In The future of European competitiveness, Mario Draghi argues that Europe’s heavy regulatory burden hampers productivity growth, particularly by slowing technological innovation. He advocates for deregulation and fiscal stimulus, but member states are likely to take divergent approaches, as the causes of weak productivity vary across countries.
Since the mid-90s, the European Union has introduced increasingly restrictive policies regarding the digital realm. Key milestones include the introduction of the GDPR in 2018, the Digital Services Act in 2022, the Digital Markets Act in 2023, and most recently, the AI Act. These regulations are intended to impose European values on the digital economies, but there’s also hope they help to strengthen the international competitiveness of European companies. Unfortunately the opposite seems to be the case.
For example, a recent study on the impact of GDPR found that companies that had to comply with the regulation experienced an 8 percent drop in profits and a 2 percent drop in revenue. The negative impact on profits was nearly double for most European tech companies, most of which are relatively small and struggle to comply. Large tech companies, which are mostly non-European, were relatively unaffected.
Tighter European labor market regulations also stifle innovation. According to a study by Bocconi University, the profitability of high-tech companies, which suffer from high bankruptcy rates, depends heavily on the cost of restructuring, which in turn is determined by worker protection legislation. The researchers estimate that restructuring costs are about 10 times higher in countries with high labor protection, such as Western Europe, than in countries with low labor protection, such as the United States.
While strict European regulations are certainly a drag on labor productivity, other factors also play an important role, as the figure below shows. In Germany, for example, productivity has declined due to a slowdown in the growth of international trade, while in France misallocation of capital – including government protection of certain sectors and companies – plays an important role.
These differences between EU countries make it more likely that each country will seek solutions tailored to the specific causes of its productivity problems. The rise of (partly populist) movements in favor of less EU legislation reinforces this development. The rejection of a European capital union in April 2024 fits into this trend.
Countries will therefore increasingly go their own way. Germany, for example, sees the solution in more international trade, since "less trade" is partly to blame for lower productivity growth. For example, the country is seeking a closer relationship with China, which is reflected in the increase in German direct investment in China between 2023 and 2024.
