The European Union has a productivity problem. Its inhabitants produce almost 30% less per hour worked than they would have,, Real production per hour has increased in accordance with that of the United States since 2000.
A failure to develop enough innovative startups in “superstar” companies is one of the reasons for the poor growth of the block productivity.
The economy and the fragmented financial system of Europe partially underpin this problem. Without a single more friction market for goods, services, labor and capital, it is more expensive and more difficult for successful startups.
In addition to this, the banking financial system in Europe is not well suited to finance risky startups. High technology startups often develop new technologies and commercial models, which are risky and can be difficult to assess for banks. And the value of startups often lies in their people, their ideas and other intangible capital, which is difficult to engage as guarantee for a bank loan. Banks are also limited by rules that rightly limit (rightly) loans to risky companies without warranty, even rapid growth that are likely to make significant profits later.
European private capital pools are also smaller and more fragmented than in the United States. Europeans travel more from their savings on bank accounts rather than capital markets. The Americans invested $ 4.60 in equity, investment funds and pension or insurance funds for each dollar invested in such assets by Europeans in 2022. Europeans are counting more on payment pensions as GOs than the Americans. But whatever the reason, the final result is less the availability of actions financing for companies.
The fragmentation of the markets follows in part from national laws, regulations and taxes which hamper transfaining consolidation, capital lifting and risk sharing. Many institutional investors prefer to allocate capital to companies based in their own country. This often applies to investments in venture capital also, especially in small funds.
Larger investments in venture capital could stimulate productivity and strengthen the EU innovation ecosystem. But the shallow pools of European capital European capital are hungry for innovative investment startups and make it more difficult to stimulate economic growth and standard of living.
As our new article argues, measures to strengthen the EU capital venture capital markets and remove cross-border financial friction to pension funds and insurers who invest in venture capital could increase the flow of financing to promising startups and fuel productivity gains.
The EU lost its largest venture capital center, London, after the United Kingdom’s vote to leave the Union in 2016 and its remaining centers do not have the scale of those in the United States.
Over the past decade, EU venture capital investments only had an average of 0.3% of the gross domestic product, less than a third of the average in the United States. American venture capital funds raised $ 800 billion more than their European counterparts during this period.
Running capital invests massively in high-risk research and development activities which are essential for the spread of innovative ideas and to increase overall growth. They are qualified to choose promising startups and channel resources to the most efficient businesses.
Compared to the competitors of the Atlantic, startups more established in Europe also have less attractive options to develop thanks to initial public offers in the EU. This reduces incentives to invest in the first place. And, when fast growing startups start to develop rapidly, they often have to seek funding abroad because availability in Europe is limited – the so -called financing gap. Many startups then move operations abroad when they get this increase in funding from foreigners. Europe then loses many advantages of succeeding startups at home – both the impact of direct growth and positive benefits such as technological diffusion.
National authorities could take several measures to support their national venture capital markets:
- The venture capital sector is characterized by high-risk asymmetries and information, but also positive externalities not internalized by individual investors. Preferential tax treatments well designed for equity investments in startups and venture capital funds could help revive the sector where it is underdeveloped or non-existent due to these market failures.
- Reduce regulatory and tax friction to invest in venture capital. The development of private pension funds would have multiple advantages, in particular in expansion of domestic capital pools to invest in capital markets and venture capital.
- Activate national public financial institutions – which played an important role in supporting the development of the venture capital sector in certain countries – to extend the availability of capital and other support for venture capital funds and innovative startups. They should invest in commercial terms and help attract more private capital, in particular institutional investors such as pension funds and insurers. This can be done quickly before other efforts have fruit.
Measures at European level would also help. The most important step that the EU could take is to complete the single goods market, services, labor and capital. It will take time.
More immediately, the authorities could:
- Refine the rules for insurers and other investors in larger capital funds in order to reduce the obstacles to invest in venture capital, in particular to support the financing of growth.
- Develop the capacity and instruments of the European Investment Fund (EIF) and the European Investment Bank to channel more resources for venture capital funds and innovative startups.
- Encourage EIF to develop a fund of ends aimed at attracting capital to institutional investors through the EU which would finance the significant capital funds with a pan-EU orientation. This would help reduce the fragmentation of capital pools, increase the familiarity of institutional investors to venture capital as a asset class and to fill the financing gap.
On the medium term:
- Reduce fragmentation of the stock market to increase their depth, liquidity and assessments, which will make the list in the EU more attractive. This is a key element in the agenda of the capital market union, but it will be more politically difficult.
Although government interventions are often a less than perfect solution, they may be necessary in the short term to accelerate the development of the venture capital sector and the financing of innovative startups. This would not only stimulate EU productivity, but would also reinforce competitiveness. Funding for more venture capital for the “clean technology” sectors would also support the green ambitions of the EU and would reduce the need to rely on expensive subsidies that could distort the single market.