Europe Is a Developing Economy

European Straits #143

Hi, it’s Nicolas from The Family. Today, I’m discussing the idea of Europe as a developing economy, and how East Asian countries in the 20th century can be a source of inspiration.

First up this week, don’t miss my latest column in Sifted. It’s about the WeWork debacle and how we Europeans should avoid drawing the wrong lessons from the whole episode. Essentially, the fact that Adam Neumann was a fraud and that SoftBank was blind in their decision-making doesn’t mean that the music should stop. For us Europeans, there are still opportunities to build thriving hybrid businesses. Read more here: Europe, don’t draw the wrong lessons from the fall of the unicorns.

Now on to today’s focus: development economics, industrial policy, and the path forward for Europe 👇

Strait Is the Gate: Economic Development in Europe

1/ You may be familiar with Joe Studwell’s How Asia Works. In this inspiring book, Studwell, an expert in everything Asia, reflects on the economic performance of eight East Asian nations over the 20th century—namely on how four have succeeded (that’s Japan, Taiwan, South Korea, and Mainland China) while four others have remained stuck in what economists call the “middle-income trap” (Malaysia, Indonesia, Thailand, and the Philippines). The book is Studwell’s framework for understanding what went right in the first four nations and what went wrong in the latter four.

Importantly, I think this playbook for tackling economic development can be applied to today’s Europe. It’s not because Europe is obviously similar to East Asia in the early 20th century. It was a different world back then and countries were confronted with different economic challenges. Still, with a bit of translation in terms of time and space, we Europeans can build upon the playbook found in How Asia Works. It only takes one thing: admitting that Europe has once again become a developing economy.

2/ The idea of Europe as a developing economy came to me while studying technology’s advance in China. Indeed, the most interesting trend in global tech these past few years isn’t anything that’s been happening in the US. Rather, it’s the rise of tech companies in China. Like many Westerners, I had long been uninterested in what was happening in Mainland China. I thought it was too far away, too different, and all happening in the impenetrable language that is Mandarin.

But I changed my mind following Alibaba’s IPO in 2014. That moment triggered my interest, leading me to watch The Crocodile in the Yangtze, a movie that tells the story of Alibaba beating eBay on the Chinese market. I then read many books and articles, met many experts, and even had the opportunity to travel there twice: to Shanghai in 2017 and then to Beijing, Wuhan, Shenzhen, and Guangzhou earlier this year with my colleague Emilie Maret. Today, I’d say that the idea of China as a tech superpower has become widely acknowledged. But that doesn’t make the country any less interesting.

3/ Why is Chinese tech so important for us Europeans? There are two things that struck me while reading about it and travelling there.

First, the fact that the US and China have now become rival tech superpowers forces Europe to do some strategic positioning:

  • One option is that the old continent remains “an ancillary market for US tech”, to borrow Hussein Kanji’s words. In this case, we Europeans will never grow large tech companies, our continent serving US tech companies both as a market for selling products and as a pool for hiring talent.

  • The other option is that Europe finds a way to become a tech powerhouse in and of itself while siding with either the US or China depending on the topic (see Huawei for a case in point). My preferred option is obviously the latter, which is why I chose to call this newsletter European Straits (alluding to the Bible’s “Strait is the gate, and narrow is the way”).

4/ The other important thing is that China became a tech superpower using a very different playbook than that of the US—and it’s really worth our European attention. For years, European entrepreneurs and investors have been trying to emulate the Silicon Valley playbook, mostly to no avail. But now that the Chinese have caught up, they’ve revealed something critical: there is another way. Silicon Valley grew over the course of eight decades, kick-started by the US Department of Defense and then lifted up by Stanford University and venture capital firms. The Chinese tech ecosystem grew up in a much shorter timespan, actively supported by the Communist Party and with a very different approach to entrepreneurship and innovation. For us Europeans, the conclusion should be obvious: If there are two paths that are so different, there could also be many more—including, maybe, one that is specifically European.

5/ So what’s that European path? There has been a temptation to renounce building large tech companies in Europe and to focus on regulation instead. But that’s a dead end. Regulation alone doesn’t make a region competitive. What makes a real difference, to borrow Kai-Fu Lee’s words, is using a “techno-utilitarian approach” as a lever to accelerate the growth of tech companies. It works in both directions. Sound regulations can boost local champions by raising the bar, forcing them to get better on various fronts, and ultimately consolidating their competitive advantage. In turn, local champions can act in a system of checks and balances—lest regulators implement stupid ideas with a corporatist or protectionist bias. What we need in Europe is not more regulations attempting to slow down outsiders, but rather a strategy to use “techno-utilitarian” regulations so as to catch up on what really matters: tech-driven per capita GDP—that is, the main indicator of economic development in the 21st century.

6/ This is where we can go back to Studwell’s framework. Again, the core of my thesis is that our old continent has become a developing economy again: it still has to catch up in growing companies tailored for the Entrepreneurial Age. If that is true, can Europe find inspiration in the development strategies employed by successful Asian countries over 50 years ago? Some may see the question as an exaggeration.Most of the EU’s member states are among the most developed in the world; in theory, they shouldn’t have to go through the same steps as did Asian countries during the 1970s.

But here’s the thing: the shift to the Entrepreneurial Age has reset all the clocks! Countries such as France and Germany were certainly racing ahead in the Fordist Age. But as the world became more digital, we fell behind. Today’s large tech companies, those that are discovering and imposing the new paradigm, are all American or Chinese. Europe is still rich thanks to its past prowess. But it is under-developed in an economy now dominated by computing and networks. And so are we ready to swallow our pride and admit that we’re once again in the process of catching up?

7/ Studwell’s book can be summed up in one sentence: Development involves getting the most out of the available workforce, even if it is relatively unskilled. What that meant in East Asia was widespread land reform—that is, redistributing land to farmers to encourage them to produce more without the risk of having the value of their production systematically extracted by predatory landlords. This was meant to encourage and utilize the available workforce without the need for advance training. As the majority of the population worked in agriculture at the time, it was better to allow individual farmers to grow richer where they were, even without any significant productivity gains, rather than having them be exploited by large landowners or pushing them to go live in cities where there wouldn’t be enough jobs for them all.

8/ My belief is that today’s equivalent of agriculture in Europe is proximity services in urban areas. Just like agriculture back then, it may not be the most productive part of the economy. But it’s definitely the one that employs the most people. The problem is that because services are concentrated in cities, the real estate market has become a bottleneck: it makes many proximity businesses unsustainable and it prevents workers from taking those service jobs in which they could contribute to maximizing output.

This is why the equivalent of land reform in today’s Europe would be implementing what are known as Georgist reforms on real estate markets—having European urban housing markets governed by the principle of the land as a common good (as is the case in Singapore) rather than that of real estate tycoons and NIMBYists extracting value (as is the case in Hong Kong, Paris, New York, San Francisco, London, Munich...pretty much everywhere in Europe and the US).

9/ Once the new foundation has been laid, the second part of Studwell’s playbook shows how to support the nascent part of the economy that generates higher productivity gains. What he calls “export discipline” once applied to high-tech manufacturing. It implies the state supporting certain businesses if and only if those grow to effectively compete on foreign markets, which makes it possible to prevent rent-seeking by companies that only serve the domestic market. “Export discipline” is easy to emulate in today’s Entrepreneurial Age, because we already know where there’s room for more productivity gains: in software-driven businesses as well as in industrial businesses targeted at making the economy more climate-friendly and energy-efficient (what Carlota Perez calls “smart green growth”). These export-driven industries with increasing returns to scale can then take in a growing number of workers migrating from proximity services (sectors characterized by decreasing returns to scale), making them more productive thanks to on-the-job training.

10/ Last but not least, Studwell’s playbook addresses what he calls “repressing finance”—that is, that the state should prevent free movement of capital and force those with capital to invest mostly in developing the domestic economy. In today’s case, that would mean allocating domestic capital mostly to financing infrastructures benefiting proximity services (in transportation, affordable housing, urban logistics) and export-driven companies with increasing returns to scale.

It comes with costs for those with money. When finance is so “repressed”, capitalists are pushed to renounce the higher returns that can be found in foreign assets. It also means renouncing investments from abroad, which would typically be allocated in ways detrimental to the development of local economies. (For instance, Malaysia’s development engine was killed when large foreign corporations arrived to take advantage of a low-cost workforce, without actually contributing in a significant way to the country’s development.)

It’s all a bit disconcerting: we’ve been taught for decades that capital should move freely (that’s a pillar of the “Washington Consensus”). Yet in fact what Studwell’s work suggests is that economic development only happens when countries reduce their dependence on foreign capital and local capitalists are more or less forced to invest exclusively in the domestic economy.

So… a narrow path indeed. It’s easy to draw it all on a napkin, but then you need the economic and political power to implement radical measures:

  1. A ruthless Georgist regulation of real estate markets so as to support massive job creation in proximity services (all backed with a broad social safety net)

  2. Actively supporting European tech companies as they expand on foreign markets and create a growing number of more productive jobs

  3. Forcing European capitalists to allocate money (mostly) to all the above, at the expense of other investments that might be more lucrative over the short term

Are European leaders able to deliver this? Honestly, I don’t think so—and a frequent objection to Studwell’s argument is that it was all implemented by authoritarian regimes like Park Chung-hee’s in South Korea or the Communist Party’s in Mainland China. But do we have an alternative to European leaders tackling that challenge in a democratic context? I’m not sure I’d like to see it. What do you think?

Please scroll down to dig deeper into the idea of Europe as a developing economy.

🇩🇪 My colleague Irina is leading an intense 3-day startup bootcamp in Berlin to give European founders the boost and network they need to take their startups to the next level. From Nov. 14-16, it's free and will feature hands-on startup knowledge from both The Family and leading EU startups including Zalando, Delivery Hero, N26 and more. Here’s the link: The Family Begins.

⚗️ My colleague Sandrine's HR and interviewing articles continue, this time with 5 practical exercises you can use during interviews to improve your intuition: How to Properly Conduct an Interview, Part 2

📦 Finally, tomorrow (Thursday) I'll be hosting an event at The Family Paris, diving into the world of logistics. If you know me, you know that logistics is one of the industries that intrigues me the most, especially as it's the industry that has given birth to mighty Amazon. Tickets are free, you can get them right here.

Here are more readings about economic development in general and industrial policy in particular:

From London, UK 🇬🇧