and innovation at the intersection of digitalisation and decarbonisation will be paramount. Examples of enabling digital technologies include smart urban mobility and smart grids, precision agriculture, sustainable supply chains and environmental monitoring. The growth of teleworking during the pandemic illustrates how economic processes and products can increasingly be dematerialised. Innovation that uses digital technologies to achieve greener processes is of particular strategic importance for both future sustainability and competitiveness.
Europe is a global leader in green innovation, and even more so in innovation that is both green and digital – despite the United States’ leadership in most digital domains. According to the most recent data, Europe registered 50% more patents in green technologies than the United States, with Japan and China further behind. Moreover, Europe registered 76% more patents that combined both green and digital technologies than the United States, and four times more than China. Likewise, while the top global companies for digital innovation are largely American – with potential challengers from China – the top innovators for green technologies and technologies that combine green and digital elements tend to be European companies, with Japan in second place.
European firms lead the United States for green investment and digital adoption by green firms. Compared to the United States, European firms are less likely to have adopted digital technologies, but are more likely to invest in measures for mitigating or adapting to climate change. The share of firms that make green investments and are also digital adopters is also marginally higher in Europe (32% vs. 28% for the United States).
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,
