The European Union has fallen behind its economic peers and the gap will widen without urgent action. That message was delivered to policymakers by former European Central Bank chief Mario Draghi in a report titled The Future of European Competitiveness.

Released in two parts, the report explores the roots of Europe's productivity problems and highlights key sectors where the EU lags behind its global competitors. From innovation to venture capital, and industrial production, the findings paint a concerning picture for European leaders. 

The report reveals that Europe's economic growth has trailed the U.S. for over two decades. Draghi attributes this largely to Europe's lower labor productivity, which he argues stems from insufficient investment in innovation and infrastructure. 

Europe had nearly closed this productivity gap by the early 2000s, but divergence has since returned and steadily widened. According to the report, stagnating productivity is a primary factor behind slower income growth and weaker domestic demand in Europe. 

Falling behind

A central theme in the Draghi report is Europe's chronic underinvestment. 

Public and private investment as a percentage of GDP in the EU has already lagged behind China for decades but since 2010 it has sunk even beneath U.S. levels, a surprising and counter-intuitive development given Europe's traditionally larger role for government in economic affairs.

In critical areas like venture capital and technological innovation, too, Europe is falling far behind both the U.S. and China. While the U.S. and China are attracting the lion's share of global venture capital, Europe is trailing far behind. Only 5 percent of global VC funds are raised in the EU, compared to 52 percent in the U.S. and 40 percent in China. 

The gap becomes even more evident in the quantum computing sector, which is set to transform industries in the coming years. The report notes that out of the top 10 global tech companies investing in quantum computing, five are based in the U.S. and four in China - none are from Europe. This stark absence underscores Europe's shortfall in cutting-edge technology, where the stakes are high for future competitiveness.

China and the automotive industry

China has rapidly emerged as a global champion in key sectors, moving to higher value areas traditionally dominated by European companies, the Draghi report emphasizes. Over the past two decades, the share of sectors where China directly competes with euro-area exporters has surged from 25 percent in 2002 to nearly 40 percent today. 

In the automotive sector, the power of French and German brands has for some time been struggling against Japanese and South Korean exporters. But today, Chinese carmakers are making their presence felt on the global stage, especially in the growth sector of Electric Vehicles (EVs). In 2022, China accounted for 14 percent of vehicle imports into the EU, a sharp increase from just 3 percent five years earlier, as Chinese manufacturers have quickly established themselves as leaders in EV production. 

Meanwhile, Europe's automotive industry has experienced a significant decline, with EU-based vehicle production dropping by 25 percent since 2000. Despite substantial R&D investments by European automakers like Volkswagen and Daimler, Europe is struggling to compete with the rapid advancements coming from overseas.

A failure to accelerate the shift toward electric mobility could leave Europe with an obsolete internal combustion engine vehicles industry, the report cautions. It also emphasizes that while Chinese companies have made significant strides in high-tech sectors like AI and quantum computing, Europe's fragmented efforts in these areas are limiting its ability to compete at the same scale.

A radical proposal

Perhaps the most striking recommendation from the Draghi report is the call for a dramatic increase in investment. 

To revive competitiveness, the report suggests that Europe needs to invest between $840 billion and $890 billion annually, equivalent to between 4.4 percent and 4.7 percent of EU GDP. This investment would represent a significant departure from the multi-decade decline in spending that has characterized Europe's major economies since the 1970s.

Achieving this level of investment would bring Europe's spending closer to the post-World War II era, a period of rapid growth driven by both private and government investment. However, realizing this vision will require overcoming resistance from fiscally conservative member states, particularly Germany, which has historically opposed new common debt and large-scale public borrowing. 

In addition, it would threaten conflicts with the bloc's budget rules which limit state borrowing.

Strategic reorientation

The Draghi report makes it clear: without a fundamental shift in policy toward innovation-driven, investment-led growth, Europe risks falling further behind. 

It argues that the status quo - defined by low levels of public and private investment and fragmented markets - offers no path to reversing the continent's economic decline. Whether the EU can overcome political hurdles and implement the necessary reforms will determine whether it can rise to this "existential challenge."

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