By Sam Bowers

In an era of heightened international competition, the European economy currently lacks the digital foundation to stay in the race against the world’s major powers, notably the US and China. The fragmented nature of EU banking and capital markets means that the superstate struggles to promote the innovation achieved by its competitors, which is being used to improve industrial productivity and leaves vast quantities of EU data in foreign hands. In recent years the EU has tried to offset this trend by asserting itself as a global regulatory power. This reactionary approach puts Europe at the centre of global technological innovation, allowing it to protect its own interests and data, without actually having to develop its own technology. However, many argue that this simply will not be enough to keep the EU internationally competitive, and that tangible progress of planned homogenising reform is needed through the region.

The comparative weakness of the EU tech sector is seen simply by considering big tech household names: Europe has no home-grown alternative to the likes of US giants Facebook and Google or state-backed Chinese alternatives WeChat, Alibaba or Tencent. According to data from CB Insights, the US accounts for 48% of tech unicorns, startups valued at over $1bn, China 26% and Europe a meagre 7.2%.

The lack of alternative European social media platforms, in particular, poses a risk to what has been termed the ‘digital sovereignty’ of the EU. This threat stems from European consumers’ use of foreign platforms, which allows the likes of the US and Chinese firms, the largest of which are state backed, to harvest their data. Existing regulations ensure that European consumers are protected from any sinister intentions, but these swathes of data allow foreign firms to continually improve their products and services based on intimate knowledge of the market, legitimately obtained through their online platforms. This gives foreign firms a perpetual advantage over any potential European alternatives. Devolved responsibility for digital security throughout the EEA (European Economic Area), though, does affect its ability to take a united stance and protect itself from potential threats. This has led to what some commentators describe as “naïve” handling of digital issues such as the high-profile debate surrounding TikTok, with varying priorities of national digital security authorities leading to, potentially costly, indecision in this instance.

Perhaps more importantly, Europe’s sluggish tech progress means that it isn’t developing technologies such as AI, biometric recognition or more advanced batteries which are transforming Chinese industry in particular. This means that, due to a lack of comparable innovation, Europe could soon be usurped in industries of traditional strength such as pharmaceuticals and automotive production, which are evolving towards adoption of biotechnology and production of electric vehicles respectively, areas with little foundation in Europe.

The EU have at least planned efforts to reverse their relative decline, however such initiatives remain in their formative stages regardless of the disruption to their implementation caused by coronavirus. In February 2020, the EU released its digital strategy. The agenda included investment totaling to €15bn into the “Digital, Industry and Space” cluster, with AI prioritised as a key activity. The European Data Strategy was also pegged out, with plans in the making to establish a true single market for data in the hope that this will give both the public sector and businesses access to high-quality data and promote innovation. This would be regulated by the proposed Digital Services Act (DMS), which aims to take a harder line on data security, circulation of fake news, disinformation and generally place a greater responsibility on internet firms for the content uploaded by their users.

Variable enthusiasm from member states, make some of these visions very distant, which is the reason that in recent years the EU has attempted to establish itself as the pre-eminent regulatory power in aid of rivalling more technologically advanced competitors. The latest manifestation of this policy is the proposal of the Digital Markets Act (DMA), sister to the DMS. The DMA is designed to keep digital markets “open and contestable”, with particular focus on ‘gatekeeper’ companies who, as established tech firms, could stifle the growth of smaller firms. This legislation contains some highly significant proposals, for example granting a commission the power to fine tech companies up to 10% of global revenue for antitrust infringements, so will therefore have to be thoroughly scrutinised by the European Council and Parliament, likely over the course of the next 2-3 years.

The DMA is indicative of broader progress that the EU has made in establishing itself as a global regulatory power, but as the European Council on Foreign Relations comments: “referees do not win the game”. Experts have cited issues such as language barriers and a cultural aversion to risk for Europe’s tech limitations, but the most persistent comment is the lack of risk and venture capital. For households and small-to-medium sized businesses in Europe, there are few alternatives to domestic banks. As a result of this, the banking system of the EEA is very fragmented. Compounded by the lack of a pan-European equity market, pools of risk capital are very shallow for companies in general but tech start-ups in particular. Structurally, therefore, Europe’s comparative weakness in the technology sector is a result of its lack of integrated banking system and broader capital markets.

Despite resistance from some polities within the EU, Italy and Spain for example, and the logistical challenge of negotiating 27 different regulatory and insolvency regimes, the Capital Markets Union (CMU) does seem to be making progress. In 2020, the CMU announced its core objectives and has since been pushing its agenda. Of the little certainty that the pandemic has brought all of our lives, technology has been cemented and recognised as a genuine cornerstone of social welfare, industry and the economy more broadly. Beyond our individual lived experiences, this is demonstrated by the fact that investment in European fintech was resilient in the face of coronavirus, €3.2bn invested in the first half of 2020, and in Q3 alone 13 new European unicorns emerged, with the group as a whole now valued at over €100bn. Global recovery will be dependent on investment in R&D and fintech, which should only add urgency to the EU’s plans for further integration of national banking systems and capital market.

Unfortunately, the pandemic has also resulted in, and will continue to cause, a huge number of bankruptcies and subsequently a large volume of government-backed emergency loans which will never be repaid. However, for the EU this poses a unique opportunity to shift European business from credit to equity financing, converting debt into equity which can be floated on a pan-European market. The EU must take this opportunity to establish the capital resources to facilitate innovation. Without a clear strategy and imminent action, the European superstate could risk digital colonisation by rival powers.

The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.