science base and a strong pool of expertise, and it proved through the pandemic that it could innovate. Nevertheless, funding in biotech varies amongst areas. In 2018–20, the US spent $260 billion, Europe $42 billion, and China $19 billion.

In cleantech, Europe is extra formidable than most different areas on targets for the discount of carbon emissions by 2030 however is dropping floor within the subsequent wave of cleantech. European gamers maintain 38 % extra cleantech patents than corporations in the US, and greater than double the quantity in China, and have extra put in mature applied sciences per capita. General, nevertheless, Europe’s prospects of main on cleantech are fading. China leads on cleantech manufacturing in almost all areas, usually with market shares of greater than 50 %, and the US leads on most breakthrough applied sciences.

Europe’s lack of scale in transversal applied sciences jeopardizes its place in almost all sectors, together with present strongholds like automotive and luxurious items. In automotive, US producers account for near 70 % of all kilometers made by stage 4 totally autonomous automobiles.

The worth at stake is excessive, not just for development but in addition for sustainability, inclusion, and Europe’s strategic autonomy

At stake are usually not solely the efficiency of Europe’s corporations, its tech prowess, and its financial development and prosperity, but in addition its progress up to now on sustainability and inclusion. Though there are debates over whether or not decrease development is required to attain sustainability and arrest local weather change, the other argument is compelling: development strengthens confidence and creates a wholesome funding local weather to generate sustainability-related innovation and new earnings streams which can be wanted to pay for the vitality transition. Lagging development might, furthermore, undermine inclusion by limiting the pool of funds accessible to spend on social packages.

If Europe isn’t capable of enhance on transversal applied sciences, European corporations might miss out on a value-added alternative of €2 trillion to €4 trillion a 12 months by 2040—worth that might translate into larger wages, higher healthcare, extra sustainability investments, and so forth. The worth at stake equates to 30 to 70 % of Europe’s forecast GDP development in GDP between 2019 and 2040, or one proportion level of development a 12 months.





For additional context, this might be equal to 6 instances the quantity wanted to transition to net-zero emissions.





And it might quantity to about 90 % of all present social expenditure in Europe (Exhibit 5).

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There was a lot dialogue about vitality dependence and autonomy, however world financial shifts intensify the necessity for strategic autonomy on important applied sciences. Technological autonomy is appropriate with open economies and world collaboration. It may be achieved through a number of unbiased world sourcing choices in addition to a powerful footprint of worldwide main corporations in Europe. However it should additionally require functionality buildup by, and scaling of, European corporations. As we speak, as an illustration, semiconductors produced in Europe meet simply 9 % of European demand, and European corporations have solely about 10 % of the market throughout the semiconductor worth chain. And Europe has no market participant with a market share in infrastructure-as-a-service of greater than 1 %.

European determination makers and firms must go on the offensive for a step change on technological capabilities and competitiveness

Europe can, and will, proceed to leverage its many strengths. They embrace its high-quality training techniques, which produce main science, know-how, engineering, and math (STEM) expertise in addition to among the best vocationally educated employees.





Europe can also be essentially the most open and related giant financial system on this planet.





Nevertheless, the stakes are so excessive for Europe that call makers could wish to think about breaking new floor and reevaluating trade-offs in a means that has been uncomfortable heretofore.

As winner-takes-most dynamics unfold, Europe must play at higher scale and pace and to stage the taking part in area for its corporations to compete

Because the sources of competitors—and development—shift towards disruptive innovation and intangibles, a winner-takes-most dynamic emerges wherein scale, pace, and established tech ecosystems are more and more very important. A altering geopolitical panorama complicates and deepens that problem.

On this context, a spread of challenges put Europe at a drawback. Amongst them, 4 stand out and mutually reinforce each other: fragmentation and lack of scale; lack of established know-how ecosystems; much less developed risk-capital funding; and a regulatory atmosphere that could possibly be extra supportive of disruption and innovation.

These challenges are well-known amongst Europe’s leaders, who keenly admire what must be achieved on the institutional stage. Many initiatives are being designed and launched. Within the EU, the €95 billion Horizon Europe program, the Sensible Specialization initiative, the Essential Initiatives of Widespread European Curiosity framework, and the Digital Decade program are however a number of current examples.

But if Europe desires to deal with its company efficiency hole and keep away from a slow-motion disaster unfolding through the years forward, it might usefully think about one query: does the sum whole of all of the initiatives below means and deliberate not solely match the dimensions of what main areas are doing however exceed it, and due to this fact allow catch-up from as we speak’s weaker place?

To assist European corporations to compete, Europe might reevaluate trade-offs on 11 coverage and regulatory initiatives

As a thought starter, we provide 11 initiatives that might kind a part of an built-in bundle to vary the principles of the sport for European corporations and overcome a spread of handicaps (Exhibit 6). They’d allow corporations to construct scale and appeal to scale-up funding, function at larger pace and with higher levels of freedom, and stage the taking part in area with different areas and established corporations. Many have been matters of long-running debates and include main trade-offs, but this diagnostic suggests revisiting the present stance on them. The preliminary response to the invasion of Ukraine reveals that Europe can leverage its scale and transfer quickly when confronted with a extreme problem. The same strategy will even be wanted to deal with its slow-motion know-how and competitiveness disaster. We invite feedback and collaboration to progress these preliminary concepts.

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• Scale and scale-up funding. In transversal applied sciences the place scale of markets, corporations, and funding issues, might Europe enhance and pool its sources, develop a European company rule guide for high-growth corporations, and facilitate and encourage cross-border consolidation, together with by finishing the Single Market? May Europe amplify the pool of scale-up capital and think about pooling extra public procurement and R&D help amongst a coalition of the prepared? Europe may think about growing growth help to Central, Jap, and elements of Southern Europe.
• Velocity and ease. In sure breakthrough applied sciences, might Europe rebalance its regulatory strategy from a precautionary consumer-protection crucial to 1 that balances prices and advantages of speedy experimentation and disruptive innovation? May Europe think about creating fast-track regulatory approval and decision-making processes, significantly within the case of disruptive innovation? And what scope is there to embrace quicker labor reallocation and reskilling within the face of spreading disruption?
• Degree taking part in area. The place may state intervention help the competitiveness of European corporations in a world context? May Europe think about guaranteeing a stage taking part in area for smaller corporations round pure digital monopolies? May Europe provoke a debate about the way to defend nascent technology-savvy corporations earlier than they face the total power of global-scale opponents? Lastly, might Europe think about methods of turning into a stronger magnet for expertise?

Whether or not the aggressive enviornment improves or not, company leaders and homeowners must step up their sport to take dangers and compete

Even when coverage and regulation create a extra enabling atmosphere wherein European corporations can compete, they, too, must step up, creating scale and agility with a purpose to develop and succeed not solely on the nationwide and regional ranges, however globally. Choices to think about embrace the next:

• Set stretch long-term targets and modify incentives. Within the present atmosphere of disruptions, companies must intention past their incumbent enterprise, develop a imaginative and prescient for world management ten to twenty years out, and take dangers and deploy capital and R&D funding commensurate with that imaginative and prescient. European corporations and their boards might additionally think about adjusting govt and worker compensation to raised align with these visions and the risk-taking wanted. As we speak, solely about 5 % of the private-sector workforce in Europe has some type of worker possession, in contrast with about 20 % in the US.
  
  
  
  
  
  The biggest European tech corporations have already taken this strategy.
• Leverage programmatic M&A and alliances to amass the dimensions and capabilities wanted. This would come with cross-border European and world consolidation, together with—painfully—sell-side M&A the place world management is out of attain. It might additionally embrace utilizing vertical and capability-based acquisitions to ramp up the event of innovation strengths and ecosystems, as an illustration utilizing company enterprise capital. Corporations also needs to be proactive in in search of and creating cross-sector alliances to speed up the event of transversal applied sciences. Corporations and entrepreneurs can even search to arrange new disruptors.
• Put money into innovation and know-how governance and capabilities at scale and tempo. Corporations might want to implement agile and extra customer-centric innovation governance capable of take care of higher-risk, long-term tasks. They might want to discover or reallocate funds for long-term innovation and enterprise growth at a bigger scale than they used to. They usually might want to construct abilities.

European nations have been leaders on sustainability and inclusion. They’re now involved with the safety of provide chains, vitality, meals, and protection. How a lot ought to the area additionally fear about its company and know-how hole, which is jeopardizing future development and strategic autonomy—and when? Can the momentum of widespread motion triggered by warfare in Ukraine now additionally present the impetus to make the trade-offs wanted for know-how and competitiveness which have lengthy felt troublesome?

Extra work will seemingly be wanted to find out the way to deal with Europe’s gaps in company efficiency and innovation intimately and in observe, know-how by know-how and sector by sector, constructing resilience into the European mannequin for the long run. This text marks the beginning of a McKinsey initiative to assemble insights throughout Europe in an effort to make a contribution to addressing these questions.