Fredrik Erixon and Oscar Guinea / Mar 2026
Image: Shutterstock
Brussels has returned to its habitual routine of quarrelling about basic industries and state aid to big industrials. Various versions of ‘European preference’ and ‘Made in Europe’ policies are being floated. There is even a proposal for raising the share of the manufacturing sector in Europe’s value added – an outcome that can only happen if the growth of other sectors is artificially constrained.
Increasingly, we see two parallel worlds in the competitiveness debate. One is the real world, where Europe struggles to keep up with frontier innovation and offer a hospitable climate for experimenters and investors. The other is a narrative world, where Europe’s main competitiveness problem is allegedly found in the shrinking industrial sector. While some industrial sectors face genuine challenges with high energy costs, Europe can only connect with modern streams of productivity growth if it focuses on the real world.
Our argument is a simple one that can be summarised in a single sentence: Europe doesn’t have an industry problem, it has a technology problem!
This observation was plainly laid out in Draghi’s Competitiveness Report. The EU is less active in sectors where much of the productivity growth has originated in recent years, notably the Information and Communication Technology (ICT) sector and large-scale digital services.
The evidence of Europe’s technology lag has been accumulating for decades. Long-term patterns in upstream Research & Development (R&D) funding illustrate this problem. Europe under-invests in R&D relative to countries at the technological frontier. By 2021, US R&D expenditure was 77 per cent larger than the EU’s, and the gap is widening. Only seven out of 126 first-level EU regions have R&D spending as a share of GDP that exceeds the US average.
Crucially, this shortfall reflects a structural problem. While EU industrial R&D is broadly comparable to the US, the divergence is almost entirely in services. By 2023, services R&D accounted for just 15.3 per cent of total corporate R&D in the EU, compared to 43.5 per cent in the US. Manufacturing still dominates EU business R&D. In the US, computer programming and software account for over 34 per cent of total business R&D; in the EU, they account for barely 6 per cent. The sectors driving the largest productivity gains are precisely those where European firms are most absent.
Figure: Corporate R&D spending in the industry and services sectors as a share of GDP for the EU-27 and the US, 2003–2023 (percentage of GDP)
Source: ECIPE calculations based on EU Industrial R&D Investment Scoreboard panel data.
This structural lag is further compounded by recent trends in Artificial Intelligence. In 2024, the US private sector invested over USD 110 billion in AI, compared to USD 13 billion in the EU’s top-performing member states. The consequences are visible in model development and compute capacity, where Europe trails significantly behind both the US and China.
However, it would be a mistake to blame the EU’s ICT sector. Where it is allowed to grow, Europe’s digital economy is in good health. The information and communication services sector contributes more to productivity growth and has higher earnings per employee than manufacturing. Yet, Europe is falling behind because modern, high-productivity services do not contribute enough to general economic growth.
A significant factor exacerbating this problem is regulation. High regulatory restrictions affect the extent to which firms can adopt digital technologies. The amount of EU regulation in the digital sector has grown at a remarkably fast clip. Regulations such as the General Data Protection Regulation (GDPR), the Digital Markets Act (DMA), and the Artificial Intelligence Act (AI Act) are complex and ambiguous, generating significant legal uncertainty and economic costs.
These regulations impact what economists call endowments. In the digital economy, the key endowments are data and digital competencies. When regulation restricts access to these endowments, it does not merely raise compliance costs; it reshapes what firms can produce and where they do it. It is no secret that EU regulation has led firms to pause the introduction of new digital services in Europe and shift European investment towards jurisdictions – outside the EU – that have adopted more proportionate and pragmatic approaches to regulating digital markets.
There are now several reform opportunities to build on. The European Parliament has just voted to pause and reform the AI Act – a regulation that dulled many innovative projects in Europe before it was implemented. Some initial reforms of the GDPR have been tabled in the Digital Omnibus. The European Commission is currently consulting on its digital fitness check. Since last summer, the DMA has been under review and the Commission now has an opportunity to propose improvements.
It is also these three regulations – GDPR, the DMA, and the AI Act – that have had the most damaging effect on Europe’s digital endowments and the opportunity to use them. The GDPR saddled Europe with old data applications and a data market that was outpaced by other developed regions in the world. While antitrust actions against Big Tech have often been justified, the DMA has confused many markets with forced interoperability standards – often in conflict with data privacy demands under GDPR and cyber resilience rules. The result has mostly been that new services have not been introduced in Europe.
This is Europe’s challenge. We are in a technological shift, and competitive relations in the world are defined by the creation and use of new endowments. Right now, Europe is holding its endowments back by a fanciful idea that it can regulate firms and markets harder, deeper, and faster than anyone else – without there being negative consequences. This idea, however, is no longer holding up.
