THE WARSAW INSTITUTE REVIEW

Date: 1 February 2017    Author: Roch Baranowski

Missing the Future

Europe risks falling behind in developing the disruptive technologies of the future – not only behind the United States, but increasingly behind China and other Asian countries.

© Stephanie Lecocq/EPA (PAP)

Among the top-20 largest internet companies in the world, there are already more Asian than European companies. And it is increasingly these companies which – fueled by the cash collected by first generation, e-commerce applications – drive the development of next generation technologies. If Europeans do not want to wake up left behind in a decade or two, with their technologies and business models obsolete and their societies fighting for ever-smaller scraps of wealth accumulated by previous generations, they need to find a way to catch up in next generation technologies.

Recent years have been hard for Europe – the Eurozone’s common currency is in permanent crisis, mass immigration has spiraled out of control, the European Union’s integrity has been shaken by Brexit and on a broader level, the cultural authority of Brussel’s liberal elites is increasingly being challenged by a “populist”s counterculture. All of this has forced European leaders to rush breathlessly from fighting one fire to the next.

As if all these short-term challenges were not enough, Europe now risks not noticing its biggest challenge yet, which could render it structurally incapable of competing on equal terms with North America and Asia on the economic battlefields of the future.

Over the last two decades of the internet revolution, for a variety of reasons, Europe has failed to produce relevant, domestic, internet-based business champions, instead becoming a target market for American technology and e-commerce companies.

Among the key success factors for internet companies, in particular e-commerce and social networks, is being able to quickly build up a critical mass of users in a target group and then being able to scale the model to additional target groups.

While the majority of social networking, e-commerce and digital marketing concepts were developed in the U.S., local European players were typically quick to copy and adapt the concepts to their particular national markets, resulting in many European eBay, Amazon and Facebook clones, developed in the 2000s. Instead of Facebook, there was the German Facebook clone studiVZ and the Polish LinkedIn clone GoldenLine. However, most of these regional players were able to grow only as long as the American originals were busy elsewhere. When Google, Amazon, eBay and Facebook directed their eyes towards European markets and started entering them, the local players were heavily disadvantaged against them – having a smaller domestic market base, often a non-English original language and user community, and less access to growth capital, leaving them with too few resources to defend their market leader positions. With a few notable exceptions, for example the Swedish music streaming service Spotify – European players had to let themselves be taken over by their American big brothers or risk slowly bleeding user numbers into irrelevance. Today, the European internet is firmly ruled by the American triumvirate of Google, Amazon and Facebook, with the sharing economy dominated by the American Airbnb, Uber and others.

In the short term, this seemed like a beneficial, win-win situation for both sides of the Atlantic, the result of globalization and integrated markets. America gives Europe Facebook and Twitter, while Europe gives America German cars and French wine, so what could be wrong with that? Also, this type of development might be structurally unavoidable. In industries where scale matters above all, the fragmented cultural landscape of Europe just doesn’t seem fit with the creation of large internet players. If service offers are unique and customized to the specific cultural needs of a European country, they are automatically confined to this particular market – be it German, French, Polish or Hungarian. It is very unlikely for a French person to use a Polish social network or vice versa. There is no common European market for local identity and culture. The only common denominator is the English language and American popular culture. And therefore Facebook, Twitter, and the like, are a natural fit.

This phenomenon is similar to the European movie industry. Economically, production budgets in the film industry are directly correlated with the size of the addressable market. The 80 million Germans, 35 million Poles and the 10 million Hungarians, will never be enough to justify similar budgets as 320 million Americans and the additional billions associated with the English language and American culture.
Therefore, the European film industry has become marginalized and dominated by Hollywood and is currently only in existence due to state subsidies. Today, having a domestic film industry is a luxury that European societies choose to afford themselves, rather than a self-sustained driver of economic growth.

So maybe the same applies to web pluralize or social networks? Perhaps all of this isn’t a problem? Google and Uber work just fine in Europe, so what does it matter where their headquarters are?
The problem is that it is increasingly the cash accumulation from web searches and advertising, social networks and e-commerce applications that fuels the development of next generation technologies such as artificial intelligence, virtual and augmented reality, zero-emission and autonomous mobility, robotics and more. While old economic giants such as Siemens and Daimler struggle to quickly change course, it is the dynamic players in Silicon Valley who push forward into new terrain. The mountains of cash collected by Google from its basic search and advertising services give the company the resources, stamina and appeal to pioneer artificial intelligence, robotics and self-driving cars. For example, Google has invested $400 million in the artificial intelligence company DeepMind, which then created AlphaGo, which defeated the world champion in the boardgame Go, a game until recently considered unwinnable for computers due to the need to use intuition to navigate through the almost infinite number of potential moves. Facebook, Amazon and Uber all invest heavily from the cash they collect from their American and European user base and global investor base into artificial intelligence startups.
This division of labor between the innovative U.S. and consumer-providing Europe creates a vicious structural circle for Europe where risk-friendly capital generated from first generation e-commerce players only accumulates outside of Europe, further amplifying the already pronounced dearth of private risk capital. What seemed like a win-win example of globalization might end up as a win-lose setup with Europe left with the short-end of the stick.

Another worrisome example is the European auto industry. For decades, Europeans were used to considering their car industry – German, French, Italian – as vastly superior technologically to the struggling American giants like GM and Chrysler. However, the tables appear to be turning due to the entrance of Silicon Valley players into the industry. The breakout success of built-from-scratch Tesla cars was a first warning shot that could have been brushed off as a billionaire’s extravagance. Google’s less public effort to develop self-driving technology resulted in more than one million kilometers driven on public roads by autonomous, self-driving cars in 2016 alone, a figure which no traditional automaker can come close to. All this testing has allowed Google’s self-driving car company, Waymo to refine its technology to a level where human intervention is required once every 5000 kilometers on average – an improvement from once per 1000 kilometers one year earlier; and while Google and Elon Musk revolutionize the car industry, and with companies like Apple joining in, Europe’s biggest car manufacturer, Volkswagen, is still dealing with the fallout from its diesel emission cheating scandal.

So while it is no problem that European consumers are using Facebook or Google, it is becoming a problem that Europe hasn’t been able to create any comparable, large-scale applications on their own, which could direct their resources and investment to pioneer next generation technologies. Europe risks being left behind.

China, on the other hand, has kept American internet companies at bay. The restrictions set on Google, Facebook, and others in China, were officially driven primarily by concerns that they could undermine the censorship and control of the ruling party. However, no matter how just the motivations for these restrictions were, in consequence, China has developed their own players, which are now catching up to and sometimes overtaking the American archetypes. The web search leader Baidu, social networks like Sina Wei and the messenger-turned-mobile-platform WeChat, have grown strong, protected from Western competition. The strength of the Chinese internet industry gained global prominence with the IPO of China’s largest e-commerce platform Alibaba, which is now the world’s fifth biggest internet company by market capitalization.
Among the top-10 biggest internet-based businesses in the world, there are now seven American firms (Amazon, Google, Facebook, eBay, Netflix, Priceline, and three Chinese ones: Tencent, Alibaba and Baidu). There is not a single European company.

However, what is more critical is how these first generation social and e-commerce players are the catalysts for the next generation of internet businesses. A good example is the ride-hailing application Didi. Didi, a local competitor to Uber, was backed by investments from Tencent, the Chinese social media champion and Alibaba, the Chinese e-commerce behemoth. After a long battle for market dominance with Uber, Didi finally overtook Uber China and became the largest ride-haling application in the world, with all three Chinese internet giants among its shareholders (Tencent, Alibaba and Baidu).

Similarly to their American counterparts, it is these Chinese internet companies which use the cash generated from their mass applications to push forward next generation technologies. Baidu, for example, recently acquired the Beijing-based artificial intelligence outfit Raven Tech and is also pushing into the autonomous vehicles industry. It is telling that Baidu is among the companies to have received an Autonomous Vehicle Testing Permit by the Department of Motor Vehicles in California.

What does that development mean for Europe? Unfortunately, nothing good. Once the boat is missed on a certain technological development, it is not that easy to catch up. A good example is the economy of the Soviet Union. While, of course there is only limited sense in comparing the European Union to the Soviet Union – one being a voluntary union of democratic and capitalist states, and the other a totalitarian planned economy created by force – the Soviet case still provides a useful illustration.

There are many reasons for the economic and as a consequence, political collapse of the Soviet Union – the economic costs of the revived arms race, the oil price drop of 1986 and so on. But one interesting element is the Soviet failure to compete in the realm of microelectronics. Semiconductor-based electronics was initially developed in the U.S. and mass manufacturing was successfully developed in Asia. By the 1970s, the Soviets realized the growing importance of that technology and made some strides to catch up with the West in integrated circuit production, but were always lagging behind by several years. By the mid-1980s, the Soviet integrated circuit production capacity was approximately 10% of that in the U.S. and two generations behind the latest chip models, while at the same time microprocessors started playing an ever-bigger role as growth drivers of the global economy. By the late 1980s, the Soviet Union de-facto gave up on developing its own microprocessing technology and started refurbishing plants to copy American technology, just as developing Asian countries had done many years before.
So, does Europe stand a chance of catching up or is it structurally destined to become a backwards backwater, doomed to watch the technological progress of the future from the sidelines, at most as passive consumers? Over the last few years, the EU – and the Eurozone in particular – has already become the sick man of the world’s economy. Average annual growth rates over the last five years were 2.7% for the world, 2.1% for the U.S., 7.9% for China and 6.7% for India. The economy of the Eurozone however grew only by 0.7% in that period. While many Europeans still believe that this prolonged economic stagnation is a temporary challenge that will somehow be overcome, it could also be the beginning of a long-lasting structural disadvantage that will make Europe fall behind in the growth drivers of the future.

To avoid this, a paradigm shift is required – European leaders need to stop focusing on how to restore the wealth generators of the twentieth century, and let European companies join the competition for building the twenty-first century. European states need to help alleviate the lack of private risk capital and investment structures, while avoiding the trap of creating a bureaucratic parallel world where startups adjust their business models to the requirements of EU funding programs, rather than market needs. Europe needs to rethink its often-restrictive regulations, that protect the vested interests of the old economy at the expense of disruptive, new technologies, be it with financial services and the upcoming blockchain revolution, or elements of the shared economy, such as ride and apartment-sharing.

Europe needs mechanisms for quicker, pan-European rollouts of local ventures and must improve direct access to the U.S. market, to restore the transatlantic economic relationship to a two-way street, especially when it comes to new technology. Both the private and public sectors can team up to create platforms to ease access to overseas markets. But most of all, Europeans need to overcome complacency and a sense of false security. In focusing our attention on fighting fires, we might be missing the boat to the future. A wake-up call is required. And it seems that the more dynamic East-Central European region is quicker in understanding and adapting. Increasingly, countries like Poland, Romania, Hungary and the Baltics are becoming growth drivers, including in the new technology space. The innovation zone is shifting outside the Eurozone. But will it be enough to turn the European ship around?

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