The Constitution of Innovation: A New European Renaissance

"The regulatory bicycle is pedaling at full speed. But it is pedaling towards a wall of bureaucracy created by its own policies." 

 "To face the great transformation ahead, Europe needs both an innovation system and creative destruction." 

By Luis Garicano, Bengt Holmström & Nicolas Petit. Holmström is a Nobel Prize winning economist. Excerpts:

"While the United States maintained a remarkably constant 2 percent growth rate in average income, the European core economies decelerated, slowly and then sharply. Since 1995, Europe’s average annual growth has been just 1.1 percent; since 2004, it has been a mere 0.7 percent – all while the United States has continued on its steady track. By 2022 the relative gap in output per head has returned to where it was in 1970. Decades of convergence were surprisingly wiped out" 

 

"Last year, Enrico Letta found the European market critically fragmented, while Mario Draghi concluded that Europe’s competitiveness had fallen so far it now required ‘radical change’ just to survive."

"The European Union does not need a new treaty or powers. It just needs a single-minded focus on one goal: economic prosperity."

"The European Union currently pursues a long list of goals, including (as given by the Commissioner titles): promoting the ‘European way of life,’ ‘health and animal welfare’, ‘environment, water resilience and a competitive circular economy’, ‘intergenerational fairness, youth, culture and sport’ or ‘social rights and skills, quality jobs and preparedness’. Meanwhile, the internal market has become so fragmented that, according to recent IMF analysis, internal trade barriers are equivalent to a 44 percent tariff on goods and 110 percent on services."

"With peace secured, the European institutions began to look for new problems to solve."

"From the 1980s Europe began legislating on topics with little to no connection to economic integration or peace – the amount of fruit in marmalade, the conditions under which a piece of clothing could be considered sustainable, or what constitutes appropriate political advertisement. What started as functional integration – removing barriers to trade – morphed into the superstition of regulation for the sake of integration. Each new regulatory text justified the next"

"This regulatory overkill has culminated with the response to the digital and environmental challenge, which led to an avalanche of rules"

"the General Data Protection Regulation (GDPR), favors US tech giants which can shoulder the burden of massive compliance costs but undermines European startups. A recent study shows that GDPR reduced European Union technology venture investment by 26 percent relative to the US."

"These rules raise the cost of innovation and slow the dissemination of digital technology across the European Union."

"it must work with the Member States to complete the internal market.

The internal market has only one definition: the free movement of goods, services, capital, and workers. It is against these standards that it should be judged, exclusively and fully."

"The European Union needs to stop wading into new policy areas like housing or animal welfare and get serious about enforcing basic internal market rules."

"To face the great transformation ahead, Europe needs both an innovation system and creative destruction. We lack in both areas, but we are particularly weak in creative destruction. The ECB has pointed out repeatedly that Europe’s failure to kill zombie firms crowds out credit for healthy firms.¹⁵ We must stop defending legacy assets and build a system that accepts both market entry and exit as the basic conditions for innovation."

"we must actively seek and eliminate barriers to entry that favor incumbents, such as special rights, subsidies, or skewed regulations from banking to telcos, from energy to agriculture. We must support market exit through streamlined bankruptcy laws and flexible labor rules. Market exit is not failure; it is how we reallocate assets, people, and resources from old businesses to new ideas."

"supported by secure property rights"

"If a product is safe enough to be sold in Lisbon, it should be safe enough for Berlin. We should not burden traders with the task of removing local barriers to trade through judicial remedies in the target country"

"European Union law in reality allows Member States freedom to restrict imports of goods and services and only forces them to demonstrate why imports are not good enough for the home market under a specific procedure. Traders are therefore subject to ‘an unstable litigation-driven trading environment of inter-State regulatory diversity’.¹⁷ The business of business is business, not litigation."

"We must create simple and clear rules that free competition instead of centrally planning our economy by regulatory fiat."

"Europe’s frenzy of regulation has been predicated on the existence of free lunches. For instance, climate laws have been sold as leading to job creation and innovation (the ‘green deal for jobs’) not just as the solution to climate change. Citizens were asked to swallow make-believe propositions, like the idea that fighting global warming would be free of economic cost.

Similar Nirvana fallacies have been observed in other domains, like migration, trade policy or digital regulation."

Legal reforms

1.  Eliminate the usage of directives

[A court in 1979 ruled that] "goods lawfully produced and marketed in one Member State must flow freely to all others."

"Member States cannot enforce their own domestic laws to bar imported goods."

 "businesses must still comply with a maze of national barriers. France imposes unique carbon tests on imported diesel. German Länder require separate fire safety certifications for construction materials already approved elsewhere in the European Union."

"The solution is to abandon directives entirely"

"Businesses end up facing 27 different versions of supposedly ‘common’ rules."

2. Specialized Commercial Courts

"The internal market’s main weakness is enforcement. When Italian regulations illegally block a French trader, that company faces only bad options. It can file a complaint with the Commission and wait years for action that may never come; sue before Italian courts only slightly familiar with European Union law; operate illegally and hope to reach the European Court of Justice through proceedings brought against it; or simply give up."

"We propose that the European Union create Specialized Commercial Courts with exclusive jurisdiction over internal market violations by Member States."

3. Federal field preemption

"traders face a regulatory thicket, which only gets denser as more national, regional, and local regulations are introduced. Right now, banks answer to European supervisors, national central banks, and local regulators simultaneously. According to the Draghi report, there are over 270 digital regulators in the European Union, each interpreting “common” rules individually."

"The solution is that when the European Union regulates in areas of exclusive competence and internal market legislation, all national, regional, or local rules in that specific area cease to apply."

4. A 28th regime that is appealing to businesses

"give up on harmonizing 27 different corporate systems"

"In practice, Portugal would not need to adopt German corporate law or vice versa, as there would be a European alternative that companies can embrace if it serves them better."

"statutory conditions for the formation of SEs require businesses to incur high set-up costs and follow time-consuming and complex procedures for incorporation. This has tended to favor large firms.²⁸ Moreover, the law embodied a high number of referrals to national law and burdens in terms of employee participation.²⁹ This forced companies and investors to navigate a complex web of rules"

"This self-inflicted flaw stripped the SE of its core utility: giving small and medium-sized firms scale through simple and swift pan-European incorporation."

The US demonstrated the power of this solution when it allowed companies to bypass state securities laws by being regulated at the federal level – late-stage firms became four times more likely to attract out-of-state investors.³¹ The European Union could achieve similar results by letting businesses opt into European rules rather than forcing all Member States to abandon their national systems. This would also go some way towards unifying capital markets.

Countries that wish to maintain their legal traditions can keep them. Businesses seeking European scale can bypass them.

5. Rely on existing institutions when possible

"much of the European Union’s expansion has taken place in areas where existing institutions already operate."

"a worthwhile policy would consist of systematically determining which other existing institutions the European Union could use to discharge some of its core missions." 

6. Reform legislative practice

"Many temporary law and policy programs have become permanent. New regulatory structures entrench interests and are hard to dismantle. National regulatory authorities (NRAs) in network industries like telecoms illustrate this problem. Created to open monopolistic markets, they were supposed to hand over their powers to national competition authorities (NCAs) following liberalization. Decades later, the European Union has both NRAs and NCAs, adding compliance costs to industries no longer in need of market opening reforms."

"review clauses should be replaced with sunset clauses. Unless evidence shows a persistent market failure requiring maintenance or reform of a regulation or directive, the presumption should be that once a set period has elapsed, the instrument is no longer useful."

"the European Union fails at submitting new rules to a rigorous analysis of their costs and benefits. The Commission does have the duty to run an initial cost and benefits analysis of draft legislation. However, the Parliament and the Council, when they rewrite the law, often in private meetings (called ‘Trilogues’), are not required to check the costs and benefits of their own changes." 

"Whenever a change is proposed to a law that alters its purpose, key terms, or costs, the team must produce a short, public report on the effects."

"Whenever a change is proposed to a law that alters its purpose, key terms, or costs, the team must produce a short, public report on the effects."

[there were] "13,000 legal acts between 2019 and 2024"

"Poland entered the millennium at 47 percent of the European Union average income and today stands at 93 percent."

[that was not] "achieved through the competencies that have been layered on in the last twenty five years." 

[it was because of] "economic integration and solid European institutions."