Europe Embraces New U.S. Growth Model --- Following the path of America will require more government intervention in industrial and trade policy

"The European Union's economic planners might want to shout "U.S.A., U.S.A.!" Ironically, though, emulating America today would involve more state intervention.

The bloc's politics were shaken last week after Mario Draghi, the former European Central Bank president credited with saving the eurozone in 2012, published his long-awaited report on how to stop an economic stagnation that has been worsened by the competition posed by Chinese exports and the end of cheap Russian energy.

His demand for more joint debt has already been opposed by Germany, which is hardly a new controversy.

But this is a distracting political football. The crucial point of the report is that "the EU should aim to move closer to the U.S. example in terms of productivity growth and innovation," highlighting that no listed European company valued at more than 100 billion euros, equivalent to $111 billion, has been created in the past 50 years. In America, Apple, Microsoft, Nvidia, Amazon.com, Alphabet and Meta Platforms all surpass $1 trillion.

What does moving closer to the U.S. mean, though? Draghi emphasized the importance of the technology sector, saying it is responsible for almost all of the U.S. productivity outperformance over the past 20 years. He argues that "Europe cannot afford to remain stuck" in old industries.

This "vertical" emphasis on a single sector is a big departure from the post-1980s status quo, which has exhorted free markets, entrepreneurship and "horizontal" policies meant to boost the entire European economy such as educating the labor force and building up infrastructure. This view is enshrined in the very foundation of the European Union, the 1992 Maastricht treaty.

Why the U.S. is more productive is an old question. It was raised in 1928 by Allyn Young, the American chair of the London School of Economics. In a speech, he denied that the gap had to do with U.S. companies being better run. "The largest domestic market in the world," he argued, meant that "productive methods are economical and profitable in America which would not be profitable elsewhere." Over time, this leads to the most complex industries sprouting there.

The takeaway is that firms will only make big productivity-enhancing investments if they operate in growth sectors where it makes sense. This is why Europe has a gap in nonconstruction investment rates relative to the U.S.: Its top three research spenders in recent times have consistently been petroleum-car companies. In the U.S., by contrast, big R&D spenders were in automobiles and pharmaceuticals in the 2000s, then in software and hardware in the 2010s and more recently in digital applications.

But nations can't easily move into these more-complex sectors, because increasing returns to scale create a natural barrier against any entrepreneurial challenger.

Indeed, today's world of "winner-take-all firms," entrenched trade imbalances and agglomeration in a few metropolitan areas can't be fully explained by comparative advantages, or even the impact of misaligned exchange rates and capital flows.

Nor can the history of any nation that ever attempted to catch up economically. During its own catch-up phase to the U.K. in the 19th century, the U.S. was an ardent user of industrial protectionism. More-recent successes like Japan and South Korea have relied heavily on favored sectors and export markets.

The U.S. was a champion of multilateral free trade in the second half of the 20th century, and it had ample incentives to do so until very recently. But America started to change its mind as China became a direct competitor. Industrial subsidies and a vast domestic market are now helping the Asian country flood global markets with electric vehicles, solar panels and other advanced technologies made at a cost that is unachievable for lower-scale Western competitors.

The response came first through Donald Trump's tariffs, and then President Biden's Chips and Science Act and Inflation Reduction Act, which shoveled federal money at the domestic semiconductor, electric-vehicle and clean-energy industries. Despite growing pains, they have resulted in a boom in manufacturing construction.

But the EU has failed to react to the same extent, paralyzed by fractured governance, Germany's corporatist interests in China and Russia and an acute case of believing its own free-market propaganda.

Draghi's image as the ultimate technocrat gives him a shot at changing this, while avoiding a destructively protectionist turn. To do so, the document proposes a trade policy based on "a case-by-case analysis" of what will enhance productivity growth, and an industrial strategy based on picking sectors, rather than specific winners.

In the case of semiconductors, it earmarks foundries focused on European strengths, such as automobiles and network equipment, as ripe for subsidies. In the space economy, it promotes targeted preference rules to scale up domestic companies. In solar technology, it suggests pushing back against Chinese trade practices and overcapacity, but also warns that retaliating too harshly could jeopardize the bloc's trade surplus in wind tech.

The so-called Washington consensus of the late 20th century preached free trade and laissez-faire economic management. Today, being Team U.S.A. means targeted protectionism and aggressive subsidies for high-tech sectors." [1]

The Global South does not and will not buy technologically backward and expensive US products. The Global South does not and will not buy technologically backward and expensive EU products too. Imitating the failed US strategy is a poor idea for Draghi.

1. Europe Embraces New U.S. Growth Model --- Following the path of America will require more government intervention in industrial and trade policy. Sindreu, Jon.  Wall Street Journal, Eastern edition; New York, N.Y.. 17 Sep 2024: B.11.