Regulatory quality key to boosting Europe's high-tech investment
A new ECB working paper investigates how institutional and regulatory quality influences investment in high-tech sectors across 25 EU countries. The study finds that better governance and less burdensome regulations are associated with significantly higher investment shares in innovative industries.
Europe's high-tech investment deficit
Since the mid-1990s, European Union countries have experienced slower productivity growth compared to the United States, a divergence closely linked to an innovation gap.
The US has consistently prioritized investments in innovative and high-technology sectors such as information and communication technologies (ICT), artificial intelligence (AI), cloud computing, and biotechnology.
In contrast, Europe has largely remained focused on traditional mid-tech sectors.
This difference in sectoral investment focus, including research and development, has constrained Europe's productivity growth due to the more limited spillover effects from mid-tech compared to high-tech innovation.
For instance, in 2021, high-tech sectors accounted for approximately 17 percent of market sector gross fixed capital formation in EU countries, while the corresponding share in the US was nearly double at 33 percent.
The ICT sector alone explains about 48 percent of the average annual hourly productivity growth gap between the EU and the US from 2000–2019, underscoring Europe's lag in disruptively innovative high-tech sectors.
The paper investigates the role of institutional and regulatory quality in shaping these investment patterns, using data from 25 EU countries from 2004 to 2019, extended to 2023 for AI-specific analyses.
Regulation's double-edged sword for innovation
Institutional and regulatory quality is particularly crucial for disruptive, high-tech sectors because these industries inherently carry higher risks and greater uncertainties.
Investments in disruptive technologies often involve significant trial-and-error processes, higher rates of project failures, and rapid scaling needs.
Consequently, burdensome regulations, rigid employment protection laws, and inefficient institutions disproportionately increase the costs and complexities associated with failure and restructuring, thereby deterring investment.
In contrast, mid-tech sectors typically involve lower risk and fewer innovation-driven disruptions, making regulatory constraints less critical to their investment decisions.
The study employs three key indicators: the Institutional Delivery Index, the OECD Employment Protection Legislation (EPL) Index, and the World Bank Starting a Business Score, linking these to sectoral investment shares classified by technological advancement, patent intensity, and AI intensity.
A clear path, but a long road
The study provides a clear, data-driven diagnosis of Europe's innovation deficit, firmly linking it to institutional and regulatory quality.
While the identified 50% potential gain in high-tech investment is significant, achieving such deep structural reforms across diverse EU member states remains a substantial political challenge.
This research offers a crucial roadmap, but its impact hinges entirely on the political will to implement its demanding recommendations.