Sunday, October 29, 2017

The EU's definitive defeat: digital tax plans and a declaration of surrender to Silicon Valley

What you're reading here is a highly skeptical take on the EU's innovation policy and economic outlook from an EU citizen who will leave the EU as soon as possible (more on my personal conclusions at the end of this post).

The EU has a huge competitiveness issue already, and due to the eurozone's lack of innovation, especially in its Mediterranean member states, the sovereign-debt crisis is never going to be resolved. The European Central Bank is, in some ways unlawfully, keeping Europe's south afloat and will do so for some more time, but at some point there will be a crisis of unprecedented proportions--either an acute and dramatic crisis or an extended depression from which the eurozone as an economic area won't really recover.

In the 21st century, innovation is the only way that industrialized countries can achieve more than 1% or 2% of year-on-year organic growth--obviously short of an unexpected discovery of natural resources, which is not realistically going to happen in the EU, or wage cuts in underperforming countries that are even less realistic than the existence of huge undiscovered gold mines in France, Spain, and Italy. The Finnish economy, for example, was performing extremely well while Nokia was setting new records all the time, but shrank by about 9% in a single year as a result of the iPhone/Android revolution. And it's shrinking again. Countries like Spain and Italy--and even France--never had a Nokia in the first place. The Mediterranean economies are strong in industries that mostly existed already in ancient Roman times (agriculture, construction, with even textile going to Asia). Tourism is, relatively speaking, the most modern industry that is strong in those countries, and the EU predicts about 5 million more tourists per year, which I don't doubt but it's not going to do much about youth unemployment rates of 46% in Greece, 38% in Spain, 36% in Italy, and more than 20% in France.

The EU wanted to become "the most competitive and dynamic knowledge-based economy in the world capable of sustainable economic growth" by 2010, and failed, as even the then-prime minister of Sweden conceded in 2009. For example, per-capita GDP in the EU was less than $38K last year vs. $57K in the U.S.

By now the EU appears to have given up on its ambitions for the digital economy. Instead, its focus is on a new tax that could lead to a full-blown trade war with the U.S. and would definitely harm European companies and consumers in the end.

I'll write about the tax plan again soon because I'll try to make a contribution to the mobilization of app developers and other European technology companies against that plan. In this post, I'll connect a few dots to show the broader picture.

In a Q&A document on the EU's digital tax plans, the EU recognizes the increasingly important role of digital business to the economy:

"In 2006, only one digital company was among the top 20 firms by market capitalisation, accounting for only 7% of the market capitalisation. In 2017, 9 out of the top 20 companies were technology companies accounting for 54% of the total top 20 market capitalisation. Between 2008 and 2016, the revenues of the top 5 e-commerce retailers grew by 32% on average per year. During the same time period, revenue in the entire EU retail sector grew on average by 1% per year."

The largest companies in the digital economy are U.S. and Chinese companies, plus South Korea's Samsung. As a Wikipedia page shows, no EU company has been among the world's largest 10 companies (from all industries, but with digital businesses now leading) by market capitalization since Royal Dutch Shell in the second quarter of 2014. That's a huge failEUre, and a strategic issue because it means that to the extent Europe has any innovative businesses at all (such as SAP), they're not at the top of the M&A food chain.

While that tax plan Q&A still claims the EU wants its digital startups to succeed, the EU's digital industry commissioner has just given an interview to Frankfurter Allgemeine Zeitung, in which she says Europe doesn't need a company like Google. How little weight the digital economy has in the EU is reflected by the commissioners assigned to that area of responsibility. Presently, the EU's digital commissioner is Mariya Gabriel, a young Bulgarian politician with an even less impressive track record than her technology-illiterate predecessor, Germany's Guenther Oettinger, who became the laughing stock of many people in the EU tech industry. Mrs. Gabriel said in the aforementioned interview that the EU should focus on fields such as nanorobotics, security chips, and "automotive digitization", where she says EU companies are leading the way. I checked on who the current leaders in nanorobotics are and found more U.S. than EU companies among the top 10, with all of those EU companies being small enough to be acquired sooner or later, and I've previously outlined my thinking on the automotive future.

There are structural reasons for which the EU not only lacks major players like Apple and Google but why it's highly unlikely that any of its startups will, as an independent company, ever reach that level:

  • The U.S. market is the most important single market, followed by China. That's why I decided to focus on the U.S. first (we'll create content for other markets later), just like this blog has more readers in the U.S. than anywhere else, but EU companies usually serve their domestic market first. No matter how often the EU talks about the "Digital Single Market" (DSM), which is also the context of those terrible digital tax plans, it simply won't be a single market like the U.S. market anytime soon. Multilingualism is a major challenge for the EU, but most countries are too proud and too lazy to think for even one second of adopting English as an EU-wide official language. Therefore, startups can't address the EU market as a single market. It's about a lot more than just translating one's product. For example, there's no major tech news website or IT magazine that people read across the EU.

  • That EU tax document refers to something that is a huge factor indeed: network effects. It's not just that large U.S. companies benefit from network effects. In a way, the U.S. tech industry as a whole has the equivalent of network effects because it attracts and funds many of the world's most talented technologists. There's a virtuous circle involving business angels (many of whom made a fortune through stock and stock options in previous-generation tech startups) and institutional investors of the kind the EU won't have.

  • Investor mentality also plays a role. In the EU, investors generally prefer niche businesses, while in the U.S., there is more of a willingness to "think big" and place bets on what EU investors would consider unrealistic long shots.

  • Partly as a result of unselective migration, in many cases combined with dumbing-down educational policies, the eurozone's population is, on average, becoming weaker and weaker in math according to the Trends in International Mathematics and Science Study (TIMSS). Non-eurozone industrialized countries take fairly high percentages of their 12-year-old students to the top performance level (Singapore: 50%; South Korea: 40%; Northern Ireland: 27%; Russia: 20%; United States and Kazakhstan: 14%), while the largest eurozone countries perform worse each time the study is repeated. Germany, for instance, dropped by 10 ranks between 2007 and 2012 and is now at 5%, which makes it the one-eyed among the blind among major eurozone economies (Italy 4%, Spain 3%, France 2%). The French number is an unbelievable disaster. If you looked at an average class of 30 students in Northern Ireland, eight of them would reach the top level, while in France you'd need two classes of that size to find just one such student. But to address the root causes of that problem would require French politicians to say and do highly unpopular, politically-incorrect things. That's why no one's talking about the big elephant in the room.

Contrary to what the EU says, its tax plans won't make any EU company more competitive. Also, it doesn't make sense that U.S. and other digital businesses "can take full advantage of the networks, infrastructure and rule of law institutions available in EU Member States, without paying any tax in that country." Seriously, how many lawsuits have Apple's App Store or Google's Play Store given rise to in the entire EU? Few and far between I would guess. Do they use such infrastructure as roads and bridges? Not really. It just comes down to cheap electrical and optical signals going over the networks, and the network traffic caused by the download of an app is typically less than a couple of minutes of even a low-quality video stream.

Unfortunately, the Commission's tax initiative has drawn support even from normally libertarian, free-market and fiscally conservative parties such as Germany's FDP, whose secretary-general said last week that she wants to impose higher taxes on the likes of "Apple, Google, and Facebook."

There is some resistance from such countries as Ireland, and unanimity would be required for an EU-wide rule, but something bad could come out of this. Ideally, the EU would like to address the issue at an even higher international level (OECD). If not, the Commission will make a proposal for the EU to act unilaterally. And then, if some countries tried to block the plan, the largest EU member states such as Germany and France might just go ahead without the rest of the EU--and once that threat becomes real, an EU-level agreement might materialize.

Whatever may or may not happen in the end, it's already clear that the EU's dubious "state-aid case" against Apple was just an attempt by the Commission's competition enforcement arm to position itself as the vanguard of the EU's tax crusade against the digital economy's winners. This is just the behavior of sore losers.

I wouldn't have been against a small EU consisting of quality countries in economic and educational terms, with everyone giving up national sovereignty for a greater good. But an unselective and expansive EU that consistently puts the cart before the horse (common currency for disparate economies without a common economic and fiscal policy; internally open borders without effective external controls) was a bad idea.

A few days ago, the European Central Bank announced that, after spending (literally) trillions of euros buying government debt mostly from the likes of Italy and Spain, it was now going to reduce the extent of that program to 30 billion euros a month. By comparison, that is about 10% more than Germany's federal budget. Also, the ECB already owes Germany approximately 800 billion euros through its Target 2 system (with Italy and Spain being the primary net lenders, and even Greece being a significant net recipient). The only way that those countries could ever repay their debts would be sustainable, organic, rapid economic growth. The ECB says that the need for growth is why its "quantitative easing" must continue, and mainstream media in Europe largely parrot that pretext (and even those who criticize the ECB don't tell the whole truth about the mess). But quantitative easing and zero interest rates don't change the fundamental problems I mentioned above. It certainly won't hone anybody's math skills or prevent European tech companies from being bought by U.S. and Chinese acquirers. Instead of spurring growth, the ECB simply enables southern European governments to avoid hard and unpopular decisions. As their excessive borrowing continues, the mess gets bigger until the system implodes.

Just like the ECB's quantitative easing doesn't benefit innovative businesses, the kind of digital tax the EU has in mind would just benefit governments in the short term.

Finally, the kind of disclosure I promised further above. I must admit that I was totally against the 1992 Maastricht Treaty (the treaty that converted the European Community into the European Union and laid the foundation for the euro currency) and now, 25 years later, everything that could have gone wrong with the euro currency and free movement (and that experts had warned against before those fatal decisions were taken) has indeed gone wrong. In 2004-2007 I opposed various EU policy initiatives and consistently got along very well with the "Brexiteers" in the European Parliament. I do sometimes support EU competition cases if they involve genuine antitrust and merger control issues, but not if they're "total political crap".

I don't want to be a resident of the dysfunctional EU anymore. I'm on my way out of the EU as we speak. After years of development, I'm finally about to launch my app, which has already been approved by Apple for App Store distribution, in the U.S. market. I haven't announced the name of the product and of my company on this blog or on Twitter yet, but I will soon. All that I have said so far is that it's going to revolutionize the trivia game market. And it will.

Once my app generates a certain level of revenues, which I'm sure it will soon (just don't know exactly how much and how soon), I'll be in a position to relocate to the U.S. on a permanent basis. That step is actually overdue. As a matter of fact, this blog has widely been perceived as a U.S. tech/IP law/policy blog (even by the Library of Congress). I've always considered, despite its challenges, the United States the greatest country on Earth, and I've traveled a lot more in the U.S. than in Europe already. Now it's not just about personal preferences or the greater opportunities I see in the U.S.--I'm really deeply convinced that the eurozone is on the completely wrong track without any hope that things could somehow work out in the end. The overindebted economies of the Mediterranean region won't recover, and Germany isn't strong enough to support them forever. For example, Italy technically owes Germany (through the ECB) many hundreds of billions of euros, but Germany's trade surplus over Italy is just on the order of 10 billion euros a year. The numbers just don't make sense. Once Germany's pension system becomes unsustainable due to the demographic gap (by the 2030s at the latest), it will be game over for the eurozone, if not before.

Should the EU levy a special tax on digital businesses, its innovation problem would only exacerbate. It's worse than merely rearranging deck chairs on the Titanic.

Share with other professionals via LinkedIn: