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The EU challenge in 2014 and the competitiveness dilemma

By Terence Tse* & Mark Esposito**

This year will be a crucial one for the European Union. While we are still struggling with the ongoing eurozone crisis, the European elections will be taking place this coming May. This means that work is already winding down and the new EU machinery may not be running in top gear until 2015. With both Slovenia and Portugal probably needing rescues and austerity programs elsewhere, it looks like the bloc’s competitiveness will further deteriorate.

What not to do and what to do to build competitiveness

But this does not have to be the case if the EU and national governments turn their target to raising competitiveness. Contrary to what many people believe, the fundamental trouble of the eurozone is much less about heavy debt – both the US and Japan are more indebted – it is its inability to compete effectively. As our colleagues previously pointed out, enhancing productivity through innovation is the only way to restore competitiveness. And the EU has to do more, much much more on this front. So, how to go about doing that? Here's a short list of suggestions:

Forget about following the “German model.” This is because the country’s current strong performance is more due to its past labor. It has not been investing nearly enough to build up its future competitiveness. Indeed, Germany seems likely to undo some of its past reforms, which would only hamper its ability to compete effectively.

Stop trashing the weaker economies in the eurozone. It does not help to keep thumping them yet expecting them to stand on their own feet tomorrow. We should instead celebrate their successes. And there are no shortage of reasons: There are many what we called fast-expanding markets – fast-growing but hidden pockets of excellence – in these countries. For example, Spain has been very successful at moving up the value chain by turning more of their agricultural products into organic ones, thereby moving away from competing on price to competing on quality. Successful stories can also be found in Greece: The country has been churning out high-tech ventures, including Sboing and Taxibeat. Italy, on the other hand, has been producing carbon-fiber chassis for racing cars manufacturing near Palma. If we want to get the peripheral countries to be prosperous again, we should start helping and not suffocating them.

Help the small and medium-sized enterprises (SMEs). The reason is simple: They are the engine of growth and sources of new jobs. They can only flourish if the EU and national governments create a conducive environment for them to grow. Ironically, even in the absence of help from the governments, we can expect the number of SMEs in the EU to go up substantially in the next couple of years. However, this has less to do with people’s entrepreneurial flair and more to do with the lack of job opportunities. Consequently, many of them, especially those aged between 18 and 24, have turned to starting their own businesses instead. The trap here is that policymakers would become complacent (again) as the unemployment rate comes down. What they are going to miss is that small companies will remain small – and therefore inefficient – as they cannot scale up in the current rigid and costly business and regulatory environments.

Attract foreign capital. The European Commission has been working hard to find new ways to give greater access to capital to Europe’s companies, especially the SMEs. While the banking union, when completed, will help banks become healthier – and therefore more able to lend, it is in itself insufficient. Surely finding new financing sources, such as crowdfunding and promoting competition among banks – as the EU government has been trying, would certainly help. But neither of these would give the instant boosts that capital-starved businesses need. The EU should therefore redouble its efforts to attract and convince foreign investors. This does not mean more trade missions to China – these often benefit large companies. What’s more important is to convince investors that there remains a great number of businesses in the EU that they can put their money in, even in the peripheral countries. This is one of the reasons why we argue for making the fast-expanding markets in the weaker economies more visible to the investors. The truth is that there are lots of Americans and Asians considering investing in European companies. The truth is that Germans tend to save a lot. Yet all of them prefer to invest their money outside the EU. Therefore the first step is for the EU to change people’s perception of itself and promote both what it can do and what it is good at.

The huge cost of doing little


The EU cannot really afford to slow down even though it is about to go into a governmental transition. All the more reason for national governments to make the necessary reforms to help SMEs grow. Not doing enough not only leaves the EU becoming less and less competitive; what’s worse is that it is nurturing more problems down the road. While we have somewhat defused the sovereign debt problem, we could be facing another crisis as a result of corporate and household debt. Moreover, there is already talk about using credits – which only adds more debt to households – to boost consumption in order to reboot the national economies. On the surface, the economy of Spain is growing again, but if we dig deeper, we can see that it is by and large property-fueled. If it continues in this manner, we are setting ourselves up for calamity again. So, if we continue to do little to raise our competitiveness, we would not only be falling further and further behind in global competition; we could end up finding ourselves in another crisis. There is no guarantee that the EU can survive this one.

*Dr Terence Tse is an associate professor of finance at ESCP Europe Business School in London, UK, and head of Competitiveness Studies at the i7 Institute for Innovation and Competitiveness in Paris. He is a member of the faculty of the Microeconomics of Competitiveness Curriculum developed by the Institute for Strategy and Competitiveness at Harvard Business School.
**Dr Mark Esposito is an associate professor of business and economics at Grenoble Graduate School of Business in France, an instructor at Harvard Extension School, and a senior associate at the University of Cambridge-CPSL in the UK. He serves as Institutes Council co-leader on the Microeconomics of Competitiveness program (MOC) at the Institute of Strategy and Competitiveness at Harvard Business School.

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