EU Innovation Policy: Strengthen European Companies’ Competitiveness and Capacity for Innovation
Investment in Research and Development
Innovation and technology are key drivers of growth and prosperity. This insight is all the more true in the face of growing ecological and demographic challenges. Recently, however, experts have been drawing increasing attention to the growing innovation gap between the US and China, on the one hand, and Europe, on the other hand. Artificial intelligence (AI) and its applied technologies such as autonomous systems represent one area in which this gap is pronounced. Another is Europe’s investment in research and development (R&D), which lags behind that of the US, China, and South Korea (see figure below).
Investment in R&D essential for future competitiveness
The large-scale challenges facing Europe today demand productivity increases and sustainable innovations. In Germany, governments at the federal and state levels significantly increased funding for R&D over the 2005–2021 period. During this time, government R&D funding as a share of GDP rose from 0.69 per cent to 0.94 per cent. However, the data indicate an end to this trend.
Germany’s lagging research spending has yet to be offset by joint European funding programmes. Not only is the volume of funding at the EU level relatively low; its programmes are fragmented. Improved cooperation between Member States – particularly necessary for the creation of strategically important technologies – could help scale up research and development initiatives. Some positive examples here are CERN and the European High Performance Computing Joint Undertaking (EuroHPC).
The importance of business formations for fundamental innovation
Rapid technological progress is currently happening in the field of generative AI, and its potential is far from exhausted. While young companies have played a key role in advancing AI, they often face substantial hurdles, mostly due to a lack of financial resources. Another factor is regulatory uncertainty, which, when combined with Europe’s fragmented markets for goods and labour, has produced an environment in which few high-growth companies emerge. The risk profile of investments in young companies in the market for innovative technologies makes venture capital (VC) a suitable source of financing. Augmenting VC investment for business formations would mean additional opportunities for rapid firm growth. However, VC investment is much scarcer in the EU than elsewhere in the world. Europe’s global share of VC is only 5 per cent. By contrast, the US is responsible for 52 per cent of global VC investment, while China accounts for 40 per cent.
Recommendations
Create New Impetus for Research, Innovation and Business Formation
Promote science and its application
Germany’s past federal governments laid an important foundation for stable and predictable R&D funding in the private sector through the passage of the R&D tax credit and the Growth Opportunities Act. In the academic sector, however, current levels of institutional and project funding can only compensate for increased costs to a limited extent. This is fatal, as almost all future technologies are science-driven. In order to be effective and build on strengths, research and science funding should focus on high-risk projects and cutting-edge research.
The R&D tax credit has proved valuable as an R&D funding instrument in the private sector. It has already led to a significant increase in the number of companies with continuous R&D activities. Germany should continue the path taken with the Growth Opportunities Act to better help medium-sized companies by further increasing the upper limit for eligible R&D spending.
Recognise government R&D spending as an investment in the future
An across-the-board budget increase in EU programmes for R&D cannot be anticipated. At the European level, a stronger focus on Important Projects of Common European Interest (IPCEIs) is therefore crucial. In order to improve the necessary financial resources for Germany’s national-level R&D funding, R&D spending by federal and state governments should be recognised for what it is in economic terms: an investment. This is already the case in the national accounts used to calculate gross domestic product. Federal and state budget rules should be revised accordingly.
Improve financing for young companies
The attractiveness of VC in Europe could be increased for both investors and companies through improved exit options and more flexible stakeholding models. Due to regulatory requirements, stock exchange listings in the EU are so complex and costly that IPOs for young growth companies are rare. The ability to issue shares with different voting rights throughout Europe would increase the attractiveness of public offering for founders, as they would be able to secure more voting rights. In Germany, the Future Financing Act (ZuFinG) is an important reform that should be implemented throughout the EU. To create better financing opportunities for scale-ups, requirements could be relaxed at the European level via the Solvency II regulatory framework. The mandate of the European Investment Bank (EIB) should also be expanded to enable investment in equity markets.
The introduction of a special EU-wide legal form known as an Innovative European Company (IEC) for start-ups could reduce the limits to expansion that young companies face due to market fragmentation in Europe. This new legal form would not only facilitate the establishment of innovative companies, but also grant them a special status with regard to certain regulations (such as financing, insolvency, taxation, location flexibility). In addition, the costs for patent applications should be reduced for young, innovative companies as part of the Unitary Patent system. The Competitiveness Compass for the EU presented in January 2025 addresses these challenges and proposes a European Innovation Act to improve conditions for innovative companies by offering them R&D funding, regulatory sandboxes and access to research and technology infrastructure. A “28th legal regime” would also create opportunities to reduce the competitive disadvantages caused by fragmentation.
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