The EU should be fast followers and take it seriously.

One of my professors had an interesting quality criterion when judging our ability to prove theorems: the explanation had to be simple enough so that a stranger at a bus stop would understand.” We didn’t have to come up with proofs, we just had to explain how Lagrange or Kantor did it, but do it in a way that was clear and convincing. The course was computational complexity, not the easiest on the curriculum; nevertheless, if you are smart enough to understand something, you should be good enough to make it simple.

I often quote my professor at work and was thinking about him when going through the 400+ pages of Mr Draghi's report (European Commission, 2024) on EU competitiveness. For the last decade or so, lack of competitiveness was hitting me in the face more or less weekly; as I would work on a proposal, aligning a cloud architecture with their strategy, the vast majority of products are American, as if it is the end of nineteen forties. SAP,? Spotify, Klarna and Linux are the well-known exceptions. But when you work through a couple of architectural footprints every week, it's hard not to think why in the world, 95% of everything you put in is coming from the US. The fact that many of the outliers are a sweetener to the otherwise sour pill. The new EU report does a great job of putting both the context and the challenge through statistics and frameworks.

I have dozens of economics books and articles on my Kindle. It is a bit of my passion. Naturally, I am not more than an amateur. Leaving in-depth analyses to those who are better positioned to do it, I believe that biggest impact of this and similar reports is when it successfully lands on the other side of the academic economic fence. Magic can happen if people from different professions and industries try to make sense of the narrative on their own terms.

So, I was thinking, can I put the conclusion of those four hundred pages in a way a stranger on a bus stop could relate to? The formulation that came up in my mind, courtesy of good training from mr. Freivalds is very simple: “EU has to be a successful fast follower.” Let me explain.

You may want to be rich, famous and beautiful. But you don’t have to.

Comparison of approaches between the US and EU is somewhat of a topic in economic circles. Both areas are Western in their foundations, free-market in their thinking and democratic in implementation. Given those similarities, the outcome cannot be more different.

One of the better hacks on the difference comes from an international team Acemoglu, Roberts and Verdier, in an article from 2013 (Acemoglu et al.). The question they tried to understand is whether America can retain its leadership position while at the same time building a more reliable social support structure. The question is different from ours, it’s a mirror reflection of what Europeans are trying to understand, nudged or not by a report. Their conclusion was in the negative.

The team defined American approach as ‘cutthroat capitalism’, while European one got a moniker of a ‘cuddly capitalism.’ As said, they are trying to resolve the opposite problem to ours, trying to understand why America didn’t adopt more of a European approach. Greater inequality in America is the engine of entrepreneurship and innovation, which leads to a more substantial impact on the global economy. They’ve developed a model for asymmetric economic growth, showing that in an interconnected global economy, not all countries will adopt the cutthroat model that fosters innovation. Some will adopt the cuddly version with its comfortable safety net. Some countries, especially those that are more unequal, will drive advancements in the technological frontier. But other countries can then free-ride on these advancements, without adopting similar levels of inequality. Paradoxically, the cuddly friends ( that is - us) might achieve higher welfare, even if they are not the leading technology innovators.

The work by Acemoglu, Roberts and Verdier helps to get to a ‘stranger on the bus-stop’ type of an explanation.

The model emphasises that high levels of innovation often require incentivising entrepreneurs, which can lead to increased inequality. Technological innovations in leading countries benefit others, reducing the incentive for followers to foster the same level of inequality and innovation domestically. There is a world equilibrium where some countries (e.g., the U.S.) adopt "cutthroat capitalism," generating technological advancements. In contrast, others ("cuddly" countries like Scandinavia) can afford more equality and social welfare. Domestic political constraints, such as the presence of strong social democratic parties, can prevent countries from adopting "cutthroat" capitalism. This may force other countries to take on the role of the "cutthroat" innovator.

Authors draw their conclusions from a lot of empirical data, such as the number of patents and hours worked, to illustrate the differences in innovation and work culture between the U.S. and Scandinavian countries. Countries adopting a more "cutthroat" approach will be wealthier and more unequal. Conversely, countries with "cuddly" reward structures have less inequality but do not lead the global technology frontier. Prosperity and welfare enjoyed by "cuddly" countries are partially due to their ability to free-ride on the technological advancements made by "cutthroat" countries. “Cutthroat" countries is necessary for "cuddly" countries to maintain their social welfare systems. Thus, a global move towards Scandinavian-style institutions might be infeasible for the US. And the move towards a successful cutthroat approach is unfeasible for the EU. Historical and domestic factors make it difficult for countries to switch their institutional models (e.g., from "cutthroat" to "cuddly").

Asymmetric world equilibrium is inevitable, where some countries adopt cutthroat capitalism, driving technological progress, while others adopt more egalitarian approaches.

Copy with pride

It may not be too pleasant to think of EU as free-riding, but if we reframe this as ‘complementing’, put the emotions away and focus on the economics – there are choices to be made. One choice is to make is to accept the European starting position and look for solutions within the frame of what is achievable and is short of a revolution in the cutthroat/cuddly split of roles.

So, the right question is, are there ways we can close the gap before we have to cross over into the cutthroat part of the field?

To give an example, one of the key differences quoted by Mr Draghi’s report is the size of Venture Capital deployed on opposite sides of the Atlantic. Despite the many efforts over several decades, the difference remains vast, 73-82%, depending on the stage.

One problem is that this difference is so substantial, but the key problem is that its been like that forever. Even if the ‘beautiful world’ of venture capital was not devised and deployed in EU, it's been 67 years since the concept of investing into industry-changing ideas was first deployed.

One of the first deals VC deals ( by many accounts – the first) was when the Traitorous Eight (Gordon Moore,?C. Sheldon Roberts,?Eugene Kleiner,?Robert Noyce,?Victor Grinich,?Julius Blank,?Jean Hoerni?and?Jay Last? ) established Fairchild Semiconductor. This was back in 1957.

Being at the frontier is a choice, staying in the game is a must. We can happily admit to not being at the frontier, but if we want to stay in the game, European needs to take its fast-follower approach seriously. This looks like the (only) option we have. So, we should learn to stay close to the frontier and learn from what works. We may not even want to be the first because not all of the innovations, social or technological, will work. The wide usage of opioid painkillers was a bad idea and created an epidemic. Good that we didn’t follow.? Conversely, Ryanair started in 1984 on a model pioneered by Southwest Airlines in 1967. It is now doing better than the original.

Fast following is a strategy that has strong sides and challenges in implementation. But it is one that can work for the EU. We just have to be serious about it.

References

European Commission (2024) EU Competitiveness: looking ahead. Available from https://commission.europa.eu/topics/strengthening-european-competitiveness/eu-competitiveness-looking-ahead_en

Daron Acemoglu, A. Robinson, ?Thierry Verdier (April 2013) Can’t We All Be More Like Scandinavians? Asymmetric Growth and Institutions in an Interdependent World. Available from https://scholar.harvard.edu/files/jrobinson/files/varieties_of_capitalism_april_9_2013.pdf

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