At the intersection of green and digital technologies, leading early in innovation may create a winner-takes-all effect. The development of green technology still offers great opportunities. Firms that have innovated in this sphere see the climate transition as leading to more dynamic markets, with more competitors entering, but not necessarily with a loss of competitive advantage for themselves. In addition, green-digital innovators are more likely to enjoy a wider, more global playing field. Such potentially large markets for green and digital innovations offer enormous possible rewards, perhaps leading to winner-takes-all dynamics for Europe.
However, Europe’s leadership in green-digital innovation could easily be lost. When looking at how much patents are cited by other innovators, Europe’s green-digital patent portfolio has a higher impact than all other regions. However, this impact per patent is still higher in the United States. Europe’s relative weakness in general digital innovation and its dependence on digital innovations from elsewhere could potentially undermine its position. Nevertheless, one of the key strengths of Europe lies in the transport sector. There, Europe leads not only in green and green-digital innovation, but also in digital innovation overall.
How has COVID-19 changed the economic landscape?
When the pandemic struck, investment had been strong in most of Europe, but had abruptly begun to slow. In 2019, aggregate investment in the European Union grew around 3% from a year earlier, outpacing growth in real GDP. The rate of investment at the end of 2019 was above its long-term average in all areas of Europe except Southern Europe. However, intensifying international trade disputes and weakening global trade started to weigh on that growth. On the cusp of the coronavirus outbreak, concerns were mounting about the stalling of trade-oriented economies – notably Germany’s.
The outbreak of the pandemic in Europe in mid-March had immediate and dramatic consequences for investment:
• Investment contracted precipitously, along with other economic activities, as a direct result of lockdown restrictions. This effect was mostly felt in the second quarter of 2020, when investment fell 19% compared with a year earlier, as most restrictions were lifted by the summer.
• Economic sentiment deteriorated strongly, with firms adopting a pessimistic outlook for the year ahead. Firms’ perceptions of the economic climate had already turned negative in 2019. Those sentiments took a further dive with the arrival of the pandemic. Overall expectations of sector-specific business prospects and the availability of internal and external finance also turned negative.
• Uncertainty about the future rose to become a major deterrent to investment. Uncertainty indicators spiked at the beginning of the pandemic. Although Europe’s determined economic policy response succeeded in calming short-term fears, a high degree of uncertainty about the future course of the pandemic and the resulting economic crisis has remained. Unsurprisingly, uncertainty now stands out as the most serious barrier to investment, being mentioned by 81% of EIBIS respondents.
• EU firms revised down short-term investment plans, adopting a wait-and-see attitude. Some 45% of firms expect to reduce investment in the coming year, while only 6% expect to increase it, a dramatic reversal of the relative optimism seen in recent years. Of those firms that decided to invest less because of the pandemic, half said they were postponing investment and another 40% said they were changing or re-scaling their plans.
• Climate change investment will not be spared. 43% of firms that plan climate-related investment in the next three years say the pandemic will negatively affect their investment plans. In general, utility-scale projects (such as windfarms) are expected to remain resilient in the short-term, but smaller scale investments in renewable energy and energy efficiency, which are linked to spending by households and firms, are expected to fall.
The pandemic also raised firms’ expectations about the need to digitalise and innovate to adapt to the future. The belief in the need to digitalise holds even as firms curtail investment and optimism declines.
• Half of European firms foresee an increase in the use of digital technologies in the future as a specific result of the pandemic. The proportion is even higher among firms that have already adopted digital technologies.
• More than one-third of firms expect the pandemic to impact their supply chains or the products and services they offer, underlining the need for adaptation and innovation.
• Some 20% of firms foresee a permanent reduction in employment, suggesting that a significant number of firms are pessimistic about their ability to “bounce back” once the pandemic recedes.
The impact of the crisis on firms’ financial situations bodes ill for investment, the recovery and Europe’s structural green and digital transformation in the medium term. The policy response to the COVID-19 crisis has so far succeeded in maintaining firms’ access to short-term credit. Nonetheless, the massive demand shock has cut firm revenues dramatically, particularly during phases of strict lockdown. Small and medium-sized enterprises (SMEs) have been particularly hard hit. A conservative estimate puts the loss of firms’ net revenue at nearly 13% of GDP in the first phase of the crisis. Firms could cover an estimated 3 percentage points of this shortfall with the buffers of cash and other liquid assets they built up before the pandemic. To cover the rest, however, they will have to reduce investment or increase borrowing. EIBIS data show that firms have consistently used internal resources to finance around 60% of investment. If they maintain this pattern, investment would have to drop by some 6.4% of GDP, equivalent to a 48.5% fall in corporate investment relative to 2019, with corporate debt rising by an estimated 3.2% of GDP. An alternative scenario, in which corporate borrowing is doubled, still sees firm investment fall by a quarter. Modelling based on historical responses of corporate investment to demand shocks, and the size of the COVID-19 shock, also suggests that a reduction in investment within this range is to be expected.
The crisis-driven expansion of government debt could pose a medium-term threat to much needed public investment. Across the European Union, public debt is forecast to reach 95% of GDP by the end of 2021, an increase of 15 percentage points since the start of the pandemic. With the fiscal rules of the European Union’s Stability and Growth Pact temporarily suspended and interest rates expected to remain very low, constraints on public spending are still limited. Nonetheless, as the global financial crisis demonstrated, times of strong fiscal stimulus have very often been followed by periods of sharp fiscal correction that tend to impact public investment disproportionately.
Post-pandemic, Europe’s digital and green transformation will be even more pressing, yet the investment needed to drive that transformation is at risk. Europe faces a critical decade for the success of the climate transition and for maintaining its ability to complete technologically. The pandemic has even intensified pressure for digitalisation and for innovation to adapt supply chains and product portfolios to the “new normal” that will prevail. Yet, the pandemic has also created severe obstacles to the investment surge that is needed for recovery and transformation. These obstacles include uncertainty and the legacy of the pandemic lockdowns on firms’ ability to finance future investment. Decisive, forward-looking intervention will be needed.
Action for a green, smart and cohesive Europe
Long-term vision is needed to lead Europe out of the crisis. The pandemic represents an almost unprecedented shock to European and world economies. A massive short-term emergency response was needed. In Europe, policymakers have done well to limit the immediate economic ramifications