Advice To Europe: Don't Strangle Tech Investment

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Europe has a conflicted relationship with digital technology. On the one hand, its policymakers say they support the digital transformation of Europe. On the other hand, the controversial EU court ruling that people have a "right to be forgotten" -- along with calls to tax online companies, impose draconian privacy laws, and establish a "Europe-Only Cloud" -- make it seem as if European policymakers rue the day the Internet was invented, or at least that it was invented by the Americans.

An Internet wrapped in a straightjacket of regulation would only push Europe further back in its quest to catch up digitally with the US. Indeed, European economic growth over the past 20 years has been disappointing, but it would have been far worse without the Internet specifically and information and communication technologies (ICT) generally. Indeed, ICT adoption is the key driver of productivity growth, which in turn improves living standards.

Productivity growth is a particular challenge for Europe. The "productivity gap" between the US and Europe has nearly doubled in the past two decades, with European companies today producing just 79% of US output per hour, down from 89% in 1995. The EU's lagging productivity performance will only become more critical, given that by 2050 people 65 years or older will make up 28.7% of the population in the EU compared with only 20.2% in the US. This demographic reality will require some combination of greater economic growth, lower wages, and lower benefits to adjust for the loss of workers paying income taxes and increases in entitlement spending. Without accelerated productivity improvement, either European workers will make less or retirees will receive less in benefits.

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So why has Europe fallen behind the US? To a significant extent, it's because of greater ICT investment and utilization in the US across industries, not just in high-tech ones. EU companies must invest more in ICT (they spend just 70% of what US companies spend on ICT) and get more bang for their ICT Euro. This is where EU policy and its often-ambiguous relationship with ICT come in.

If Europe is to use ICT to close its productivity gap with the US, its policymakers must first give up their hope of matching the US in the production of ICT. That is, Europe must refocus its emphasis on ICT use rather than production. European policymakers have long tried to create the next Silicon Valley, as they're doing now with calls for a "European Cloud" industry. But policies that seek to limit access to best-in-class global ICT resources to protect and grow Europe's ICT industry are unlikely to do anything other than raise ICT costs and, by extension, discourage ICT adoption in the rest of the European economy.

Moreover, it's impossible for Europe's ICT industry alone to significantly raise the continent's productivity. Because Europe's ICT sector accounts for only about 7% of the European economy, a 1% increase in ICT industry productivity raises productivity in the broader economy by only one-thirteenth of 1%. Instead, policymakers should focus on increasing ICT capital investment in every corner of the European economy -- high and low tech -- to raise aggregate productivity and make all companies more competitive and all consumers more prosperous.

One key is to reduce undue regulations on ICTs and the businesses that produce and use them. The recent European Court ruling guaranteeing a "right to be forgotten," for example, will impose significant costs on search engine giant Google as well as smaller competitors. Likewise, European privacy regulations reduce the effectiveness of Internet advertising.

But it's not just ICT regulation that limits ICT investment; it's also regulation of the broader economy. Numerous studies have found that companies in Europe get less benefit from ICT investments because of labor market regulations and other restrictions. Likewise, European policies that favor small businesses over larger ones and the failure to create a truly EU-wide economy limit ICT-driven productivity because ICT investment thrives on scale.

As Europe slowly emerges from the economic crisis and regains jobs, fostering productivity growth will have to move to center stage. Broad-based ICT adoption provides a proven path to that goal. Europe has a long way to catch up with America, not in creating the next Google or Amazon, but in driving ICT-led productivity growth across all sectors. The good news is that smart policies can help Europe achieve that goal.

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