The Constitution of Innovation
A New European Renaissance
By Luis Garicano, Bengt Holmström & Nicolas Petit
(You must have wondered what I was up to— well this!: We have been working very hard to make a manifesto with concrete suggestions on what Europe should change to benefit from its enormous scale and unleash a new renaissance. Here is part of the manifesto- the rest in the dedicated micro-website. Reactions, comments and thoughts as well as social media comments very welcome):
In 1945, Europe was ruined. Average incomes were 22 percent lower than the United States at the start of the war; by the end that gap had grown to 75 percent. These economies were different in kind, too. In 1950, for every farmer in America there were 2.7 manufacturing workers, compared to just 1.3 in Germany and 0.92 in France. 1
But rather than stay poorer, as one might have expected, Europe rapidly rebuilt itself. Not just did it reach its previous levels of development within nine years, it then blew past them. Even though the decades after the war saw some of the fastest growth in American history, Europe grew much faster. In thirty years after 1950, the core European economies grew so fast that consumption per capita tripled while their citizens worked 400 fewer hours per year.2
Part of this growth was catch-up: converging on the frontier America had set for us. But part of it was pushing the technology frontier forward. By the end of the 1970s, Europe was mass-producing jet engines and nuclear power plants. This success was not an accident; it was ‘constituted’ through a set of common beliefs, proved principles, and appropriate practices that stimulated innovation.33. As in Friedrich Hayek’s 1960 book, The Constitution of Liberty, we use ‘constitution’ to mean the basic principles and practices needed for innovation and prosperity to return to Europe, not a legal document.
However around 1980, this unprecedented growth period ended. 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.4
A long list of reports by European luminaries have diagnosed this decline. The 1988 Cecchini Report calculated the enormous ‘cost of non-Europe’; the 2004 Sapir Report identified Europe’s ‘disappointing’ growth; and the contemporaneous Kok Report argued the EU was failing through lack of political will. In 2010, Mario Monti warned that the internal market was suffering from ‘integration fatigue.’ 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.
Despite these warnings, the European Union’s response to its decline has been weak where it needs to be strong, and active in the areas where it should be passive. The problem is not a lack of reports, but a system that refuses to prioritise.
The continent faces two options. By the middle of this century, it could follow the path of Argentina: its enormous prosperity a distant memory; its welfare states bankrupt and its pensions unpayable; its politics stuck between extremes that mortgage the future to save themselves in the present; and its brightest gone for opportunities elsewhere. In fact, it would have an even worse hand than Argentina, as it has enemies keen to carve it up by force and a population that would be older than Argentina’s is today.
Or it could return to the dynamics of the trente glorieuses. Rather than aspire to be a museum-cum-retirement home, happy to leave the technological frontier to other countries, Europe could be the engine of a new industrial revolution. Europe was at the cutting edge of innovation in the lifetime of most Europeans alive today. It could again be a continent of builders, traders and inventors who seek opportunity in the world’s second largest market.
The European Union does not need a new treaty or powers. It just needs a single-minded focus on one goal: economic prosperity. This prosperity is necessary for its own sake and for all the other things we want Europe to be: a bulwark against Russian tyranny, a generous supporter in lifting the world out of poverty, and a champion against climate change.5
As Jean-Jacques Servan Schreiber observed in the 1960s:
The degree of autonomy, prosperity, and social justice that a country aspires to depends upon its growth rate. A society enjoying rapid growth is free to define its own form of civilization because it can establish its order of priorities. A stagnant society cannot really exercise the right of self-determination.
To achieve this prosperity, we need to return the Union back to its original intent, as a federal body dedicated to economic development through a common and free market.
The neglect of that purpose has been overwhelming. 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. And, as Mario Draghi famously pointed out, no European company worth over €100 billion was set up from scratch in the last 50 years; the continent that birthed the industrial revolution has wrecked its own ability to catch the digital one.
These are not accidents of history; they are consequences of our choices. In recent decades, the Union and its Member States have confused regulation with progress and bureaucracy with integration.
If the European Union keeps stagnating, our countries will not be able to maintain the things its citizens take for granted: unemployment benefits, free healthcare, lifelong pensions, and affordable education. Growth is necessary to pay for existing commitments, and fulfill the recent deluge of new ones. Stagnation is going to make the European welfare state a utopia of the past.
This paper proposes a different path, one guided by pragmatism, not ideology. This requires a clear set of principles to focus the actions of the European Union on a few critical objectives and act decisively to achieve them. To understand how to correct its course, we must first examine how the EU lost its way.
How we lost our way
The European project began with a clear purpose. The 1950 Schuman Declaration proposed integrating the coal and steel industries – the raw inputs of war – to make conflict between France and Germany ‘not merely unthinkable, but materially impossible.’ This approach, known as functional integration, was based on the proposition that when economies become interdependent through trade, war becomes prohibitively expensive.6
The Coal and Steel Community (1951) evolved into the Economic Community (1957), creating the world’s largest trading bloc. The Single Market (1993) removed trade barriers between Member States. The Euro (1999) provided price stability across borders. Nations that shared a long history of violence were progressing towards what Robert Kagan called a ‘post-historical paradise of peace and relative prosperity’.7
But initial success led to mission creep. With peace secured, the European institutions began to look for new problems to solve. Jacques Delors, Commission President, captured Europe’s principle of action in a famous metaphor: ‘Europe is like a bicycle. It has to move forward. If it stops, it will fall over’. This mantra — that integration must constantly increase or founder — converted the European peace project into a self-perpetuating regulatory flywheel. Legal scholars, practitioners, and policymakers transformed an untested vision into a grand narrative, ‘integration through law’.8
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, creating a governance culture where ‘more Europe’ became the answer to every question, regardless of whether European intervention added value.
This regulatory overkill has culminated with the response to the digital and environmental challenge, which led to an avalanche of rules driven by the ‘Brussels effect’— the theory that pretends that writing legal rules sets global standards and thus gives European firms a competitive edge.9
In practice, the Brussels effect has created high costs that harm European firms more than their global rivals. For example, 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.10 The AI Act follows the same logic, imposing technical requirements for market access on an emerging technology before Europe has even created one major AI company.
These rules raise the cost of innovation and slow the dissemination of digital technology across the European Union. The regulatory bicycle is pedaling at full speed. But it is pedaling towards a wall of bureaucracy created by its own policies.
Economic foundations
Europe must do less, but do it better. Prosperity through economic integration should again be central to the Union. In practice this will mean two things. First, the Union must simply focus on the exclusive competencies its architects gave it, which are already orientated towards prosperity. These include the customs union; the competition rules necessary for the functioning of the internal market; monetary policy for the Member States whose currency is the euro; and a common commercial policy.11
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. Every other issue of political expediency – from the energy use of household appliances to the length of the work week – is not an internal market issue, despite what has been said to justify further legislation.12 While many of these issues are important, the Union provides for their regulation through Member States at the central, regional and local levels under the subsidiarity principle.13
This is not a repudiation of social concerns. Only a prosperous Europe can fund the welfare state. As Article 2 of the Rome Treaty of 1957 already spelled out, the internal market constitutes the foundation for improvements in standards of living:
The Community shall have as its task, by establishing a common market and progressively approximating the economic policies of Member States, to promote throughout the Community a harmonious development of economic activities, a continuous and balanced expansion, an increase in stability, an accelerated raising of the standard of living and closer relations between the States belonging to it.
The treaties that have shaped the European Union provide the solutions that we need. Yet, today, the core business of Europe, the internal market, is a fiction. The European Commission, which should be its referee, has stopped calling fouls. Infringement cases are down 75 percent from a decade ago. And the time needed to resolve them has dramatically increased.14 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. This is a question of will and of prioritization, not capacity.
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.
This requires a firm commitment to economic dynamism. It means 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. This entire system must be built on a foundation that allows entrepreneurs and inventors to reap the rewards of their success, supported by secure property rights, deep financial markets, and unwavering legal certainty for risk-takers.
Some risks require prudence. But currently, Europe’s risk paranoia is killing its future. Our generalized precautionary approach disincentivizes the bold bets that lead to breakthroughs, from AI or genetic engineering to venture capital. Innovation requires risk-taking. We should enable it, not regulate it out of existence.
Ukraine provides an extraordinary example of this vision. It is much poorer than any EU Member State but it has rapidly and affordably fielded military capabilities none of them have, in large part because it has trusted and enabled its citizens’ ingenuity. If Ukraine is still standing today, it is because of the resilience of its people, but also thanks to the efforts of its hundreds of ‘tinkerers, tweakers, and implementers’ in building, testing, and deploying new ideas, especially with drones.16
Ukrainian Border Guard Servicemen with DJI Mavic Drones. Photo by ArmyInform. Licensed under Creative Commons Attribution 4.0 International (CC BY 4.0).
Europe led the industrial revolution in part thanks to its political diversity: competition among states drove societies to seek and reward the best talent and innovators. Variation is a strength. What works for five countries may not work for twenty-seven. Instead of forcing uniformity, we should embrace ‘variable geometry’, that is, letting groups of willing countries cooperate more deeply on shared goals.
Committing to diversity requires genuine mutual recognition. 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, let alone expect them to do so. Stephen Weatherill has shown that a pure mutual recognition model does not exist in the European Union. Instead, the European Union has a model of non-absolute or conditional mutual recognition. 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.
A genuine model of mutual recognition lets different approaches compete to find what works best and removes egregious obstacles to trade through swift judicial redress at the European level. 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.18 Honest policymaking requires accepting that goals often conflict. A decision to prioritize one objective, whether environmental protection or data privacy, generates a cost somewhere else – often competitiveness and innovation. We must acknowledge and face these trade-offs.
This does not mean that we should give up on the dream of political integration. But our inability to generate prosperity cost us the support needed to achieve it. In order to achieve everything else, our proposal is that the European Union concentrate on its core function – prosperity – for the foreseeable future. Other projects are and should still be possible, but, to quote Mario Draghi, they “would be built through coalitions of willing people around shared strategic interests, recognizing that the diverse strengths that exist in Europe do not require all countries to advance at the same pace.”19 The European Union has 450 million citizens. They are educated, tolerant, and committed to freedom and democracy. The continent is rich, and, for now, large. This is not a weak starting position. But the Union has become reactive, trapped by crises and caught on the back foot by events, busy protecting what it is instead of thinking about what ought to be.
A renaissance is possible. A much better Europe is feasible if it stops building walls of regulation, lets innovation happen, and focuses on prosperity above all else. It must trust its people and let them build.
Legal reforms
(Keep reading in our micro-website, the rest does not fit in email. We start formulating concrete proposals to focus policy-making on prosperity.)
