Why does the EU fail to produce its own Google, Amazon or Facebook? Is Europe lacking entrepreneurship, technical savvy or simply imagination?

Contrary to what many think, the EU does even better than the US at creating high-tech start-ups; however, many European firms whither on the vine due to a lack of finance.

Yet a simple solution has been lying in plain sight for decades – we simply need to grasp it. The answer, as with a great many questions, is money.

In each of the past five years, the EU has created more high-tech start-ups than the US. Nonetheless, many of them fail to scale up, while some move to greener pastures on the other side of the Atlantic.

Europe’s timidness on display

A root cause is that Europeans are timid investors, and many of us lack the financial sophistication to invest sensibly.

In the EU, 31 % of household savings remain in currency or deposits, versus 12 % in the US, leaving less scope for stocks and bonds in the union.

Largely as a result, and relative to GDP, the EU has twice as much money in its banks as the US and only half as much in capital markets for stocks. The same goes for bonds.

This is problematic for innovation. EU firms get some 80 % of their finance from bank loans — clearly, not the way to finance risky start-ups that typically have no established track record of earnings and whose assets are largely intangible and thus unsuitable to serve as collateral.

When we look at finance for start-up firms, the situation is even worse. The US has 20 times as much venture capital as the EU — €1.3 trillion, compared to a paltry €72 billion.

Funding for firms that aren’t yet ready to go public with an IPO receives — if they can obtain any venture capital or private equity funding at all — on average, only a fifth as much venture capital or only a twentieth as much private equity funding as their US counterparts.

The European institutions have been wringing their hands for years and will occasionally find a way to pump one or two billion euros into funding start-ups. This is all well and good, but it’s totally out of scale for the magnitude of the problem.

How did the US do it?

Overlooked in all of this is an understanding of how the US achieved its Silicon Valley. Brilliant, entrepreneurial technologists surely played a role, as did US government funding for research. However, a key development was a little-noticed change in the US regulation of pension funds.

Until ERISA was enacted in 1974, pension funds were generally restricted to relatively safe investments. ERISA changed this by recognising that a “prudent person” would typically want a portfolio reflecting a mix that included some riskier instruments.

This unleashed a growing flood of pension fund money into venture capital funds. Without this, Silicon Valley as we know it today would’ve been unthinkable.

The EU today is in much the same position as the pre-ERISA US — and this is a key reason why a “European Silicon Valley” is currently unthinkable.

But it need not be this way. EU pension funds hold assets of some €4tr, while insurance (where some of the plans are pension-like) has assets of about €9tr. Pension funds invest billions into venture capital each year, but this seemingly large investment is, in reality, peanuts — what they invest per year is less than one one-hundredth of 1% of their assets.

There is no shortage of promising EU firms in which to invest — the union indeed generates more start-ups than the US per year and the return on venture capital investments is running about 6% higher in the EU. Venture capital offers high returns, some 29% on average, with surprisingly low volatility.

Clear and straightforward measures needed

It would be natural to react by saying that pension funds shouldn’t put future pensioners at risk, but this misses the point. Any investment advisor would tell any firm or, for that matter, any household that a portfolio should be diversified with a mix of risk-return profiles that align with one’s investment goals.

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The pension funds understand this, and most would like to be freed from overly restrictive member state investment rules.

And a twenty-fold increase in pension funds’ current investments would roughly triple the annual contribution to venture capital in the EU but would still represent less than two-tenths of a per cent of pension funds’ assets.

The same logic holds for future pensioners — a balanced portfolio with a mix of instruments would tend to benefit them, especially those further away from retirement.

The ongoing shift in Europe from defined benefits pension schemes to defined contribution ones, coupled with a shift away from so-called Pay as You Go (PAYG) plans, lends itself to plans where future pensioners could steer their investments to reflect their individual risk sensitivities and investment needs.

One might perhaps worry about those closest to retirement, but simple rules or guidelines might discourage or prevent them from investing unwisely in high-risk instruments.

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The measures that would be needed to enable the EU to produce large-scale digital champions are clear and straightforward. They would benefit not only Europe’s digital sector but also our pension funds, our insurance sector and our future pensioners.

The only things that stand in the way are European timidity and conservatism, together with the lack of a concrete policy programme to put these needed changes in place.

J. Scott Marcus is an economist, engineer and public policy analyst. He is an Associate Senior Research Fellow in the Global Governance, Regulation, Innovation and Digital Economy (GRID) Unit at the Centre for European Policy Studies (CEPS).

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