How Should Europe Support its Manufacturing Sector?

by: Kris Bledowski, Council Director & Senior Economist, MAPI

A recent decision by the European Commission to block the Alstom-Siemens merger of the companies’ rail businesses unleashed a flurry of reactions. These included heated political statements, open letters issued by economists, and two serious policy proposals. Should the rest of Europe take note of this mostly Franco-German wrangle?

First, let’s look at the facts. Immediately following the Commission’s verdict, the German minister for economy and energy issued the National Industrial Strategy 2030 while a fortnight later the same minister, joined by his French counterpart, penned the Franco-German Manifesto for a European Industrial Policy Fit for the 21st Century.

The German Strategy focuses on defense of the industrial sector. It argues for keeping existing champions (Siemens, Thyssen-Krupp, Deutsche Bank) alive because they carry an “outstanding image of German economy and industry the world over.” For smaller companies that fail to grow into future champions, the policy recommends that the state comes to the rescue with direct shareholding. Then, there are strategic sectors where to quote the paper: “with preeminent issues of platform economics, artificial intelligence (AI) and autonomous vehicles, (…) – as with Airbus at the time – the state should take direct stakes in companies (AI-Airbus).”

The more compact Manifesto argues for more lenient merger rules, easier access to state aid under IPCEI guidelines (Important Projects of Common European Interest), setting up sector-specific consortia, and state shareholding of private companies. The proposal centers on picking winners in a range of fields, including AI, microelectronics, and batteries, and putting up serious public money to fund their growth. Most importantly, the document calls for changes to competition rules that would allow the European Council (controlled by member states) to override the Commission’s verdicts on competition cases.

The two papers read like panicked wake-up calls to action written over a rushed weekend. The proposals row back the tested adage that to foster innovation you need a vigorously competitive marketplace. Europe has tried more state-supported policies than the United States in the past. Yet, it is the U.S., which recorded faster growth and a higher rate of innovation than Europe. Likewise, the economic record of state ownership, in France as in Germany or central Europe, is meager. Governments are poor corporate managers, and they struggle to innovate. This is why an “artificial intelligence Airbus” - created deus ex machina by state fiat to invest in artificial intelligence or other future technology - would simply waste public money.

Where the papers get it right is in waking up to the challenge of China’s state-sponsored distortions to competition, trade rules, and strategic investments. This aspect of industrial policy warrants attention. Support for domestic manufacturing has a military dimension – a plank that is missing in the papers. A country’s defense capabilities are best served when governments source armaments through friendly supply chains and ring-fence those of the adversaries. Safeguarding technological expertise with military applications is a national security issue. Germany is right to call for reciprocity in a level playing field: “(…) Germany and Europe must intervene more actively than in the past against distortions to competition by other countries.” European institutions should set up a screening mechanism to safeguard sensitive technologies from adversaries. Just as with anti-trust regulations and trade compliance, such screening ought to be EU-wide.

There is more that the Europeans can do to foster innovation. Rather than trying to nurture national champions, policymakers should support competition instead. The single European market remains incomplete despite popular perceptions to the contrary. Services, which account for an overwhelming share of value added, often trade with difficulty across borders, protected by domestic regulations. Manufacturing directly benefits from a competitive and efficient market in services. The EU ought to redouble efforts to dismantle remaining barriers to trade in services.

If the Europeans insist on spending public money to support manufacturing, some ideas merit attention. The private sector may underfund innovation research whose outcome ends up in the public domain. This is akin to funding basic education and research through universities and public institutions. Governments might consider co-financing such research at hubs centered on universities and enticing the private sector to chip in. Such “innovation hubs” would alleviate the problem of duplicative research. As boundaries between basic and applied research blur in fast-moving technologies, consortia, hubs, and centers of excellence could internalize the results.  

Finally, Central Europe shows yet another way to shore up manufacturing. Vocational training has had a long tradition of excellence there. High technical skills of a labor force attract capital, which in turn funds innovation. Not coincidentally, the economies of Visegrad-4 managed to hold on to a share of manufacturing of about 20% of GDP (in the Czech Republic closer to 24%) compared to 11% in the U.S., 10% in France, and 9% in the UK. This comparative advantage of Central Europe is worth underwriting with increased public spending.

To sum up, Europe should take the Franco-German proposals in stride. Few of them will see the light of day. Instead, the EU will be better off spending its intellectual and financial capital on proven steps that support competition, fund research, and maintain technical skills.