If Europe can’t become more productive, it will not be able to finance its social model and will have to scale back some, if not all, its ambitions, according to Mario Draghi.

The former European Central Bank president and Italian prime minister was tasked a year ago to prepare a report on his vision for the future of European competitiveness.

The much-anticipated 400-page report will potentially be a blueprint to help Ursula von der Leyen develop the new Clean Industrial Deal within the first 100 days of her new mandate.

Restoring productivity growth is critical to reverting a trend that started early this century: slow growth and eroding global competitiveness, the report warns. Without increasing productivity, the EU will have to choose.

“Europe’s fundamental values are prosperity, equity, freedom, peace and democracy in a sustainable environment. The EU exists to ensure that Europeans can always benefit from these fundamental rights,” says Draghi. “If Europe can no longer provide them to its people – or has to trade off one against the other – it will have lost its reason for being.

Areas for action
Despite the gloomy warnings, Draghi offers three priority areas for action to reignite growth, alongside several recommendations. First, he says Europe must “profoundly refocus its collective effort” on closing the innovation gap with the US and China, especially in advanced technologies.

“Europe is stuck in a static industrial structure,” Draghi claims. “The problem is not that Europe lacks ideas or ambition… we are failing to translate innovation into commercialisation, and innovative companies that want to scale up in Europe are hindered at every stage by inconsistent and restrictive regulations.”

Secondly, there needs to be a “joint, coherent plan” for decarbonisation and competitiveness. Decarbonisation will be an opportunity for Europe, but if it fails to coordinate policies, there’s a risk that decarbonisation could instead become an obstacle to both competitiveness and growth.  

Finally, the third area of action is to increase security and reduce dependencies. With geopolitical instability rising, insecurity becomes a threat to growth and freedom. And Europe is particularly exposed given its reliance on a handful of suppliers for critical raw materials, especially China.

“We will need a genuine EU ‘foreign economic policy’,” Draghi says, noting the EU needs to coordinate preferential trade agreements and direct investment with resource-rich nations, build up stockpiles in selected critical areas, and create industrial partnerships to secure the supply chain of key technologies. “Only together can we create the necessary market leverage to do all this,” he argues.

Draghi suggests that the increasingly individual approach of member states to industrial policies is standing in the way, and Europe “is falling short.” There are common objectives but not joined-up policy actions, he says. An example is the EU’s claimed support for innovation while European companies are hit by additional regulatory burdens.

“Europe is wasting its common resources” and it “does not coordinate where it matters,” he continues. There must be a high degree of coordination between national and EU efforts, but the lengthy and slow legislative process in the bloc gets in the way. According to the report, the average time for new laws to be passed in the EU is about 19 months – from the European Commission proposal to the signing of the adopted act.

Critical minerals
With geopolitical stability waning, dependencies are turning out to be vulnerabilities. Brussels identified 34 critical raw materials and 16 strategic raw materials last year. However, its twin dependence on both mining and refining threatens its green and digital transitions.

According to the report, the EU’s share of the global production of most critical raw materials is lower than 7%. In certain cases, the EU is highly dependent on one or two countries, like in the case of rare earths and graphite – both of which are dominated by China. Looking more downstream, refining is even more concentrated.

CONCENTRATION OF EXTRACTION AND PROCESSING OF CRITICAL RESOURCES

Source: The future of European competitiveness

With limited supply diversification, markets such as the EU are more vulnerable. Since 2019, market restrictions increased fivefold globally, the report states. China’s number of restrictions alone grew by a factor of nine between 2009 and 2020, making it the country with the most extensive array of export restrictions on critical raw materials. That’s also the country that dominates most of the supply chain of such materials and downstream products such as batteries and electric vehicles.

To complement the Critical Raw Materials Act (CRMA), the report suggests the EU should prioritise a dedicated platform to deliver on the EU strategy and leverage market power; develop financial solutions to support the value chain; further promote the untapped potential of domestic resources; create a single market for waste and recycling; among others. In addition to simplifying permitting and boosting funding, Draghi also recommends the creation of a “G7+ Critical Raw Materials Club” where resource-intensive and resource-rich countries collaborate to diversify supply.

This sort of ‘friend-shoring’ strategy would include free trade agreements; joint R&D activities; a combination of investments for downstream and energy capacities; and a long-term perspective on fair prices through offtake deals of price revision provisions.

Contracts-for-difference, which already support hydrogen development in certain European countries, could also be explored to support private investment.

Clean technologies
The EU is one of the world’s largest markets for clean technologies – such as hydrogen and electrification – with China and the US as its main competitors. However, even though the EU has strong innovation potential, Draghi highlights its “inability to scale up.” Higher manufacturing costs, longer permitting and construction lead time, plus red tape are often cited as obstacles to scaling up.

With limited manufacturing capability domestically, the EU is increasingly relying on imports to satisfy its rising demand. For example, despite its legacy strength in lead-acid battery production, the region has only achieved marginal manufacturing capacity for lithium-ion batteries and components. The report estimates a 6.5% share of the global production of battery cells.

In the case of electrolysers, the EU holds technological leadership in the segment but does not yet produce at giga scale. “Electrolyser production requires at least 40 raw materials and the EU currently produces just 1-5% of these domestically,” the report points out.

CLEAN TECHNOLOGY MANUFACTURING CAPACITY BY REGION 

Source: The future of European competitiveness

“Despite the EU’s ambition to maintain and develop clean tech manufacturing capacity, there are multiple signs of an evolution in the opposite direction, with EU companies announcing production cuts, shutdowns and partial or full relocation.”

The report says overall public financial support in the EU for clean tech manufacturing is less generous, less predictable and with a lower aid intensity than the US IRA.

Some of the recommendations made to counter these negatives include the introduction of minimum local content quotas in public procurement and in contract-for-difference auctions; streamlining access to EU funding; increasing the level of resources; extending support to opex; and optimising foreign direct investment with knowledge transfer clauses and protecting intellectual property rights.

Automotive
Similarly, the EU is seeing its traditional leadership and competitiveness in the automotive industry erode. The sector, historically one of Europe’s industrial engines, is suffering competitive gaps, both in cost and technology.

It faces overall vehicle manufacturing costs 30% higher than in China. On the EV front, the report states that Chinese OEMs are one generation ahead of European peers in terms of technology in basically all domains. These include performance (range, charging time and charging infrastructure), software (software-defined vehicles, autonomous driving levels), user experience and development time (1.5-2 years vs 3-5 years in Europe).

ELECTRIC CAR IMPORTS TO EUROPE 

Source: The future of European competitiveness

The root causes for this competitiveness gap cover multiple factors, including overlapping legislation during the past decade. “Legislation has not always been fully coherent,” Draghi explains, adding that the EU has yet to succeed in reducing CO2 emissions from road transport. This is due to the increased number of cars and the fact they got bigger and heavier, offsetting emissions reductions from EV registrations.

To enable a sector turnaround, the report recommends the development of an industrial plan targeted at the auto sector, increasing coordination vertically and horizontally in the value chain. Importantly, it calls for regulatory coherence, predictability and appropriate timing and consultation for upcoming regulation. Among other proposals, it calls for so-called Net Zero Acceleration Valleys, much like the hydrogen valleys, dedicated to the automotive ecosystem.

All in all, Draghi’s 400-page report estimates the need for Europe to invest €750-800 billion ($831-887 billion) a year to ensure its future competitiveness. “The reasons for a unified response have never been so compelling – and in our unity we will find the strength to reform,” he concludes.