EU’s Innovation Path: What’s missing for the EU to catch up and become a leader in this new, fast-paced, and technologically global economy?

The EU’s economic development has been slowing down over the past 10 years, with an annual GDP growth rate ranging from 0.35 percent to 1.4 percent, compared to a US average of 2.5 percent. A decline in EU labour productivity can explain this slowdown, and the EU workforce is projected to shrink by close to 2 million workers per year until 2040, representing a period in which growth will no longer be supported by rising populations.

This low growth and lagging technological performance can be explained by three key barriers. The first is that Europe is lacking in focus. It often articulates ambitious objectives but does not back them with clear priorities or coherent follow-through. For example, the establishment of an EU Capital Markets Union (CMU) has so far been an incremental process, with the ECB's financial integration composite indicator recently pointing to some progress. However, EU capital markets are still fragmented, and remaining barriers in the financial service sector are equivalent to a 100% tariff, according to IMF estimates. While Europe claims to support innovation and entrepreneurship, it continues to impose regulatory burdens on firms, especially SMEs, which are disproportionately harmed. More than half of SMEs identify regulatory obstacles as their greatest challenge. Furthermore, the Single Market has remained fragmented for decades, reducing competitiveness and pushing high-growth companies overseas. This, in turn, diminishes the pool of projects available for financing and limits the development of Europe’s capital markets. At the start of the twenty-first century, 41 of the world’s 100 most valuable companies were European. Today, only 18 are.

The second barrier is that Europe is wasting its common resources. The EU possesses large collective spending power, but this is diluted across many national and EU instruments. Europe does not collaborate sufficiently on innovation, even though breakthrough technologies require large capital pools and generate substantial spillovers. The same lack of joint action characterises the defence sector. Although the EU public sector spends roughly the same share of GDP on R&D as the US, 0.74% of GDP in the EU compared with 0.69% in the US, only around one-tenth of this spending takes place at the EU level, with the rest fragmented across 27 national budgets. Moreover, according to Deutsche Bank’s Industrial R&D Investment Scoreboard, Europe invests around €250 billion in R&D, only about half the US total of €500 billion, placing it much closer to China’s level than to America’s.

The third barrier is that Europe does not coordinate where it matters. Modern industrial strategies combine fiscal policy, trade policy, and foreign economic policy to secure supply chains and support domestic industries. In the EU, this requires high-level coordination between Member States and EU institutions, yet the EU’s slow and disaggregated policymaking process makes such coordination difficult.

To respond to these challenges, Draghi’s 2024 report outlined three priorities.

The first is closing the innovation gap with the US, which has widened since 2003 due to Europe’s weak digital sector and a static industrial structure that produces a vicious cycle of low investment and low innovation. Draghi therefore called for a reform of the EU Framework Programme for R&I, better coordination of national research programmes, the strengthening of Europe’s academic and deep-tech institutions, and improved access to risk capital so that inventors can more easily become investors.

The second priority is a joint decarbonisation and competitiveness plan. Europe’s high energy costs and insufficient generation and grid capacity undermine growth and risk slowing digitalisation and electrification. Draghi recommends reinforcing joint procurement for gas and hydrogen, reducing exposure to volatile spot markets, limiting speculative behaviour, and accelerating decarbonisation through a technology-neutral mix of renewables, nuclear, hydrogen, bioenergy, and carbon capture. He also calls for a genuine Energy Union so that cross-border decisions are taken centrally.

The third priority is increasing security and reducing strategic dependencies. Europe has become vulnerable to coercion and geo-economic fragmentation, as demonstrated by hybrid attacks, the war in Ukraine, and China’s dominant position in critical raw materials. Draghi’s response includes swift implementation of the European Defence Industrial Strategy (EDIS) and the European Defence Industry Programme (EDIP), increased joint procurement and standardisation, a medium-term defence industrial policy to support cross-border integration and SME participation, and EU-level funding to expand defence industrial capacity.

One year after the report, progress remains slow. Only 43 of the 383 measures have been implemented (11.2 percent). Some important steps have been taken: a regulatory simplification package and the announcement of a “28th regulatory regime” to allow firms to operate under a single EU-wide framework, the Startup and Scale-up Strategy, InvestAI fund, and new AI and quantum initiatives, the Savings and Investments Union Strategy to mobilise household savings, the Clean Industrial Deal and Affordable Energy Action Plan, and, in defence, the SAFE loan programme, the Joint Purchasing Platform for Critical Raw Materials, and preparatory work on procurement reforms.

Overall, Europe is moving toward a new economic era, but progress is slowed by national governments that fear losing sovereign control, holding back deeper integration. At the same time, Europe has focused mainly on simplification and deregulation rather than on addressing its chronic underinvestment, resulting in a narrow definition of competitiveness. To overcome these challenges, Europe must remain united and tackle the deeper structural issues identified in the Draghi report. This requires accelerating investment in strategic sectors, strengthening joint action, especially in energy, innovation, defence, and capital markets, and building EUlevel mechanisms capable of acting with speed, coherence, and scale. Only greater coordination and a willingness to pool sovereignty, when necessary, can enable the EU to overcome fragmentation, close its competitiveness gap, and secure long-term economic and geopolitical resilience.