European Innovation Crisis Is There

European Innovation Crisis

Is there a European innovation crisis and, if so, what are its causes? How can innovation be fostered in Europe? And if innovation is fostered, can it be productive in increasing wealth, income, education level and consumer benefits?

The theses of this short paper are as follows: there is an innovation crisis across Europe as compared to North America and Asia. This innovation crisis is due to two factors: (1) "old" European countries do not want innovation, and (2) these countries seek policies, particularly related to taxation of capital gains, which discourage innovation. The final thesis is that innovation is unlikely to come to Europe and offer the same benefits as it has to the U.S. Or East Asia.

The U.S. versus Europe

First, what is the relative differential in innovation between the U.S. And Europe? Traditional measures, such as the number of patents or the number of Nobel prize winners, may not be the best measure from an economic standpoint. A more direct measure would be: how has job growth, income growth and wealth accumulation compared between Europe and the United States over the past, say, 25 years?

The comparison shows a stark advantage for the U.S. The U.S. has created 30 million new jobs since 1982, while Europe (with a larger population) has created just 10 million (EU, 2005). Many of those jobs in Europe came from the public sector, while nearly all growth in U.S. jobs have been in the private sector. Income comparisons are also stark: the U.S. average income per capita in 2007 was over $41,000, while the per capita rates in Germany ($33K), France ($35K) and the UK ($36K) were much lower. If one uses PPP, or Purchasing Power Parity, the actual spendable income in the U.S. is double that of Germany or France, and 60% higher than the UK (BBC, 2002). If one looks at the number of employed people, rather than unemployed, as a percentage of the entire population, one sees that Europe's employment rate is much lower than the U.S. (BLS, 2004). This may mean that there are many in Europe who have quit looking for a job altogether.

How does this happen so differently in the U.S. than in Europe? Schumpeter argues that economic growth comes through a process of 'creative destruction,' which means that few businesses endure for decades, but are systematically destroyed and new companies rise from the ashes (Schumpeter, 1942). If the government (e.g. France or Germany) attempts to stave off bankruptcy of incumbent companies through protectionist measures or direct support, they only succeed in diverting productive resources to less productive ends -- and the whole population suffers as a result. Although the U.S. has historically propped up some industries for short periods of time, the European record is far worse. Even today, French and German governments are propping up inefficient agriculture, coal mining, steel manufacturing and airline manufacturing. Their efforts, rather than building wealth, result in a wealth destruction and the long-term decline of those supported industries.

European Failures at Innovation

Why is Europe so unsuccessful at innovating new industries? There are a few exceptions -- cell phones are dominated by Nokia in Finland -- but most of the job- and wealth-creating industries have been founded and grown in the U.S.A. Semiconductors, internet commerce, service innovations, PC's and Mac's, franchises (Starbuck's to McDonald's) have all originated and continue to thrive at the behest of U.S. companies.

US Innovation Success

Why is the U.S. so successful at innovation? Three things: (1) the U.S. allows much lower capital gains rates which allow individuals and investors to keep 85% of their gains, (2) the U.S. does not, as a rule, prop up inefficient or dying businesses, and (3) there is a cultural encouragement for success, and less consequence for failure, in the U.S. As compared to Europe.

Let's take that one-by-one. The U.S. tax rate is 15% for long-term (i.e. over 12-month) capital gains. This means that those who invest early in highly risky investments (like Google stock when it went public at $85), get to keep most of what they earn when things grow. If one is skeptical of this claim, look at what happened in the 1960's when JFK reduced the capital gains rate, or in 1982 when Ronald Reagan reduced it to 15%. In both cases, venture capital and new corporate formation soared. We are still living in an era where venture capitalists receive and invest over $30 billion per year. In Europe, by contrast, there are no Bill Gates, Steven Jobs or Larry Ellison's. The reason? European taxes are confiscatory, discouraging capital accumulation. Mitterand famously said that he wanted "Steve Jobs without the money (Hornby, 2006)."

Secondly, the U.S. has let its industries 'die.' The famous claim that we've exported all our car jobs is not true -- we still have 2 million U.S. auto workers; many of them now work for Toyota, Mercedes and Honda in the U.S., rather than Chrysler, GM and Ford. Thus even the 'dying' industries are, through free-market forces, able to retain employment and increase productivity.

The U.S. has lost significant number of jobs in a lot of industries: carpet-making, cloth mills, even shoes manufacturing moved offshore in the past decades. One of the issues when an industry becomes less competitive is that the layoffs are concentrated in a geographic region or amongst a certain number of companies -- which can create political problems for the representatives in that district or state. In Europe, problems with cloth mills, shoe manufacturing and olive oil production have met with massive government subsidies to keep those businesses running -- despite being uneconomic. This means that the resources are diverted to less-productive areas, and change is delayed.