Draghi and Letta’s proposals to reform competition policy: A step backwards for European innovation

Two former Italian prime ministers, Enrico Letta and Mario Draghi, have recently published reports painting a dire picture of the EU’s economic prospects. Europe’s workforce is aging faster than the US’s. That means Europe can no longer afford to simply keep pace with the US in productivity growth – much less continue to lag behind. To become more productive, established European firms must get better at using new technologies, while small innovative firms need more opportunities to grow.

So far, so sensible. But Letta and Draghi both conclude that EU competition policy is a barrier to innovation and growth, and that it needs reform – a position now adopted by Commissioner-designate for competition Teresa Ribera. Adjusting competition policy, however, risks making Europe’s poor record on innovation even worse.

On its face, Letta and Draghi’s argument seems sound. Europe’s competition policy has, over recent decades, mostly been tougher than that of the US: more willing to block mergers and to punish dominant firms for abusing their positions. This has helped keep costs low in Europe: businesses in Europe tend to have more direct competitors and to be less profitable than US equivalents, which suggests European consumers get a good deal. However, competition was supposed to not only force firms to keep their prices low, but also to pressure them to innovate. European businesses are making fewer productive investments than US ones, however, and are investing far less in research and development. In the long run, innovation benefits consumers much more than lower prices do.

Many economists might argue that EU competition policy is therefore too tough. If too many small firms compete neck-and-neck, they may focus too much on incremental improvements (like those that cut costs) rather making large bets on more radical and disruptive innovations.There are two much bigger hurdles to EU innovation. The first is that EU firms rely far more on bank lending which requires short-term return on investment. But investing in technology often requires a ‘trial and error’ approach. As a result, small European firms invest far less in adopting technology than equivalently sized American firms. This mostly made sense in the industries where Europe was strongest, such as production of vehicles and mechanical equipment – which are mostly mature markets where radical innovation had seemed unlikely, unlike in ICT where US firms predominate.

But the EU now needs to muscle in on high-tech, disruptive industries – and even the EU’s supposedly safe, mature industries like energy and car manufacturing have become vulnerable to radical disruption from technological advances like batteries and electric vehicles.

Both Draghi and Letta therefore suggest a mix of reforms to the bloc’s competition policy. Their overall vision is to allow firms to consolidate, even if that means less choice in Europe. For example, Draghi explicitly says firms should be allowed to merge even if this would lead to higher prices for Europeans, in order to help those firms compete in foreign markets.

Yet competition policy is hardly the culprit for Europe’s lack of investment or innovation. Merger reviews can barely become more lax – the EU has prohibited only a tiny handful of deals in the last ten years. And the EU’s high fines for alleged antitrust violations have hardly changed investors’ enthusiasm for US big tech firms.

There are two much bigger hurdles to EU innovation. The first is that EU firms rely far more on bank lending which requires short-term return on investment. As a result, small European firms invest far less in adopting technology than equivalently sized American firms. The second is that Europe lacks a properly functioning single market. This means many potentially successful European firms fail to rapidly expand across the entire EU, much less become globally successful like US companies do.

To be fair, Letta and Draghi acknowledge that competition policy should not be reformed in isolation, and Draghi proposes nuanced reforms, with safeguards to stop mergers that would harm European consumers. But their recommendations miss the political reality. Improving access to capital and developing the single market are long term projects, with many political hurdles. But there zealous advocates of radical reforms to competition policy, many of whom want to move quickly and will disregard Draghi’s caution.

Competition reforms therefore risk creating a competition policy which is suitable for the high-innovation economy Europe wants – but not the fragmented and capital-constrained economy it will remain stuck with. This risks the worst of both worlds: the EU would be stuck with America’s high prices – but will still lack the US’s level of innovation and business investment.

Even worse, reforms will probably impact the markets where reforms are least needed. For example, there is much talk of loosening merger policy in telecoms – a mature market where innovation relies heavily on slow-moving international standards, and where EU competition policy has worked well. In contrast, Draghi and Letta applaud the EU’s tough approach in high-tech sectors like digital services, which disruption can happen more quickly. With Trump about to return to the White House, and willing to retaliate against perceived slights to US companies, can the EU afford a competition policy which seems designed to help European firms while constraining US champions?

Europe must make radical changes to its economic model to become more innovative – and both Draghi and Letta propose many sensible reforms to help achieve this. Their proposals to reform competition policy, however, are misplaced. Letta and Draghi understand that competition policy alone cannot reshape Europe’s economy – but their reports are ammunition to the EU’s political leaders who may believe otherwise.

Zach Meyers is assistant director of the Centre for European Reform.