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Brexit Or Not, The EU Needs To Make Itself More Competitive

30/05/2016 8:26 AM IST | Updated 15/07/2016 8:27 AM IST
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The stars of the European Union (EU) sit on banners flying outside the European Central Bank (ECB) headquarters ahead of ECB President Mario Draghi's news conference to announce the central bank's interest rate decision in Frankfurt, Germany, on Thursday, April 21, 2016. With no new measures expected at Thursdays monetary-policy meeting, the ECB president may use his press conference to point to signs that negative rates, free bank loans and a 1.7 trillion-euro ($1.9 trillion) bond-buying program should be enough to revive euro-area inflation. Photographer: Jasper Juinen/Bloomberg via Getty Images

Too many cooks spoil the broth, and this seems particularly true in the case of the European Union (EU). The Brexit debate, on whether or not Britain will leave the European Union, has raised questions on where the EU's economy is headed. After years of stress post-2008, most major economies have got back on their feet, but not the EU. It remains a meaningful economy, but its continued woes are a definite cause for concern.

Why did the EU reach this woeful state?

An increasing number of diverse economies, each of varying maturity, meant an institutionalized method of policy-making to ensure each EU member benefited. But this machinery of bureaucracy was outside the direct control of citizens, and often became impractical from a business practitioner's perspective.

[The EU's] bureaucratic machinery and the protectionist environment fostered due to tariffs, quotas and excessive regulations seem to have inhibited its competitiveness, and hence economic progress.

Not only were there excessive regulations covering everything, but the officials were not directly accountable to the tax-paying electorate. Tariffs, quotas and excessive regulations by these bureaucrats ended up protecting local industries and controlled competitors from entering. This caused complacency which eroded their efficiency. Such barriers helped industries that could not have coped in a competitive world, where others would have had better and cheaper products. This impacted the very competitiveness of the EU's economy. Its companies paid a higher cost of production since they could not always buy the most efficient materials, which hit their profitability. Citizens ended up paying a higher cost of living which eroded their purchasing power. Higher cost had a multiplier effect if the product was used as a raw material in ancillary industries. Companies found it tough to raise capital and expand, and many consolidated. Unemployment hit a high. Top-down quotas also controlled the production allowed by each member in certain sectors, often sectors where it had a competitive advantage, thus dragging down its competitiveness.

Loss of competitiveness

The debate about the EU's current economic state boils down to the loss of competitiveness in the global context. Its bureaucratic machinery and the protectionist environment fostered due to tariffs, quotas and excessive regulations seem to have inhibited its competitiveness, and hence economic progress.

The World Economic Forum's Global Competitiveness Ranking shows most EU economies lagged in improving their ranking between 2013 and 2016.

This argument has some strength since the World Economic Forum's Global Competitiveness Ranking shows most EU economies lagged in improving their ranking between 2013 and 2016. It makes sense to look at data post-2013 because many countries were reeling in the aftermath of the global crisis from 2008 to 2013. Data of selected countries shows most major EU members saw their ranking slip during these three years, including the UK, Sweden, France, Italy and Finland. Eastern members like Romania and the Czech Republic improved, but they comprise a small portion of the EU's economy. In comparison, non-EU countries significantly improved their competitiveness ranking in this period. This includes developed countries like the USA and Japan, but also several developing countries of Asia like Malaysia, Thailand, Philippines, Vietnam and India.

While the larger EU members still rank high, the argument is about the number of places its global peers improved in their ranks. If this trend continues, then it is not far when other countries, including those in Asia, occupy the top ranks, pushing the EU members down. The World Bank's data on time required to start a business shows only Denmark figuring in the Top 10, that too after Australia, Canada and Hong Kong, and tied with Singapore. Not only do Asian peers like Korea and Malaysia rank above the UK, Netherlands and Italy; but Germany ranks below the USA, UAE, Turkey and Japan. The common market has not really translated into a standardized infrastructure or procedures to do business in.

Is lack of innovation a cause of this drop in competitiveness?

The complacency from knowing that competition was controlled from entering its market reduced regular innovations. Competition forces industry to bring in new ideas and new ways of efficiencies. Innovation forces changes in a product's quality, features, pricing and delivery; it means reinventing the value-proposition in the client's best interest. But was the lack of innovation really a culprit?

Larger EU members have dropped by more places in the innovation ranking between 2013 and 2016, than in the competitiveness ranking.

Data from the World Economic Forum's Competitiveness Ranking seems to show so. The innovation rank is one of the components that make up the global competitiveness ranking. It is worth noting that the larger EU members have dropped by more places in the innovation ranking between 2013 and 2016, than in the competitiveness rank. This includes UK, Germany, Italy, Netherlands and Spain. Sweden, Finland and Denmark improved by more places in their innovation rank than in their competitiveness rank, and this is probably a result of their higher allocation to research and development -- 3% of GDP vs. 2% of GDP in EU as a whole. World Bank's data on R&D expenditure as % of GDP shows Europe not only lags behind the USA and Japan, but even developing countries like China have ramped up their R&D spends significantly.

Research and innovation can become a key driver for the EU's economy competitiveness. The correlation between changes in innovation rank vis-à-vis competitiveness rank is uncanny. Europe has the infrastructure. It has research institutions, IPR frameworks and support structures. Innovation can lower the cost of production and make the EU's corporations profitable. Even if it loses production volumes to Asian peers who can produce more cheaply, it can come up with innovations in the product's technology or method of production to keep itself relevant in the value-chain. It can cement its place as a research partner. While this means it may become a trading-region instead of a producer-region, its innovations will mean it has a say in how the value-chain would flow.

In conclusion, post-war Germany or non-EU Switzerland show how scrapping excessive controls can make economies dynamic and diverse and rank high on production, exports, wages and employment to create world-class multinational corporations. Irrespective of whether the British populace votes for or against Brexit, the EU really needs to make itself more competitive in the global context. If it does not, then its own people will pay the ultimate price.

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