The Draghi Report: Digitalization, Decarbonization and Defense

A new note from a team led by Anita McBain, Head of ESG Research across UK, Europe and Middle East & Africa, takes an in-depth look at the much-awaited Draghi Report on the future of European competitiveness, written by former European Central Bank President Mario Draghi at the request of European Commission (EC) President Ursula von der Leyen. In our note analyzing the Report, we look at the key areas of digitalization, decarbonization and defense, how they’re explored in the Report, and offer our own perspective.

The Draghi Report is a wake-up call for EU politicians that warns Europe has lost out on productivity gains from the digital revolution and cites the tech sector as a reason for the productivity gap between the EU and the United States. For Europe to succeed with digitalization and decarbonization while also investing in national security, it needs to drive productivity growth: attracting and retaining highly skilled talent while incentivizing innovation backed by supportive industrial policy to accelerate the allocation of capital. The Report identifies both large and small levers for doing so; most of its proposed measures would take time to win agreement and be implemented in the best of cases. Without additional growth, the Report warns, Europe will be forced to choose between digitalization and decarbonization on the one hand and defense on the other.

But we make the case that these three areas are actually deeply intertwined: Decarbonization requires an investment in semiconductors and software, while the cyber security aspect of defense is clearly a technology issue, with significant software and hardware requirements — digitalization, in both cases.

Digitalization

The Draghi Report notes that the new technologies needed to drive future growth are lacking in Europe, with only four European tech companies among the world’s top 50. Many successful hardware and software start-ups have originated in Europe, but these start-ups are often lured to the U.S. by access to its capital and wind up selling out early to U.S. companies before going public — one reason we haven’t witnessed a tech acceleration in Europe.

We don’t see the problem as a lack of innovation; rather, there’s a need to ensure such companies can scale via skilled labor and stable capital. We disagree with the Report’s claim that Europe lacks focus in digitalization, contending instead that it lacks breadth across the sector, without a hyperscaler such as Amazon or a leading-edge chip maker such as TSMC. We think Europe does offer global leadership in a number of tech areas, such as semiconductor photo lithography, power semis and certain software niches, and has developed leadership positions within the global supply chain.

Decarbonization

The Draghi Report sees decarbonization as a growth opportunity if Europe meets its climate targets and offers policy support. A unified agenda on decarbonization should be seen as an opportunity to lower energy prices, deliver on energy security and take a leadership role.

The technologies needed for the energy transition require deployment of clean energy at scale and upgraded grid infrastructure with low marginal cost. In 2023, renewable energy accounted for 22% of the EU’s gross final energy consumption, compared with 14% in China and 9% in the U.S. While Europe is a leader in the development of clean energy, underinvestment in grids has created a bottleneck for the energy transition; the grid is 40 years old on average and needs an upgrade, with investment required.

We also note the importance of critical minerals to global decarbonization efforts. The Draghi Report highlights the need for Europe to reduce its reliance on suppliers of critical minerals outside of the continent; we see recycling as a way to improve resilience.

Defense

A lot has changed here. In 2022, our Aerospace and Defense Team argued that investors’ view of the defense industry as a “sin sector” was both damaging to European security and out of sync with public and political sentiment in major European nations. Since the invasion of Ukraine, we’ve seen increasing clarity in the EU about the links between a robust defense capability, security and the ability to defend liberal democratic values from aggressors.

Many of the arguments in the Draghi Report have already been articulated by the EU in the objectives of the European Defense Fund, the Permanent Structured Cooperation Framework and the European Defense Industrial Strategy. But the Draghi Report explicitly articulates the link between security, EU competitiveness and sustaining citizens’ fundamental rights. It ties defense in with broader security considerations such as critical raw materials, reflecting a clear recognition that in an increasingly globalized world, security demands resilience within supply chains, markets and institutions. As the Report puts it, “security is a precondition for sustainable growth.”

The Report sets out reasons that the EU’s defense industry lags that of the U.S., calling out the “narrow national interest” of member states as the most significant impediment to deeper integration. While we don’t expect rapid, large-scale change, we think we might see incremental changes as nations increase defense cooperation, with France, Germany and Italy seeking to strike a balance between retaining manufacturing capabilities and jobs and increasing scale through more common programs and collaboration.