Draghi warns Europe — and Japan — about the failure to innovate

The warning could not be clearer. Europe faces “an existential crisis.” “Over time, we will inexorably become less prosperous, less equal, less secure and, as a result, less free to choose our destiny.” Moreover, “without action, we will have to either compromise our welfare, our environment or our freedom.”

The source of those predictions could not be more credible: Mario Draghi. He is a former prime minister of Italy, former president of the European Central Bank and the man credited with saving the euro in 2012. His dire assessment is the outcome of a report commissioned by and delivered last week to newly re-elected European Commission President Ursula von der Leyen.

It’s premature to call the Draghi report dead in the water, but his grim assessment and his eye-popping recommendations — a new industrial strategy that raises investment by €800 billion a year — have even his most fervent supporters at something of a loss. Its message is invaluable, however, one that other countries, including Japan, need to take to heart.

Draghi’s diagnosis is straightforward. “EU economic growth has been persistently slower than in the U.S. over the past two decades, while China has been rapidly catching up. The EU-U.S. gap in the level of gross domestic product — at 2015 prices — has gradually widened from slightly more than 15% in 2002 to 30% in 2023, while on a purchasing power parity basis a gap of 12% has emerged.” He said, once it was “an inconvenience,” this is now “a calamity.”

Without the economic dynamism powered by innovation, Europe’s standard of living and its very security are at risk. If it doesn’t reduce or eliminate resource dependencies, the continent faces critical vulnerabilities. The EU must become competitive to maintain its independence and the ability to safeguard its core values: democracy, freedom, prosperity, equity and peace in a sustainable environment.

The solutions are simple (in the abstract). First, close the innovation gap with the U.S. and China. As Draghi notes, “there is no EU company with a market capitalization over €500 billion that has been set up from scratch in the last 50 years, while all six U.S. companies with a valuation above €1 trillion have been created in this period.”

The EU can’t “remain stuck in the middle technologies and industries of the past century.” That demands that innovation be translated into commercialization, a process that is hindered by “inconsistent and restrictive regulations.”

Second, focus on decarbonization and competitiveness. Leading the transition to secure, low-cost clean energy will be a growth opportunity for Europe. Without such a plan, energy prices will inhibit growth.

Third, Europe must increase security, as traditionally defined, and reduce dependencies. For this Draghi recommends increased defense spending along with “a genuine EU ‘foreign economic policy’ ... statecraft ... to coordinate preferential trade agreements and direct investment with resource-rich nations, build up stockpiles in selected critical areas and create industrial partnerships to secure the supply chain of key technologies.”

To accomplish these goals, according to Draghi, the EU must focus, consolidate the single market and “coordinate where it matters.” The 400-plus pages that follow “lay out a new industrial strategy for Europe to overcome these barriers.” The headline item, apart from the grim warnings, is the call for €800 billion annually in new funding, or about 4.7% of GDP, an amount that more than doubles the Marshall Plan, relative to the size of Europe’s economy. (There is a lot more in the report but this is enough for today.)

Draghi’s apocalyptic tone may sound familiar to Japanese. In 2007, the interim report of the Innovation 25 Strategy Council, set up by then-Prime Minister Shinzo Abe during his first term to realize his vision of “a Beautiful Country,” warned that “in the face of intensifying global competition, Japan may not continue to enjoy economic affluence.” It observed that the world was entering “a completely new and unexplored era,” and concluded that “a conventional approach and mentality” would not suffice. “Unless we dedicate ourselves to changing our familiar ways of thinking and conventional attitudes, we can never create a bright future.”

It too put environmental and demographic concerns at the heart of its analysis and reasoned that “without innovation, the standard of living of people can never become better.” By the end of May 2007, it said, the government would issue guidelines and implement policies to make Japan an innovation-driven nation.

Five years later, the Council on National Strategy and Policy, a Cabinet panel, produced “The Comprehensive Strategy for Rebirth of Japan,” which started with the premise that “Japan is now facing a great crisis,” the product of two lost decades, the delayed transformation of its industrial structure and “unprecedented serious difficulties,” such as the Great East Japan Earthquake.

Related reports warned that the country was “at a crossroads,” that Japan’s “course is unsustainable” and that it “must turn the current crisis into an opportunity by creating new industries and adding new value to push ahead with economic expansion.”

That strategy was buried with the the Democratic Party of Japan government that produced it. (For those who want more details, “Peak Japan” devotes several pages to the episode.) Yet its language, outlook and approach echo Draghi’s.

More recently, Japan has the Integrated Innovation Strategy. The 2022 version noted that science, technology and innovation are driving economic growth and are “the lifeblood of the nation from the viewpoint of overcoming social issues represented by climate change and ensuring the safety and security of the people. ...” The nation’s national security, national renaissance and the realization of a new form of capitalism, all rest on the country’s ability to innovate. Yet, while other competitors — the U.S., China and the EU — are boosting funds for innovation, “Japan's research and innovation capacity is on a relative decline.”

Keen-eyed readers will have noted that the 2007 report was produced by the Innovation 25 Strategy Council (that 25 refers to the target date for realization of its objectives: 2025). Continuing publication of the strategy — it’s an annual report — with dark language, increasingly high stakes and a grim outlook indicates that nearly two decades later, plenty of work remains to be done.

The Draghi report offers one measure of Japan’s accomplishments. In the 69-page summary, Japan gets seven mentions, all in the context of reducing external vulnerabilities and critical minerals. In Part B, 328 pages of in-depth analysis and recommendations, Japan get 62 mentions, more than half of which deal with its critical minerals strategy. The other citations are almost exclusively benchmarks — comparisons that also include the U.S. and China — although in one case Japan is credited for its 2022 Green Transformation strategy.

Draghi has said that this is not a “do or die” moment; rather it’s “do this or it’s a slow agony.” That too should sound familiar to Japanese readers. Threats are evident — the numbers don’t lie — but they aren’t palpable. Calls for change will be challenged by vested interests, a grand strategy opposed by free-market purists, and needed budget outlays resisted by tight-fisted politicians and bureaucrats.

But the future marches inexorably closer and the consequences of inaction are growing larger and more impactful. Like bankruptcy, the decline in innovative capacity and competitiveness will hit gradually then suddenly. Europe and Japan need to do more to fend off that fate.