Europe Can Better Support Venture Capital to Boost Growth and Productivity

IMF Blog, July 15, 2024

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The European Union has a productivity problem: its people produce nearly 30 percent less per hour worked than they would have, had real output per hour worked increased in line with that in the United States since 2000.
A failure to sufficiently develop innovative startups into “superstar” firms is one of the reasons for the bloc’s poor productivity growth.
Greater venture capital investments could spur productivity and strengthen the EU’s innovation ecosystem by funding high-tech startups that spread innovative ideas and raise overall growth.

Fragmented economy and financial system:
- Without a more frictionless single market for goods, services, labor, and capital, it is more expensive and difficult for successful startups to scale up.
- Fragmentation stems in part from national laws, regulations, and taxes that hamper cross-border consolidation, capital raising, and risk-sharing.
Bank-based financial system constraints:
- High-tech startups are risky, often lack collateral, and are hard for banks to assess; banks are constrained by rules that limit lending to risky firms without collateral.
Smaller and fragmented private capital pools:
- Europeans park more savings in bank accounts rather than capital markets.
- Americans invested $4.60 in equity, investment funds, and pension or insurance funds for every dollar invested in such assets by Europeans in 2022.
- In part this reflects greater reliance on pay-as-you-go pensions in Europe.
Loss of scale and financing centers:
- The EU lost its largest venture capital center, London, following the United Kingdom’s vote to leave the Union in 2016.
- Over the past decade, the EU’s venture capital investments averaged just 0.3 percent of gross domestic product, less than one-third the average in the US.
- American venture capital funds raised $800 billion more than their European counterparts over this period.

Less attractive IPO options and fragmented stock markets reduce incentives to invest in established startups in the EU.
The “scale up financing gap” forces many fast-growing startups to seek financing abroad and often move operations overseas after receiving scale-up financing, causing Europe to lose direct growth impacts and positive spillovers such as technology diffusion.
Venture capitalists play a pivotal role by investing heavily in high-risk research and development and channeling resources to best-performing companies.

Implement well-designed preferential tax treatments for equity investments in startups and venture capital funds to address market failures from high risk, information asymmetries, and positive externalities.
Reduce regulatory and tax frictions to investing in venture capital.
Develop private pension funds to expand domestic capital pools available for capital markets and venture capital.
Enable national public financial institutions to expand capital availability and support to venture capital funds and innovative startups:
- Invest on commercial terms.
- Help attract more private capital, especially from institutional investors such as pension funds and insurers.
- Use public institutions as a near-term mechanism to expand financing before other reforms take effect.

Complete the single market for goods, services, labor, and capital (acknowledged as the single most important step; will take time).
Near-term EU actions:
- Fine-tune rules for insurers and other investors in larger venture capital funds to reduce impediments to investing in venture capital, especially to support growth financing.
- Expand the capacity and instruments of the European Investment Fund (EIF) and the European Investment Bank to channel more resources to venture capital funds and innovative startups.
- Encourage the EIF to develop a fund-of-funds aimed at attracting capital from institutional investors across the EU to finance large venture capital funds with a pan-EU focus; this would help reduce fragmentation of capital pools, increase familiarity of institutional investors with venture capital, and help close the scale up financing gap.
Over the medium term:
- Reduce stock market fragmentation to boost depth, liquidity, and valuations, making listing in the EU more attractive (a key part of the capital market union agenda, politically challenging).

While government interventions are often imperfect, near-term public support may be needed to accelerate venture capital sector development and financing for innovative startups.
More venture capital financing for “clean tech” sectors would support the EU’s green ambitions and reduce reliance on costly subsidies that could distort the single market.

Source: Europe Can Better Support Venture Capital to Boost Growth and Productivity — Nathaniel Arnold, Guillaume Claveres, Jan Frie; July 15, 2024.