February 22, 2024

Omniverse Universe

Future Technology

Addressing the European know-how hole

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

Europe as it’s immediately has been solid in instances of disaster. The European Union (EU) was created in response to the ravages of World Battle II. The autumn of the Berlin Wall marked the beginning of a interval of financial catching up by economies in Central and Japanese Europe. The 2008 monetary disaster and the eurozone disaster that adopted led to extra monetary cooperation amongst European international locations. The COVID-19 pandemic then triggered a better degree of fiscal coordination by way of the NextGeneration EU fund.

Most just lately, the Russian invasion of Ukraine not solely is a humanitarian disaster however has uncovered a variety of fragilities, from meals safety and power to protection. The conflict has accentuated the fact that resilience relies on a robust financial system with strategic autonomy in these essential areas that has lengthy been taken with no consideration.


Addressing Europe’s know-how hole

Know-how is pivotal, too. Until Europe catches up with different main areas on key applied sciences, it will likely be susceptible throughout all sectors on progress and competitiveness—compromising the area’s comparatively sturdy file on sustainability and inclusion—in addition to safety and strategic energy, hindering long-term resilience. Given seismic occasions inside its personal continent, a sturdy Europe is arguably wanted greater than ever. But to make {that a} actuality would require the area to handle a slow-motion competitiveness disaster that has quietly been unfolding for 20 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 indicate the identical resolve and collaboration as they initially displayed of their response to the conflict 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 progress in info and communications know-how (ICT) and on different disruptive improvements.

ICT and different tech sectors have spawned a variety of transversal applied sciences, that are spreading horizontally throughout sectors and figuring out aggressive dynamics. This analysis seems to be 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 offer only one instance, Europe has been a frontrunner 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 may very well be at stake by 2040—worth that would generate wages, employment, funding, and financial progress to the broader good thing about society. To place the estimated worth at stake into perspective, that may be equal to 30 to 70 % of Europe’s forecast GDP progress between 2019 and 2040, or one share level of progress a 12 months; six instances the gross quantity wanted in Europe to realize 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 progress, inclusion, and sustainability, and its strategic autonomy and voice on the earth.

Europe can proceed to construct on its strengths. Its socioeconomic mannequin has served nicely so far. But when corporations are to play on the scale and pace wanted to compete in a world by which 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 immediately’s prime quality of life for a lot of of Europe’s residents is preserved for the long run.

Europe has traditionally had a robust file on sustainability and inclusion, with a blended image on progress

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

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

Europe is a frontrunner on sustainability and inclusion, at the least in Northern and continental Europe, our evaluation exhibits (Exhibit 1). When Europe works, it really works nicely. Nevertheless, the area’s efficiency on progress is much less robust. As in america, per capita GDP progress was sluggish over the previous 20 years. The per capita GDP of Europe immediately is 30 % beneath that of america. That hole had been narrowing however is not doing so.

Europe has been a leader on sustainability and inclusion, but the trajectory of macroeconomic growth is a concern.

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

Each emissions per capita and emissions per unit of GDP have decreased sooner in Europe than in america since 1990. Europe has additionally pledged to realize web zero carbon emissions earlier than different areas.

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

It’s 41 in america. On social mobility, all high ten international locations within the Social Mobility Index printed by the World Financial Discussion board are European.

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

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

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 immediately’s figures. This hole has lengthy been thought of a results of specialization and aggressive benefit elsewhere—that Europe is robust in different sectors corresponding to chemical substances, supplies, and vogue, as an illustration—which means that the weak point is subsequently not one thing to fret about. Nevertheless, that is not true. Know-how is now permeating all sectors through transversal applied sciences corresponding to synthetic intelligence (AI), the Bio Revolution, and the cloud.

Know-how is now permeating all sectors through transversal applied sciences corresponding to synthetic intelligence, the Bio Revolution, and the cloud.

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

Information present that Europe’s company efficiency is underwhelming in mixture. To know 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, massive 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.

Many of the variations are observable in technology-creating industries, particularly ICT and prescription 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).

Corporate Europe’s performance is not on a par with that of US counterparts largely due to tech-creating industries.

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

ICT was once a sector; now it’s all over the place. The know-how base in-built ICT has spawned a variety of transversal applied sciences which might 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 following ten years can be digitally enabled, a momentum additional accelerated by the COVID-19 pandemic (Exhibit 3).

There are over 60 future arenas of competition at the intersection of transversal technologies and sectors.

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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 hold tempo with america 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 to be 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).

Out of ten transversal technologies, such as AI, quantum computing, and cloud, Europe leads on two.

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

The truth that Europe didn’t hold tempo with america 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.

In cleantech, Europe is extra bold 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 america, and greater than double the quantity in China, and have extra put in mature applied sciences per capita. Total, nonetheless, 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 america 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 degree 4 absolutely autonomous autos.

The worth at stake is excessive, not just for progress 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 progress and prosperity, but in addition its progress so far on sustainability and inclusion. Though there are debates over whether or not decrease progress is required to realize sustainability and arrest local weather change, the other argument is compelling: progress strengthens confidence and creates a wholesome funding local weather to generate sustainability-related innovation and new earnings streams which might be wanted to pay for the power transition. Lagging progress might, furthermore, undermine inclusion by limiting the pool of funds accessible to spend on social packages.

If Europe isn’t in a position to 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 would translate into greater wages, higher healthcare, extra sustainability investments, and so forth. The worth at stake equates to 30 to 70 % of Europe’s forecast GDP progress in GDP between 2019 and 2040, or one share level of progress 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).

US companies’ market-to-book ratios are almost double and equity is 30percent higher than those of European counterparts.

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There was a lot dialogue about power dependence and autonomy, however world financial shifts intensify the necessity for strategic autonomy on essential 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 robust footprint of worldwide main corporations in Europe. However it’s going to 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 %.

A lot dialogue has been going down about power dependence and autonomy, however geopolitical shifts additionally intensify the necessity for strategic autonomy on essential applied sciences.

European choice makers and corporations have to 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 schooling methods, which produce main science, know-how, engineering, and math (STEM) expertise in addition to a few of the best vocationally educated staff.

Europe can also be essentially the most open and related massive financial system on the earth.

Nevertheless, the stakes are so excessive for Europe that call makers could wish to contemplate 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 better scale and pace and to degree the enjoying discipline for its corporations to compete

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

On this context, a variety of challenges put Europe at an obstacle. 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 may very well be extra supportive of disruption and innovation.

These challenges are well-known amongst Europe’s leaders, who keenly respect what must be carried out on the institutional degree. Many initiatives are being designed and launched. Within the EU, the €95 billion Horizon Europe program, the Good Specialization initiative, the Vital Tasks of Frequent European Curiosity framework, and the Digital Decade program are however just a few current examples.

But if Europe desires to handle its company efficiency hole and keep away from a slow-motion disaster unfolding through the years forward, it might usefully contemplate one query: does the sum complete of all of the initiatives underneath means and deliberate not solely match the size of what main areas are doing however exceed it, and subsequently allow catch-up from immediately’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 would type a part of an built-in bundle to alter the principles of the sport for European corporations and overcome a variety of handicaps (Exhibit 6). They’d allow corporations to construct scale and appeal to scale-up funding, function at greater pace and with better levels of freedom, and degree the enjoying discipline 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 exhibits that Europe can leverage its scale and transfer quickly when confronted with a extreme problem. The same strategy may even be wanted to handle its slow-motion know-how and competitiveness disaster. We invite feedback and collaboration to progress these preliminary concepts.

Four standout, intertwined challenges can be addressed through policies in three areas.

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  • Scale and scale-up funding. In transversal applied sciences the place scale of markets, corporations, and funding issues, might Europe improve and pool its sources, develop a European company rule e-book 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 contemplate pooling extra public procurement and R&D assist amongst a coalition of the keen? Europe may contemplate rising growth assist to Central, Japanese, and elements of Southern Europe.
  • Pace and ease. In sure breakthrough applied sciences, might Europe rebalance its regulatory strategy from a precautionary consumer-protection crucial to at least one that balances prices and advantages of fast experimentation and disruptive innovation? May Europe contemplate creating fast-track regulatory approval and decision-making processes, notably within the case of disruptive innovation? And what scope is there to embrace sooner labor reallocation and reskilling within the face of spreading disruption?
  • Stage enjoying discipline. The place may state intervention assist the competitiveness of European corporations in a world context? May Europe contemplate guaranteeing a degree enjoying discipline for smaller corporations round pure digital monopolies? May Europe provoke a debate about learn how to shield nascent technology-savvy corporations earlier than they face the total drive of global-scale opponents? Lastly, might Europe contemplate methods of turning into a stronger magnet for expertise?

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

Even when coverage and regulation create a extra enabling atmosphere by which European corporations can compete, they, too, have to step up, creating scale and agility with the intention 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 regulate incentives. Within the present atmosphere of disruptions, firms have to goal 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 contemplate adjusting government and worker compensation to higher align with these visions and the risk-taking wanted. As we speak, solely about 5 % of the private-sector workforce in Europe has some form of worker possession, in contrast with about 20 % in america.

    The most important European tech corporations have already taken this strategy.
  • Leverage programmatic M&A and alliances to amass the size 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 could 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. Firms must also be proactive in searching for and creating cross-sector alliances to speed up the event of transversal applied sciences. Firms and entrepreneurs may search to arrange new disruptors.
  • Spend money on innovation and know-how governance and capabilities at scale and tempo. Firms might want to implement agile and extra customer-centric innovation governance in a position to take care of higher-risk, long-term initiatives. They might want to discover or reallocate funds for long-term innovation and enterprise growth at a bigger scale than they used to. And so they might want to construct abilities.

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

Extra work will doubtless be wanted to find out learn how 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 collect insights throughout Europe in an effort to make a contribution to addressing these questions.