Only constructive destruction will increase Europe’s competitiveness

Discussions about sluggish economic growth prospects in Europe have been going on since at least the beginning of the century, but in the 2020s they took on an urgent character. And the matter is not only the invasion of Russia into Ukraine, which showed the danger of dependence on energy imports, but also the change of administration in the USA, which made Europeans think about how they will be able to guarantee their prosperity, security and sovereignty in the future.

Also, with America and China leading the artificial intelligence (AI) race – and many see it as a new general-purpose technology similar to the Internet – a lack of dynamism in Europe is tantamount to an emergency.

The problem is not only in the often mentioned lag behind the European Union in terms of per capita income. Europe has long been a technological laggard: it has very few globally recognized leaders in the digital platform economy, in the development of artificial intelligence, in the new space race and in other areas that will be important for competitiveness and security in the 21st century.

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Europe is heavily dependent on advanced technologies developed elsewhere, and is unable to provide the kind of economic growth necessary to finance its strategic goals and future commitments. It turned into a textbook example of the importance of constructive destruction, that is, the displacement of less productive firms by innovative competitors. Fail to do so, and a modest decline in economic growth prospects is only the beginning of your problems.

For all its successes as a trading and regulatory power, Europe will remain vulnerable if its innovation activity does not reach the same pace and scale as that of the US, China and elsewhere.

AI has the potential to generate new knowledge and ideas (in addition to performing a wide range of services and traditional production functions), so it may well become a double-power engine for constructive destruction that will ultimately ensure economic growth.

The importance of advanced innovations increases as the economy approaches technological frontiers. But for breakthrough innovations, it is necessary to increase investments in research and development, this is not enough.

As emphasized in the report “The future of European competitiveness“, prepared for the European Commission by the former president of the European Central Bank and the prime minister of Italy Mario Draghithis continent will be stuck at a leisurely average level of innovation unless significant progress is made on three main fronts :

• elimination of all barriers preventing the emergence of a fully integrated market of goods and services;
• creating an adequate financial ecosystem that will encourage companies to take long-term risks (starting with venture capitalists and institutional investors such as pension funds and mutual funds);
• pursuing industrial policies conducive to innovation and competition in key sectors, including energy transition, defense and space (in particular AI), biotechnology.

Europe not only avoids industrial policy under the pretext of antitrust, but also emphasizes competition between existing firms within Europe, while paying little attention to new players entering the market, as well as competition outside Europe, starting with the US and China.

Entering the market of new innovative firms from other countries of the world is actually the essence of the constructive destruction that Europe needs to accelerate economic growth. In the early 2000s, Giuseppe Nicoletti and Stefano Scarpetta from the OECD showedthat productivity growth in the US was mainly achieved through the replacement of old, less efficient firms with new, innovative ones, while in Europe productivity growth mainly occurred within already existing firms. Many of Europe’s current problems can be explained by this basic difference.

More broadly, Europe needs to revamp its economic doctrine, which has turned it into a regulatory giant but a fiscal dwarf. First of all, while fulfilling the limitation of the budget deficit established by the Maastricht Treaty, the authorities should stop taking into account investments that stimulate the growth of the economy, as well as various programs of current state expenditures (pensions, benefits, etc.).

In addition, they must allow for reasonable industrial policy measures, in particular to stimulate competition and innovation. Finally, eurozone countries should be allowed to borrow collectively to invest in new technological revolutions, provided that these countries demonstrate discipline in managing public spending.

Fostering constructive disruption and breakthrough innovation in Europe will require additional measures to help relocate workers from backward industries to advanced ones, as well as offset short-term losses through structural reforms. That is why I support the Danish model of “flexicurity”, where the state pays the wages of laid-off workers while they undergo retraining and look for a new job. The AI-based industrial revolution needs no less.

It was a European, Joseph Schumpeter, who understood the centrality of constructive destruction to economic development. Europeans today must not only support this process, but also make it inclusive and socially acceptable if they want to thrive in the coming years and decades.

Philip Aghion – laureate of the 2025 Nobel Prize in Economics, professor at the Collège de France and the London School of Economics, employee of the Center for Economic Efficiency (CEP).

Copyright: Project Syndicate, 2025.www.project-syndicate.org

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