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For much of the postwar era, European policymakers have prioritised stability and predictability over fostering breakthrough innovation. Today, as the United States and China compete for AI dominance, a stagnant Europe is struggling to regain its place at the technological frontier.

The geopolitical shocks of the past few years, particularly Russia’s invasion of Ukraine and US President Donald Trump’s assaults on the postwar order, have brought Europe’s economic and strategic vulnerabilities into sharp relief. But it is the race for AI supremacy between the United States and China that has made Europe’s lagging innovation and declining competitiveness impossible to ignore.

Against this backdrop, MIT’s Simon Johnson sat down with fellow Nobel laureate economist Philippe Aghion to examine what ails Europe and how to revive its dynamism. Their conversation addresses the costs of excessive regulation, the role of creative destruction in fostering competition, and the case for keeping AI out of the classroom. It has been edited for length and clarity.

Simon Johnson (SJ): Let’s start with your most famous contribution to economics, which is your theory of creative destruction. Can you explain it in non-technical terms?

Philippe Aghion (PA): The term “creative destruction” was coined by Joseph Schumpeter to describe the process by which new technologies displace old ones. But when I was a student, there was no growth model that incorporated creative destruction, so Peter Howitt and I developed one. The basic idea was that growth is driven by successive generations of talented entrepreneurs who create firms and expand them.

Innovation is a cumulative process. You stand on the shoulders of those who came before you. At the heart of this process lies a fundamental tension: you need innovation rents to motivate investment in R&D, but yesterday’s innovators often attempt to use their market power to block new entrants who might subject them to creative destruction. Societies must therefore strike a balance between allowing talent to flourish and ensuring that today’s successful firms do not become barriers to the next generation of innovators.

From Pioneer to Laggard

SJ: This leads directly to the focus of this conversation: unlocking European dynamism. In your view, the European economy is troubled, or at least faces some major challenges.

PA: I wouldn’t say “troubled.” Europe is not on the verge of a major crisis. Instead, the danger is a long period of stagnation or sluggish growth.

Between 1945 and the late 1980s, per capita GDP in today’s eurozone was catching up with that of the US. Much of that growth came from rebuilding Europe’s capital stock, which had been devastated during World War II, and from catching up with the Second Industrial Revolution that transformed the US in the early 20th century.

But Europe has failed to make the transition from catch-up growth to frontier innovation. In particular, it has failed to harness the IT revolution because it lacks institutions that support frontier innovators. Instead, it remains stuck in mid-tech, incremental innovation, while the US and now China have moved into breakthrough, high-tech innovation. That, fundamentally, is Europe’s problem.

SJ: Whenever I visit France, I’m very impressed by your technology and infrastructure. The high-speed trains, for example, are fantastic. We don’t have those in the US.

And then there’s nuclear power. Nuclear energy held great promise after WWII, but most countries ultimately failed to make it viable. France stands out as an exception.

You mentioned the IT revolution. I remember very clearly how a friend in Paris in 1990 or 1991 showed me his Minitel terminal. At the time, Minitel was essentially a directory of businesses in the Paris region, but in retrospect, it was the first time I saw anything like the internet.

While I understand your point about Europe struggling to become a frontier innovator after the mid-1980s, my question is: Where exactly were the frictions? Why didn’t Minitel evolve into the internet? And why did France fail to become a leader in breakthrough innovation?

PA: You’re absolutely right – and very generous – to point out France’s strengths. When it comes to transport technology, whether it is high-speed rail or even Airbus, France and Europe have achieved remarkable success.

And the same goes for nuclear energy. France, in particular, used to be a leader in nuclear power before political pressure from the Greens led us to step back from it. However, France is now rebuilding the sector. France was also a pioneer in biotech. The foundations of mRNA technology, for example, were developed at the Institut Pasteur.

Europe is still very strong in basic research. Despite severe underfunding, it still accounts for 25% of the scientific citations underlying breakthrough patents worldwide. Yet this research doesn’t translate into breakthrough innovations in Europe.

Mario Draghi’s 2024 report on European competitiveness, along with other reports I’ve been involved in, all ask the same question: Why is it that we consistently fail to turn those research breakthroughs into breakthrough innovations?

Creative Destruction Stops in Brussels

SJ: I recently spent some time in the Carnavalet Museum in Paris, and what really struck me was how innovative France was under the Third Republic. Many of the old structures, power centres, and oligarchies associated with Napoleon III were swept away, and new people, new ideas, and institutions emerged.

That seems like a perfect example of creative destruction. The Paris Metro was at the technological frontier, and France was a scientific powerhouse in the early 20th century. The US won relatively few Nobel Prizes before 1940. The scientific leaders were, without question, Germany, France, and the United Kingdom – probably in that order.

So, France has a long tradition of innovation. But somehow it hasn’t fully connected to the modern era.

PA: You’re right. We lack what it takes to become true breakthrough innovators. Sometimes it happens when you’ve been great in the past: you rest on your laurels and live on your past accomplishments. That’s what happened to us. Of course, there are exceptions, like aerospace, defence, and nuclear energy, to some extent. But we allowed too many industries to leave France over the past 40 years.

One important difference between today and the early 20th century is that the European Commission didn’t exist then. I don’t want to bash the Commission, but it has often stifled innovation.

Postwar Europe was designed to ensure that France and Germany would never again go to war. The idea was that rules would force us to depend on each other rather than fight. European institutions were thus created to help us live peacefully, not to make us innovators.

We need rules, of course. But now we have too many. Since the 1980s, economic governance in Europe has been shaped by an approach that imposes strict limits on member states. For example, budget deficits cannot rise above 3% of GDP, regardless of whether spending goes toward pro-growth investments. Similarly, Europe constrained industrial policy in the name of competition policy, whereas the US and China have found ways to reconcile the two.

As a result, European rules have limited the ability of member states, including France, to move into breakthrough, high-tech innovation. The EU institutions in Brussels do many good things, but they are often a pain in the neck.

SJ: This brings us to the Draghi report. Draghi is a very distinguished economist with a PhD from MIT and extensive policy experience. His report offers a reform agenda that largely works within existing European structures. Given your view that Brussels stifles innovation, how much progress could really be made if its recommendations were fully implemented?

PA: I did not mean to suggest that everything coming out of Brussels is negative. For example, the creation of the European Research Council has been a tremendous success. I was able to build an innovation lab at the Collège de France thanks to ERC funding.

Europe can also act effectively in moments of crisis. The COVID-19 pandemic is a prime example. The problem is that Europe tends to act only when there is a sense of emergency, and technological decline is not perceived as an emergency.

The Draghi report identifies many of the main issues. First, it argues that Europe needs a true single market to foster competition and reward successful innovators, and I agree. We don’t have one now. Each country has its own regulations on top of EU regulations – in Europe, that is known as “gold plating.” We also lack a genuine capital-markets union.

Second, we don’t have enough long-term funding for research. The ERC is great, but its grants typically last five years; we also need ten-year grants. Worse, we lack a financial ecosystem that encourages risk-taking: venture capital plays a much smaller role than in the US, as do insurers and pension funds.

Third, there is no European equivalent to the US Defence Advanced Research Projects Agency (DARPA) or its counterparts in areas such as biotech, energy, and infrastructure. These agencies represent a pro-competition form of industrial policy. In Europe, however, competition policy has often precluded any form of industrial policy.

That’s the ecosystem we are missing. The question is whether Europe can build one across 27 member states. My own view is that the most promising approach is a coalition of the willing, with Germany and France working together with any others that want to join. I would also add the UK, which brings powerful institutional investors and financial expertise to the table.

Europe’s Fear of Failure

SJ: A coalition of the willing makes a lot of sense to me, but let me offer a different perspective. During my recent trip to Paris, someone told me that part of the problem is that rich people in places like Munich don’t invest in startups. Instead, they invest in real estate, fashion, or other established industries.

Admittedly, I was speaking mostly with prominent industry figures, but it does raise the question: What kinds of risk are wealthy Europeans actually willing to take? In the US, rich people climb over each other to invest in startups. Sometimes they get carried away, but there is a strong culture of backing new ventures. Europe seems to lack such a culture. Do you think that’s a fair critique?

PA: There is a lot of truth to this. Culturally, we do not encourage enough risk-taking. In France, at least when I was growing up, we were not taught that there is no shame in failure. If you failed, you’d be ridiculed and put in a dunce cap.

I don’t think you can have breakthrough innovation without accepting, and even encouraging, failure. In the US, you have a culture that says: If you failed, try again; fail better. That’s a good thing. Europe doesn’t have enough of that, and that’s partly cultural.

Consider the French data protection agency CNIL. I’m not saying we shouldn’t protect individuals – of course, we should. But in the name of protection, CNIL has created excessive regulatory barriers for startups and venture capital firms, discouraging innovation. I met several venture capitalists in Silicon Valley three weeks ago, and they told me they would be very happy to invest in France, but there is simply too much red tape.

To change behaviour, you need to change the institutions. But even when we have startups, they can’t grow due to a lack of venture capital and institutional investors. If we want more breakthrough innovation, we need to work on both fronts.

SJ: One aspect of your thinking that I find particularly interesting is your support for Denmark’s flexicurity model. You emphasise the need for dynamism on the business side – for more churn and creative destruction – but also the need to support workers through the transitions that follow.

PA: What’s remarkable about Denmark’s flexicurity model is that when someone loses a job, they receive 90% of their previous salary for two years, up to a certain income level. It allows firms to hire and lay off employees relatively easily – that’s the flexibility part – while providing workers with income insurance, retraining, and help finding a new job.

My colleague Alexandra Roulet studied the health effects of becoming unemployed in Denmark and found that losing your job has essentially no negative impact on one’s health, unlike in the US and many other countries.

I believe all countries should have such a system, especially in the age of AI. But this model works best when it is backed by a good education system that teaches people how to learn. We need schools without AI where students learn to read, write, concentrate on a book from beginning to end, and perform calculations on their own. Those skills matter because they teach people how to adapt. If we want to harness the power of AI and limit its negative effects, we need a strong education system and a strong flexicurity system.

Schumpeterian Politics

SJ: In your view, incumbents become a problem once they are too entrenched, especially if they are not investing in startups. That raises the question: What about taxation? I’m less interested in taxing people who are in the process of building new companies, so let’s focus on established billionaires. Should there be a tax on larger accumulated wealth, perhaps setting the effective tax burden closer to what high-wage earners face? And then, instead of simply redistributing that money, countries can use it to fund a European DARPA and pursue industrial policies that complement market competition.

In other words, if wealthy incumbents are not investing enough, should governments tax some of the wealth and redirect it toward innovation?

PA: Like you, I’m not in favour of taxing unrealised wealth. If you’re building a startup that is valued at billions of dollars but generates little to no cash flow, it’s not a good idea to tax that wealth as if it had already been realised, because doing so will impede the growth of potential unicorns.

That said, I’m not opposed to the idea that billionaires should contribute more. I had a very interesting dinner in Silicon Valley three weeks ago with several venture capitalists. They told me, “We’re billionaires, but we don’t think it’s right that our children should automatically become billionaires. They should have to prove themselves. They should inherit millions, not billions.” They were not particularly left-wing, but even they felt there was something wrong with the current system.

So, what should be done? One option is to encourage the creation of philanthropic foundations, along the lines of what Bill Gates has done. Or offer billionaires the opportunity to finance existing state institutions, particularly in education or health, if they want to avoid a bigger inheritance tax. I’m open to your idea, and to other approaches, like Charles Ferguson’s idea of using large fortunes to help finance university tuitions and other public programmes. I think these are creative ideas, and we should take them seriously.

SJ: Should we think of creative destruction as playing an important role not just in the economy, but also in politics? Is it possible that political systems can also become dominated by incumbents who try to keep new people from entering?

PA: It’s interesting that you say that, because I did some work with Alberto Alesina and Francesco Trebbi on political institutions that was very much about applying Schumpeterian ideas to politics.

The core trade-offs are very similar to those we see in economics. You want to reward innovators, yet you don’t want them to use their incumbency to block future innovation. Likewise, you want to give political leaders enough power to govern effectively while ensuring they do not abuse that power against minorities.

For example, if you rely solely on majority rule, governments can become unstable. But if you need a supermajority for everything, then nothing gets done. There’s a fundamental trade-off: the executive should be able to act, but you also need safeguards to protect minorities and preserve the possibility of turnover.

Philippe Aghion, a 2025 Nobel laureate in economics, is a professor at the Collège de France, INSEAD, and the London School of Economics and an associate at the Centre for Economic Performance. Simon Johnson, a 2024 Nobel laureate in economics and a former chief economist at the International Monetary Fund, is a professor at the MIT Sloan School of Management, Co-Director of MIT’s Stone Centre for Inequality and Shaping the Future of Work initiative, Co-Chair of the CFA Institute Systemic Risk Council, and an AI Ambassador for the UK. He is a co-author (with Daron Acemoglu) of Power and Progress: Our Thousand-Year Struggle Over Technology and Prosperity (PublicAffairs, 2023) and a co-host (with Gary Gensler) of the podcast Power and Consequences. Copyright: Project Syndicate.