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Europe's Ballyhooed “Industrial Strategy” Might Be a Disaster

Andreas Kluth

(Bloomberg Opinion) -- The European Union is getting close to unveiling a ballyhooed “industrial strategy,” the better to give the continent’s companies a leg up in competing against American and Chinese rivals. Not so fast. Based on what’s leaked so far, half of the proposals sound reasonable, but the other half could prove disastrous. It’s not too late to rethink.

This latest push for an industrial strategy started last year, after the EU’s antitrust czar, Margrethe Vestager, wisely blocked a rail merger between two manufacturing giants, Alstom SA of France and Siemens AG of Germany, because their combined market power would’ve been bad for customers. Predictably, France, with its long history of coddling “national champions,” complained.

More surprisingly, so did Germany, which has a tradition that favors tough competition law and otherwise eschews state intervention. What changed minds in Berlin was the perceived competitive threat from China. It would be naive for Europe not to nurse its own continental champions, Chancellor Angela Merkel said.

This vogue for European champions is the product of flawed logic. It’s Eurocrat code for letting government officials, in Brussels or national capitals, designate specific companies or technologies as “strategic.” As the bureaucrats then mete out their largess, they fall into predictable mental traps.

First, they tend to confuse size with strength, when it’s often small and obscure niche firms, such as the appropriately named “hidden champions” in Germany’s Mittelstand, that have the best shot at becoming globally competitive. Second, they assume that they’re better than private investors at knowing which firms and technologies will prevail. They’re wrong. The market is usually better at picking winners, and it’s always better at spotting losers and pulling money out of failing ventures that politicians want to keep on life support.

What happens in practice is that the alleged champions become lobbying machines that seek privileges at the expense of taxpayers, smaller rivals and consumers. This is one of China’s big problems, and one reason why its state-owned enterprises haven’t blossomed even more. Ironically, Europe should panic only if China ever drops its industrial policy.

What’s true for companies also applies to technologies. Brussels has set itself a laudable goal of becoming carbon neutral, but keeps misdefining its role as allocator of capital, rather than mere regulator. For example, the EU has just decided to put billions of taxpayer euros into a pot that also includes money from BMW AG, BASF SE, Fortum Oyj and others, to pay for those companies to build lithium-ion batteries for cars. If it’s a good investment, why can’t they do it with private capital alone? If it’s bad, why do it at all? And how did Brussels even decide that batteries are more “strategic” than, say, fuel cells or something else?

The EU would be on firmer ground if it just stuck to supporting basic research. That’s where market failures are common, because boffins often have trouble raising funds for breakthroughs that could benefit entire industries rather than individual firms. As the internet once sprang out of a project by the U.S. Department of Defense, tomorrow’s green tech or artificial intelligence could come out of labs funded partially by the EU. But it’s the scientists who should choose what to research.

By far the best industrial policy, however, is simply to focus all of the EU’s energy on completing two existing but unfinished projects. One is the so-called single market, the other the stalled integration of the EU’s disparate capital markets. The U.S. and China offer home-grown firms huge domestic markets to expand into, and the U.S. also provides deep and liquid troves of capital for that purpose. The EU doesn’t.

The EU may be one market for goods, from toothpaste to MRI machines. But in services it just isn’t. Just ask a Belgian pharmacist hoping to move to Germany, or a Danish lawyer wanting to practice in Italy. Or imagine how much better cellphones would work if operators competed across the whole EU. A single market in services, moreover, is crucial for the development of fintechs and 5G, and in turn essential to progress in the “internet of things” and AI.

A capital markets union worthy of the name is just as important. Thanks to America’s sophisticated finance markets, U.S. companies, from startups to behemoths, have easy access to cheap capital. By contrast, firms in the EU (excluding the U.K.) tend to get money from banks instead of venture capital, bond or equity markets. The money is there, but it’s divided into many national pots, so the cost of capital and hassle of raising it is unnecessarily high. Cross-border capital flows in the EU have been pretty flat since the 2008 financial crisis.

So Brussels should get busy working down a long and unsexy list, from harmonizing 27 different insolvency and bankruptcy codes (a prerequisite for a common bond market) to re-regulating life insurers so they can invest across the whole EU. That way, Europe’s firms can tap into affordable funding to invent and build the things that will make them global champions.

Brexit should be a wake-up call. The U.K. was usually able to deflect the worst ideas (often from France) about European industrial policy. And it was the only EU member with a top-notch capital market. Now the 27 other members must figure out alone how to stay competitive. In doing so, the EU should resist jettisoning its proven liberal principles for a crude economic nationalism. Europe won’t beat China by becoming Chinese.

To contact the author of this story: Andreas Kluth at akluth1@bloomberg.net

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Andreas Kluth is a member of Bloomberg's editorial board. He was previously editor in chief of Handelsblatt Global and a writer for the Economist.

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