EIB Investment Report: Transforming for competitiveness

Investment in Europe has held up surprisingly well, despite the shocks that have rippled through the economy in recent years. Public support from EU institutions and national governments rolled out during and after the COVID-19 pandemic are part of the reason. That support spurred the investment needed to transform and modernise the economy. Firms have made progress on digitalisation, energy efficiency, decarbonisation and building up the resilience of supply chains.

Nonetheless, European businesses are still under pressure. Economic growth largely stalled in 2023, and the challenges to Europe’s competitiveness are rising. The pace of change needs to accelerate, even as investment becomes harder to sustain. To remain competitive in a sustainable way, the European Union and its members should focus on improving productivity, encouraging innovation, addressing skill gaps, scaling up new technologies and supporting young, dynamic firms. The economy needs to be transformed, becoming more digital and less dependent on fossil fuels.

The investment needs are huge, and public funds have an important role to play. But pressure on government finances means that future financial support must be more targeted and focused on catalysing the private investment needed to meet Europe’s ambitious goals. 

The combined shock of the COVID-19 and energy crises hit the European economy hard, but investment has proved significantly more resilient than in past crises. Part of that resilience is due to the strength of government investment. After the global financial crisis, European governments sharply cut investment as they pared down spending. This time around, however, government investment was largely spared.

The financial buffers that companies had built up during the pandemic also stimulated investment. Public support shielded many firms from the worst of the COVID-19 crisis. As the pandemic waned, pent up demand caused corporate profits to surge. This strong financial position compares to the high levels of debt companies had built up before the global financial crisis.

• 80% of EU firms were profitable in 2023, 2 percentage points above the historical average.
• Firms with profits of at least 10% of turnover were 8 percentage points more likely to accelerate investment than firms that only broke even.

Strong investment helped EU firms begin to transform. They improved their digitalisation, invested in energy efficiency and diversified their supply chains, all of which helped them navigate difficult economic conditions caused by the energy crisis and supply bottlenecks that developed after the pandemic.

• EU firms adopted advanced digital technologies, and in the past few years they have narrowed an 11 percentage point gap with the United States in the use of those technologies.
• 51% of EU firms surveyed invested in energy efficiency in 2023.
• Responding to supply disruptions, 20% of EU firms invested in digital inventory tracking systems and 24% of importers took steps to diversify their supply chains.

While corporate investment remains strong across the European Union, big differences exist across EU members. In some countries, for instance, real corporate investment exceeded the level before the pandemic by 5% or more in early 2023, while in others it stagnated.

Looking ahead, corporate investment is showing signs of weakening, dragged down by high interest rates and slow to non-existent economic growth. When the EIB Investment Survey (EIBIS) was conducted in the summer of 2023, many firms were already expecting to pull back on investment in the coming year. Firms are also pessimistic about the availability of external financing to fund investment.

Another squeeze to investment could come from tighter government budgets. The European Union suspended budget rules during the pandemic, enabling countries to spend freely to prop up the economy during the COVID-19 crisis and later on to provide relief to businesses and households as energy prices spiked. Those budget rules are expected to take hold again in 2024, although the way they are implemented is expected to change. That could lead governments to consolidate their finances, which historically has resulted in lower public investment.

• An EIB analysis of past episodes of government belt-tightening for 16 countries in the Organisation for Economic Co-operation and Development found that fiscal consolidation equal to 1% of gross domestic product leads to a 1% fall in private investment.

Investment could be shielded by the Recovery and Resilience Facility, which provides €723 billion to modernise the EU economy and facilitate the green and digital transition. Grants provided by the facility are similar in size to the spending cuts that would be required by a reinstatement of EU budget rules, particularly for countries in Southern and Central and Eastern Europe. The implementation of projects and reforms paid for by the facility are already facing hurdles, however, leading to a delay in disbursements.

The longer-term outlook for corporate investment is also clouded by structural issues, such as high energy costs, a lack of skilled staff and uncertainty about the future. Energy costs are a major concern. Firms cited them most often as a reason for potentially pulling back on investment.

• 70% of EU firms said energy prices rose by more than one-quarter in 2023, compared with only 30% of US firms.

Europe maintains a leading role in green technologies, but it lags on digital innovation and is at risk of being overtaken by China in the overall issuance of patents.

• European firms account for 18% of the top 2 500 R&D companies globally, but only 10% of the new entrants to this group, vs. 45% for the United States and 32% for China.
• The European Union still leads in the number of patents for green technologies, but China has been catching up. China and the United States already issue twice as many patents for digital technologies.

European firms are also lagging in the adoption of new technologies. Data from the EIBIS indicate the European Union has a lower share of firms that are investing to develop or introduce new products, processes or services than the United States (39% vs. 57%). This difference is overwhelmingly driven by the number of firms that invest to adopt products, processes or services that are already used in their industry, but are new to the company.

Europe wants to fuel innovation by providing more public support for the financing of fast-growing and scale-up companies. Venture capital finance in the European Union is underdeveloped relative to the United States and has been hurt by tighter financial conditions. This particularly affects funding for companies trying to scale up their operations. Despite strong public support, the fragmentation of Europe’s capital markets limits investors’ opportunities to exit their investments and results in an over-dependence on investors from outside the European Union.

• Europe particularly suffers from a dearth of financing for more mature scale-up activities. Financing for those activities are six to eight times greater in the United States (in dollar terms).

Venture debt is a nascent market in Europe, while other forms of growth finance are still in their infancy. The tightening of financial market conditions appears to have disproportionately affected companies’ efforts to scale up their operations.

EU firms responded quickly to the energy shock by increasing energy efficiency, but the more thorough transformation of energy-intensive industries is taking time, and going forward it might affect the competitiveness of some industries.

EU firms addressed high prices in two ways: they cut their energy needs by investing in energy efficiency, and they passed higher energy costs onto clients or consumers. It may take ten or 15 years, however, for electricity prices to be pulled down by lower production costs for clean or renewable energy. While increased investment in energy efficiency is positive, other investments to address climate change or cut emissions are being slowed by uncertainty over the direction of public policies or tight financial conditions.

Firms’ climate investments are also influenced by whether they view the green transition as an opportunity for their business or a threat.  

Higher prices for carbon allowances traded on the EU European Emissions Trading System are stimulating investment and innovation, leading to a decline in the emissions intensity of industries it covers. An EIBIS analysis of data from firms covered by the Emissions Trading System found that higher carbon prices pushed firms to reduce emissions, with little or no effect on the amount they produced or the prices they charged.

• A 1% increase in the price of carbon is associated with a significant 0.2% reduction in companies’ emissions intensity, but with only a very marginal effect on production volumes and prices.
• A 1% rise in carbon prices is associated with increases of 0.1% in investment and 0.2% in spending on research and development, suggesting that investment and innovation have been critical to reducing emissions.

EIBIS research also finds that public funds play a vital role in encouraging businesses to invest in climate adaptation, especially in vulnerable regions and sectors. European firms are more likely to invest in adaptation when a higher share of EU funds within the country is devoted to climate adaptation. These funds help companies to adapt by providing direct financial incentives, by creating a framework of standards and guidelines for climate adaptation and by supporting the development of new skills, knowledge-sharing and research.

However, a chasm remains between the share of firms that say climate change is affecting their business, and those that are investing to adaptation measures.