Tuesday, October 21, 2014

A Future Made in Europe

ROME – Over the last three years, the European Union, faced with the imperative of calming roiled markets and laying the foundations for a sound recovery, has concentrated largely on financial stability and reducing fiscal deficits and debt. Now, with financial tensions easing and confidence returning, Europe’s leaders should shift their focus in 2014 back to the real economy and the industrial base. February’s meeting of the European Council of Ministers will be a good place to start.

To decide the best way forward, Europe’s leaders should look to the past. Investment in manufacturing – historically one of the main drivers of growth in Europe – holds the key to revitalizing the European economy.

Over the last decade, industrial policy has been sidelined in favor of the financial and service sectors. Manufacturing was deemed a pursuit of the past, and Europe was no longer considered a suitable location for competitive industry. Many European countries have since undergone deindustrialization. Industrial production in Italy, for example, has declined by about 20% since 2007.

Nonetheless, the industrial sector continues to play a key role in the EU economy, employing more than 34 million people and accounting for 80% of exports, while providing a substantial share of private investment in research and development. Industrial manufacturing thus affects every other sector of Europe’s economy, including the service sector.

In fact, despite policymakers’ shift in focus and emerging-economy competition, European countries remain among the world’s top performers in manufacturing, owing to the many firms that have managed to adapt and innovate. Such firms have enabled Italy to move beyond the “three Fs” – food, fashion, and furniture – to cutting-edge sectors like biopharma, mechatronics, and aerospace.

A similar shift toward higher-value-added manufacturing activities is occurring across the EU. These developments suggest that Europe’s future success will depend on its ability to combine its traditional economic strengths with strong innovation.

EU countries should be working to create the conditions that a thriving industrial sector needs. For example, Italy’s recently launched Destinazione Italia program will help Italian companies succeed by establishing a more predictable tax system, reducing bureaucratic red tape, and ensuring more effective contract enforcement by strengthening the civil-justice system. Such an environment would enable firms to grow, while attracting foreign and domestic private investment.

But national efforts alone are not enough. European firms are integrated into regional and global value chains. A component produced by a company in Brescia might go into equipment produced in Stuttgart, which might then be assembled as a final product in Malaga. In this context, no single country can reach its full potential unless all are successful.

The most effective approach to restoring European competitiveness would be to combine EU member countries’ individual strengths, thereby forming increasingly productive European supply chains – or capturing the top positions in global supply chains. This would require deepening the connections among national economies and fostering a genuine, unbounded single market that integrates different countries’ relative strengths.

To this end, more targeted policies at the EU level are essential. Remaining globally competitive will require investment in the key determinants of future industrial production: energy efficiency and technological innovation. Given this, the EU should pursue measures that support the competitiveness of energy-intensive industry, with a particular focus on reducing the energy-price gap with Europe’s industrial competitors, such as the United States and the emerging economies. An efficient internal energy market is vital to the delivery of affordable energy.

Another important initiative – a European Research Area – is already underway, and should be implemented by 2014. By creating a shared agenda for national research programs and facilitating the circulation of skills and scientific knowledge – allowing, say, a top-notch center for mechanical sciences in Italy to attract researchers from Finland or Portugal – the research area promises to create an optimal environment for innovation.

Beyond research and development, an innovation-driven industrial economy demands workers with specific, high-level skills. Meeting this demand requires EU policies that promote secondary, upper secondary, and higher education.

In order to create deeper, more integrated, and more multi-dimensional markets, the EU should place a high priority on free-trade agreements, especially the Transatlantic Trade and Investment Partnership currently being negotiated with the US. Such trade integration – and, eventually, a Transatlantic Common Market – could prove to be one of Europe’s most effective growth mechanisms, especially for small and medium-size manufacturing firms, in the coming decades.

European manufacturing companies also need much better access to finance. One of the most damaging legacies of the financial crisis has been persistent credit rationing. In some countries, half of all loan applications are rejected and financing costs have reached prohibitively high levels.

There is no reason why loans in Bozen (Bolzano) should cost twice as much as those in nearby Innsbruck; in fact, such arbitrary divergences merely undermine competition and cause economic stagnation. If EU leaders do not resolve this issue, including by pursuing a full-fledged banking union, the positive effects of reform efforts will quickly be nullified by the lack of new investment.

Reindustrialization – together with the fight against youth unemployment – should top Europe’s agenda in 2014, with the goal of establishing an industrial sector that accounts for 20% of GDP by 2020. This will be possible only through deeper EU integration. Indeed, ever-closer union represents Europe’s only hope of building a modern, innovative, and prosperous economy.

Read more from "2013: Reversing Gears" here, or on Kindle and iBooks.

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  1. CommentedFrank Mampaey

    Mr Letta is one in a long line of politicians who seems to think it is up to politicians to decide what the economy should look like. I suggest it may be time for politicians to consider reducing their influence on the economy, and taking some of the less sensible regulation, taxation and subsidies with them. Given a greater degree of economic freedom and less red tape, people in Europe are quite capable of shaping their own economic destiny.

  2. Commentedsande cohen

    I found this article by Letta depressing: more of the same, or integration for 20% of Europe's population and pretty much crumbs for the rest.

  3. CommentedMariano Mamertino

    Energy prices in the US are falling mainly because of the shale gas boom. Something that the EU policymakers are opposing by pushing additional burdensome regulations to drilling, even if just for exploratory purposes. How is this approach supposed to promote lower energy costs in the continent?

  4. CommentedJason Gower

    Excellent piece that squarely hits the key points that will be crucial to Europe's economic future.

    The key is indeed innovation and this is precisely where Europe has fallen behind in the past 20+ years. If one looks at R&D spending of European enterprises in the core, developed economies in comparison to countries that have managed to consistently produce higher innovation, it is not hard to see why. This of course is where an agile, 21st century education policy and perhaps more importantly the promotion of entrepreneurship and above all the proper incentives (and culture) for entrepreneurs are vital. Naturally the lower value-added activities will be outsourced/offshored to locations that make most economic sense; this is the globalized supply chain. This implicitly leaves the higher income world with the high-tech, high value-added activities; if a country can't deliver from a skills standpoint then it seems to reason that income levels must come down. This of course is a scary proposition given the massive debt levels that the developed world has already accumulated, thus even further highlighting the need to formulate and urgently implement forward thinking policy.

  5. Commentedyassin sabha

    Very insightful and substantive op-ed. For too long EU policymakers have thought that a common trade and monetary policy could be enough to overcome the crisis letting fiscal and industrial policies at the discretion of member states. With increasing emerging market competition and other developed countries starting to grow again (US above all), the only way the EU can not only resume, but sustain growth is through a coordinated industrial policy at the EU level. This does not entail a revival of socialist style state interventionism, but a coordinated effort to create an enabling business environment for the private sector, above all advanced manufacturing, to grow, innovate and be productive, being the EU a leading export-manufacturing player in the global economy.Mr. Letta highlights several important points. The differences in input prices and skills among EU's economies can be levered to create a EU level value chain. Energy efficiency is key to lower energy costs to firms. Shifting from traditional sectors at low value added to innovative export-oriented high-value added sectors is key to remain competitive vis-a'-vis emerging economies. Access to finance is indeed a key business constraint, particularly for SMEs. I would add the large differentials in fiscal pressure among EU countries, the skill-mismatch between demand and supply in the labor market, the regulatory red tape for starting, operating and closing a business, the poor infrastructure increasing transportation costs. With most EU countries under fiscal constraints, only a coordinated effort at the EU level can tackle most of these constraints. However, member states can start by pursuing (inexpensive) business regulatory reforms.

  6. Commentedsanjeev verma

    A very well written prose,with multiple prescriptions,coming out from the powers -that -be.If Mr. Letta's postulations,on energy efficiency, are are an accepted view,among other constituent nations ,then Europe will do well to embark upon clean ,renewable sources.It will rejuvenate the carbon trading mechanism -which also got a hammering in the economic crisis.
    Mr.Letta could do well
    to harmonize the efforts of European Union on this issue. It will also be a shot in the arm for the climate change dialogue

  7. CommentedVal Samonis

    With Germany's trade with China/Asia growing much faster than the its inner EU trade, the rest of Europe will soon acquire the roles of Hinterland rather than any serious modern industry place.

    Val Samonis

  8. Commentedhari naidu

    Single Market (SM) was supposed to overcome some of the barriers to trade and development within EU. These barriers or NTBs are still serious obstacles to integration, and Mario Monti produced a report, at request of Borosso, which current Commissioner Barnier (Fr) is trying to implement.
    In my view, and having been there when the Maastricht Treaty was formulated, it is now imperative to focus on making the SM finally work.
    There are still a lot of NTBs within EU boarders which affect the movement of labour and goods and services.