The EU is a political and economic union of twenty-eight European nations with a collective GDP of 16.5 trillion USD  and a population exceeding half a billion. Yet, despite high standards of living, education, and technological access, innovation in the EU trails far behind that of the United States (US).
The Global Innovation Index ranks the US the fifth most innovative country in the world, above twenty-five of the twenty-eight EU member states. Bloomberg’s Innovation Index places ranks the US in sixth place, above twenty-six EU members. The World Economic Forum finds that the US beats out all but one EU member state.
And the data matches the rankings. Look at patent applications: at the time of the signing of the Maastricht Treaty in 1992 – which lead to the creation of the EU – both the US and EU had about 90,000 annual patent applications. By 2014, annual US patent applications had tripled to 285,000. But in the EU, annual patent applications barely rose, reaching 108,000 in 2014, a meager fifteen percent increase.
Research and development (R&D) tells the same story. R&D spending as a percent of GDP in the EU approaches 2%, 30% lower than in the US. In most EU countries, it is more difficult to start a business and bankruptcies – always a key concern for start-ups – take longer and cost more than in the US.
But perhaps the biggest factor inhibiting innovation in the EU is access to credit. Domestic credit to the private sector – resources provided by financial corporations to the private sector – is one-hundred percent of GDP in the EU. In the US, the figure is nearly two-hundred percent. The World Bank’s Doing Business report finds that the US is ranked 2nd in the world for credit access. The four largest Eurozone economies – Germany, France, Italy, and Spain – are ranked 28th, 79th, 59th, and 97th respectively.
A key source of financing for start-ups is venture capital because many commercial banks are unwilling to take on the risk of financing early stage businesses. In the US, venture capital investment totals 0.28% percent of GDP. That’s 10 times larger than France and Germany, 30 times larger than Spain, and over 130 times larger than Italy.
Former US Ambassador to the EU Stuart Eizenstat, speaking at the Atlantic Council in July 2016, noted that “There are very few starts-ups [in the EU] compared to the US. 80% of all private sector financing is from commercial banks. [There are] very few IPOs, hedge funds, private equity firms, and venture capital. The kinds of funds that are necessary for starts-ups and SMEs simply do not exist.”
The EU is cognizant of this disparity. Last year, European Commission President Jean-Claude Juncker began implementing the Investment Plan for Europe – dubbed the Juncker Plan – with the aim of boosting investment by 315 billion Euros over three years. A key component of the plan is the use of guarantees and loans to support riskier investments in research and innovation. However, according to a study from Bruegel in May, it is “still too early to judge” the efficacy of the program.
The EU is also looking to an economic partnership with the US. Such an agreement has been the dream of Atlanticists for decades. President Obama and European Commission President José Manuel Barroso announced the start of formal negotiations for the so-called Transatlantic Trade and Investment Partnership in 2013. By July 2016, fourteen rounds of negotiation had taken place and diplomats on both sides of the Atlantic noted substantial progress.
A successful conclusion of TTIP – either within the self-imposed deadline of the end of Barack Obama’s presidency, or in the future – could help promote innovation within the EU. An important component of TTIP is facilitating cross-Atlantic capital flows. The negotiations are focusing on investor protections designed to reduce the uncertainty of international investment. In November 2015, the EU proposed a series of investor protections, including guarantees of due process, guarantees against discrimination and arbitrariness, fair compensation for losses in the event of war or civil conflict, greater restrictions on nationalization and expropriation, guarantees of unrestricted currency convertibility at market prices, and an investor-state dispute mechanism. As in all trade deals, there will be haggling over the details of this proposal – as we have already seen with the Investor State Dispute System (ISDS) – but both parties agree on the direction: an open and protected investment climate.
The US-EU investment relationship is already strong. The US is the largest source of EU inward FDI and the US is the largest recipient of EU outward FDI. In 2014, the stock of EU FDI in the US was two trillion Euros and the stock of US FDI in the EU was 1.8 trillion Euros. But TTIP can improve this already impressive level of investment, according to a study by the Center for Economic and Policy Research.
The authors of the study write that “any policy aiming to remove regulatory barriers to transatlantic investments can be expected to have a potentially very large impact.”
The study found that US firms face significant non-tariff barriers (NTBs) to investing in the EU, whereas EU firms investing elsewhere in the EU face comparatively lower NTBs. If the barriers facing US firms were reduced to the level facing intra-EU investment, the report indicates there would a ten percent increase of US FDI into Europe.
Additionally, the reduction of tariffs and NTBs in EU-US trade will likely incentivize EU firms to innovate since they will be in more direct competition with American firms. A 2016 study by ECORYS projected that US exports to the EU would increase by between 15.3-27% and EU exports to the US would increase by 22-35.7%. EU firms will feel pressure to increase R&D spending and advocate for more competitive regulatory policy.
The fate of TTIP is uncertain. Both in the EU and the US, there has been a public backlash against economic integration. The UK Referendum also raised doubts about the ability to complete the agreement by the end of the year – if at all. That being said, EU Trade Commissioner Cecilia Malmström and US Trade Representative Michael Froman have both reiterated their commitment to a successful conclusion of the partnership.
The causes of the EU’s innovation deficit are varied and will not be solved by any single EU mandate, reform, or international agreement. However, TTIP offers a unique opportunity for substantive progress. A successful conclusion of TTIP has the potential to significantly increase US FDI into the EU and give EU businesses an impetus to boost R&D spending. After years of high level talks, TTIP is nearing possible conclusion – and brings with it a promise to increase the dynamism and growth of the European economy.
Compliments of Nathaniel Rome at Penn Wharton