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The Building Blocks of Energy Innovation in Europe

The race for comparative advantage 

March 20, 2024 Category: Policy
Europe night view

Europe has cemented itself as a climate leader on climate ambition and action, having reduced emissions by a third since 1990. Nevertheless, neither Europe nor any other region has all of the tools that it needs to meet the climate challenge. For all the deserved praise for solar and wind deployment over the past ten years, those technologies will be incapable of meeting the sum of Europe’s energy needs due to both hard-to-abate sectors and practical limits to deployment on the continent. That’s why Europe needs more and better solutions. Innovative new technologies are on the verge of commercial reality, particularly critical for hard-to-abate sectors such as heavy industry and transportation. Innovation leadership offers an opportunity for Europe to not only achieve clean energy deployment targets, but also to enhance its competitiveness in the world’s fastest growing industries. 

The value of the global renewable energy market alone is projected to reach 1.9 trillion euros by 2030. Add to that the value of other clean technologies – such as carbon capture and storage, advanced nuclear energy, and demand-side solutions like clean vehicles – and global decarbonization will create enormous new industries and markets that will drive economic growth, reshape the global economy, and create new – or renewed – economic and technological superpowers. Leading on these technologies can help Europe drive economic growth and competitiveness while also achieving decarbonization targets, and achieving that growth will require regulatory clarity and a reliable market framework for investors. Policymakers already know this; the challenge is how to do this while every other country and region races to compete on the same front. 

As the proposed Net-Zero Industry Act recognises, competition over these industries of the future is heating up: the Inflation Reduction Act as well as the Infrastructure Investment and Jobs Act in the United States seek to restore the United States’ leading position in clean energy innovation and manufacturing, while China dominates the manufacture of most critical clean energy technologies today, such as solar panels, batteries, wind turbines, and electrolysers, as well as the supply of minerals critical to their production. China’s dominance of the solar industry in particular is expected to increase, with its share across manufacturing phases set to rise to 95% in the coming years.  

Europe can learn much from the United States’ policy approach toward innovation, but it cannot simply cut and paste the policies and practices of its transatlantic ally, any more than it could those of China. What will yield success for Europe is different from what has worked in other regions; not because of lesser competitiveness, but rather because of a different context and set of resources that will require a different pathway. Staking a different path is doubly important because no innovation or related policy will occur in a vacuum: forging the same path as the U.S. or China may yield some progress, but competition will be fierce and any progress may fall victim to it, much as Germany’s solar industry fell to China. 

Carving out a more durable industry will require identifying or building a comparative advantage with which to drive innovation and competitiveness. To do so, Europe needs to develop innovation policy that not only supports technologies through their development lifecycle, but also enables growth of innovative capacity. Funding and incentives are essential, but they are just one component of building a strong, competitive innovation ecosystem in Europe.  

Policy can help build innovative capacity and a comparative advantage – in any industry or for any technology – through four major efforts: (1) building human capital; (2) pushing early-stage technology by de-risking early applications; (3) establishing demand-side incentives to create markets and pull technologies through development; and (4) helping the industry access key resources for innovation. Innovation has long been thought of as a product of culture as much as resources – that risk-aversion baked into certain cultures thwarts innovation – but that interpretation is incorrect. It is rather the product of an alignment between resources and market opportunity, both of which policymakers can influence. If Europe can adopt an innovation strategy that holistically addresses each of these four pillars, it can create an innovation ecosystem that will enable it to not only build an advantage in critical new technologies, but also insulate that advantage against imitation or erosion. 

What is Innovation? 

Before we dive into those four major efforts, it’s important to align around a common understanding of innovation as a concept. It is a vague and often misapplied term, generally used as a catch-all for ‘technology improvement’, whether in terms of costs, speed of deployment, or performance. But each of these improvements requires different resources and competencies, which yields different comparative advantages across regions. Innovation can thus be broken down into more specific efforts: product innovation, which improves performance and efficiency of a technology; and process innovation, which improves technology cost by creating more efficient or novel production methods. The solar industry’s development is paradigmatic. 

An advantage in product innovation allowed Germany to become one of the world leaders in solar equipment in the late 2000s, and more recently in battery technology. But China’s advantage in process innovation allowed it to seize the solar industry by cutting costs and scaling rapidly. In an industry with relatively slow product innovation, like solar, China’s advantage proved more salient and decisive. Europe, the United States, and Japan – all centres of product innovation at the time – could not compete. A similar story is playing out in the battery market, as China becomes increasingly dominant. But these advantages are also not static: China leveraged its process innovation capabilities to build industry share, which it has since used as a foundation from which to catch up on product innovation. It has used its advantage as an entry point, rather than a destination.  

China’s example is useful in demonstrating the viability of focusing efforts to build market share and control, which can then be used as a foundation for expanding capacity. But comparative advantage is likely to look different now than it did in the 2000s when China shocked the global solar industry, and it may not be quite as simple as winning on either process or product innovation – which is good news for Europe. 

First, Europe needs to maximise its innovative capacity – not simply maximise its innovation investment – to compete. Both product and process innovation are ultimately the result of that capacity, and maximising it is the only way that Europe can compete.   

The 4 pillars of innovative capacity 

1. Skills: Build human capital and expertise 

Human capital – in the form of researchers, engineers, and other skilled professions critical to each stage of the innovation life cycle – is perhaps the most important component of innovative capacity. The United States’ status as favoured destination for high-skilled labour was a major driver of its lead in innovation. 

Europe is already one of the strongest centres of innovation in the world. Still, over the past decade, the European Union as a whole trails China, the United States, and Japan in energy technology-related patents – by 17%, 14%, and 5.7% respectively – a common if imperfect indicator of innovation and expertise. The EU does however lead the world in science and engineering doctoral degrees awarded each year – a proxy not only for current skilled human capital availability, but also future growth – with about 77,000, while the United States (40,000) and China (34,000) trail. However, China stands out as one of the only countries, in addition to Taiwan and South Korea, in which most of these degrees were in engineering rather than natural sciences. And China and the United States account for far larger shares of global scientific publications than any European country. 

With a strong human capital pool for research and development, the priority for European policymakers should be to retain and expand that resource and to invest in re-skilling experienced workers from related industries to support growth in the energy sector. Fortunately, both of those can be accomplished through investment in the sector that can make it more attractive. The NZIA’s provision to establish academies aimed at instructing skilled workers in select clean energy technologies recognizes how central human capital is to successful innovation. Europe nonetheless would benefit from further prioritizing human capital development through more funding to develop transferable skills in the sector and attract skilled workers from other regions, and by broadening training support beyond a narrow set of technologies.  

2. Technologies: Technology push 

Technology innovation push policies are most closely associated with traditional innovation policy, as they focus directly upon the development and demonstration of novel technology. It is indeed critical to ease the trialability for nascent technologies through demonstration and early adoption funding, de-risking, and regulatory easing for early-stage deployment.  

Technology push policies have been a central focus of the current wave of new industrial policies, with investment and incentives directed toward commercializing novel energy technologies across regions. Across the world, these policies have taken several forms: grants and subsidies for technology development, demonstration, and early deployment; R&D programs directed by the government, often in partnership with the private sector or academic institutions; and regulatory easing to remove speed limits to technology development, among others. Removing regulatory hurdles is another focus of the NZIA, which seeks to streamline both the permitting and administrative processes for key energy technologies. This recognition is promising but its success remains to be seen. Easing the early deployment and demonstration of pre-commercial technologies is essential to trialling and further developing innovative technologies; that China’s government has prioritized technological development and thus eliminated barriers to deployment has been a major advantage. Governments in Europe are less able to unilaterally shed regulatory burden – for good reason – but finding a way to accelerate approvals will not only drive faster technology commercialization, but also encourage and de-risk private investment to do the same. 

3. Markets: Demand pull 

Europe has been a leader in clean technology pull policies over the last two decades, by creating incentives – such as through the ETS – and providing funding for clean technology deployment across sectors. Without such market creation, full-cycle innovation is essentially impossible. However, there are also risks from having robust deployment incentives, as they can create lock-in that prevents future innovation. For instance, incentives and funding for renewable energy deployment may in fact quash further necessary innovation by saturating the market with inexpensive, lower efficiency products and diverting funds from potentially higher impact upstarts. That lock-out phenomenon necessitates both technology-neutral clean energy deployment policies and effective technology push policies to ensure a healthy innovation cycle. Stimulating and enabling demand growth must go beyond financial incentives however: regulatory clarity and simplified planning and permitting processes are critical to enabling early deployment and reducing the administrative costs facing new technologies. 

4. Resources: Access key inputs and resources 

Finally, access to an inexpensive and reliable source of key resources can determine a country’s ability to compete, and is a factor with which governments can directly assist. The most salient such resource for clean energy technologies today is critical mineral supply, which is critical to most novel energy technologies and has been a key topic for major economies. Governments around the world – including the European Union, through the European critical raw materials act to enhance Europe’s access to minerals – have sought to secure access. Critical minerals are not the only such resource, however, and others can be much harder to develop or acquire abroad. For instance, geologic storage for carbon dioxide storage, salt caverns for hydrogen, a sufficient geothermal resource, and even sufficient wind to deploy advanced wind turbines are all far more difficult to acquire. These resources can thus be a key source of comparative advantage, and governments still must ensure that the industry has access to them domestically, such as through regulatory support or incentives for developing technologies that suit the country’s resources. 

Iceland’s geothermal development is an excellent example of a country leveraging its resource access to drive technological development and competitiveness. The country’s unrivalled geothermal resources allowed it to become a world leader in climate action, but they also served as Iceland’s foundation to become a leader in geothermal innovation, beyond leveraging the unique resources it can access at and near the surface. Tapping surface resources gave Iceland a platform of expertise, regulatory experience, and technology that have enabled it to become a world leader in accessing more advanced and widespread resources like superhot rock energy, which it has already tested in the Reykjanes geothermal field. Access to this resource was of course a primary driver of Iceland’s leadership, but it does not tell the whole story: Iceland paired it with training programs, incentives, and clear regulations that helped de-risk investment. In other words, Iceland’s policymakers took advantage of its resource advantage by prioritizing the other three key pillars of innovative capacity. 

In some cases, key resources may not be physical. China’s artificial intelligence industry, for instance, has benefitted enormously from the government’s provision of enormous amounts of data on the Chinese population through relaxed privacy regulations when in pursuit of a ‘national interest,’ such as winning the race for technology supremacy. Similar non-physical resources may become equally critical for energy technologies, particularly as predictive and grid management software gains traction and relies upon having access to large amounts of accurate data. 

Building an innovation ecosystem without one of these components may be possible, but it will either be far slower or far more transiently competitive. Similarly, pursuing any one alone may generate economic benefits, but is likely to create perverse incentives or stunt growth in other areas. Only coherently addressing each component can unlock the region’s full innovative potential. 

Building Europe’s comparative advantage in innovation 

The U.S., China, Europe, and other countries and regions are investing enormous amounts of capital into clean energy technologies to find an advantage. Accepting that as the determinant of competition and the basis for industrial policy will lead to failure; Europe is not going to out-invest the rest of the world. Investment is critical, but it is meaningless unless paired with the above resources and conditions that will channel it into innovation and technological progress. The winners of the clean technology race may not have spent the most, but they will have spent the best.  

Still, addressing each component may not yield a distinct comparative advantage in innovation; Europe will need to both build its innovative capacity and identify, leverage, and build from its existing comparative advantages. The sector is far more crowded and more competitive than it was when either the United States first built its industry on the backs of its world leading product innovation resources or China leveraged its process innovation to drown competing solar manufacturers. Advantage is not as simple, and as China has demonstrated, must be inimitable. 

There are two routes for Europe to take that will thwart imitation and thus yield durable advantage. The first is to target technologies and sectors in which Europe has a distinct and steady resource advantage. This includes carbon capture and storage, which is being pursued around the world but for which Europe has significant advantages, including Norway’s expertise and the continent’s capacity for carbon transport and storage. By targeting such technologies and aligning innovative capacity with attractive resource endowments, Europe can use them as a springboard to broader competitiveness across the clean energy sector.  

The second, and more important for broad competitiveness, is to ensure that efforts toward each component are mutually reinforcing and cohesive. That mutual dependency will not only strengthen Europe’s innovation capacity and its ability to compete across sectors, but will make it far more difficult to replicate. An innovation system that includes interwoven policies and investments targeting resources, skills, markets, and technologies cannot be easily copied into a new environment. An ecosystem is harder to copy than a line item. 

Europe can and must innovate, and it can lead the clean energy technology revolution. But it will require rethinking innovation policy to maximize its innovative capacity over the long term, rather than focusing on short-term funding or deployment. By fitting together human capital, market creation, resource access, and research and development funding, Europe can create an innovation ecosystem fit for the new era of industrial policy. If it instead continues to pursue each piece of this puzzle independently, its pieces will be copied, laser-cut, improved, and mass-produced elsewhere, whether across the Atlantic, in Asia, or in a new technology powerhouse that puts the pieces together first.