At the end of the 19th century, Europe was a global powerhouse of innovation. It is where the Industrial Revolution and the Great Enrichment began. Yet, today it is clearly lagging behind. Most innovative companies today operate elsewhere.
Although entrepreneurship exists in all countries, a few stand out. Indeed, some produce a disproportionate number of super-entrepreneurs. This is not the case for the large European countries. More generally, Europe has only 0.8 super-entrepreneurs per million people, compared to 3.1 in the U.S. One extra super-entrepreneur per million adult inhabitants is associated with a 0.88 percentage point drop in unemployment. This figure grows to 1.1 percentage points for the middle-educated middle class.1
Europe is large, wealthy, and well-educated. Yet, it is falling behind in emerging sectors and high-impact entrepreneurship. Why is it having such difficulty in generating fast-growing high-tech companies?
The failure of top-down strategies to promote entrepreneurship
Many governments have attempted to develop policies to promote entrepreneurship. Most attempts, however, do not meet expectations: strategies are conceived and run by policy-makers who ignore how the market operates and tend to focus on political rather than economic goals. The European Union, for example, adopted what is now known as the “Lisbon Strategy” in 2002. It aimed to make the EU the most competitive and dynamic knowledge-based economy globally by 2010 through growth, innovation, research investment. It aimed to stimulate entrepreneurship within a competitive business environment. Long before 2010, EU officials admitted that the Strategy was a colossal failure.
The Lisbon Strategy ignored the crucial impact of economic policy such as taxes and regulation. It should have included measures to reduce the tax burden on entrepreneurs, simplified and streamlined regulation. This would have enabled entrepreneurs to focus on their core business and take advantage of new technologies and innovative business models. It would also have encouraged more people to take the risk of starting a business and thus contribute to economic growth.
Many of those EU-funded projects remain on paper and seldom generate products that make a difference. This is not surprising: the fact that a civil servant is responsible for selecting the projects to be financed is a recipe for failure.
Taking risks with public funds is a controversial issue. Any decision to invest public funds will almost certainly be subject to intense media and public scrutiny, making it difficult for civil servants to take risks. Furthermore, the very rules that govern the public sector are designed to discourage the decision maker from taking a chance.
The EU barriers to innovation and entrepreneurship
Exceedingly heavy regulation is indeed a key issue. The EU acquis (the body of EU laws and regulations regarding companies, charities, and individuals) is divided into 35 chapters; it is officially 110,000 pages long and grows at a rate of some 5,000 pages per year.2 Such massive regulatory body imposes a burden on all firms, and in particular on small businesses, which are less able to comply with them and cannot afford experienced compliance departments.
An analysis done by economist Leora Klapper and colleagues studied the impact of regulations on the growth of new businesses using a database of 3.3 million firms from 21 European countries.3 The data confirm that costly regulation stifles the birth of new companies, particularly in innovative industries. Competitive pressures weaken and, not unexpectedly, incumbent firms grow more slowly.4
Taxes also have a significant impact on innovation and entrepreneurship. For example, according to the Tax Foundation, every 1% increase in U.S. corporate tax results in a 3.7 percent decrease in new company registrations.5 There are compelling reasons for this. Entrepreneurs live in an uncertain world. They cannot tell whether their investments will pay off or not, and taxation increases their expected losses.
The EU bureaucracy and protectionism are problematic as well. Their main purpose is to keep the status quo in the member countries. Yet, free trade and an open competitive business environment are critical to promote successful entrepreneurship. Entrepreneurs benefit from freedom because it allows them to reap the rewards to their ideas and efforts. Indeed, entrepreneurship and freedom go hand in hand: the correlation between a country’s overall score on the Index of Economic Freedom and its score on the Global Innovation Index is high (0.77).6
Finally, Europe’s relatively cautious approach to investment stands out as a significant impediment and among the most difficult to overcome. Europeans do not see business and entrepreneurship with admiration. According to a sentiment analysis of media coverage, only about 17 percent of press coverage in Germany portrays entrepreneurship positively, compared to 39 percent in the United States.7
Entrepreneurship requires not only the right conditions for entrepreneurs; but also the right conditions for investors, employees, and customers. Entrepreneurs necessitate easy access to capital, managerial skills, as well as a stable political and economic environment. You cannot have path-breaking entrepreneurs without secure property rights, light and simple regulatory contexts, lower taxes on profits and capital gains and better education. Only then, can people plan and invest for the future.
1 Europe’s Entrepreneurial Deficit Is a Warning for the U.S., Nima SanandajiKlas TikkanenKristoffer Melinder, September 16, 2022, City Journal, Economy, finance, and budgets https://www.city-journal.org/europe-entrepreneurial-deficit-a-warning-to-united-states
2 Entrepreneurship: A Primer, By Eamonn Butler, Chap9: The Entrepreneurial Environment, page 113, Oct 12, 2020
3 Entrepreneurs and Regulations: Removing State and Local Barriers to New Businesses, Chris Edwards, Cato Institute, MAY 5, 2021, POLICY ANALYSIS NO. 916 https://www.cato.org/policy-analysis/entrepreneurs-regulations-removing-state-local-barriers-new-businesses
4 Leora Klapper, Luc Laeven, and Raghuram Rajan, “Entry Regulation as a Barrier to Entrepreneurship,” Journal of Financial Economics 82, no. 3 (December 2006): 591–629.
5 Watson, G. and Kaeding, N. (2019) Tax Policy and Entrepreneurship: a framework for analysis. Washington D.C.: Tax Foundation, April 3.
6 Kim, A. (2020) Economic Freedom: Promoting Economic Opportunity and Prosperity, presentation to the Mont Pelerin Society, Stanford University, January.
7 Matthias Jacobi, Media judgment of entrepreneurial failure–implications for founders, Technical University of Hamburg, 2018, semanticscholar.org.
Photo by Viktor Talashuk