[Interview] EU’s new merger overhaul risks ignoring the small firms that keep Europe competitive, economist says

One of the great questions facing Europe at this moment is how to compete with Chinese companies.  

Chinese exports are threatening to swamp EU markets with cheaper and increasingly sophisticated goods, particularly in mid- and high-tech sectors where European firms once dominated. 

This all happened in a matter of years. Part of the explanation, many policymakers in Brussels believe, lies in scale. Chinese giants such as BYD, CATL and Huawei have poured vast sums into research and development, opening up new technological frontiers, particularly in clean tech and AI.

After years of soul-searching (and fat reports by former Italian prime ministers), the EU Commission at the end of April presented a draft of what could be the most ambitious overhaul of merger rules in more than two decades.

This followed a broader debate within the commission over whether competition policy should “look more favourably on monopolies given their potential to foster innovation”, an issue discussed during a meeting of commissioners in March.

The reforms would change how Brussels judges mergers, placing greater weight on whether larger companies can boost innovation and compete globally. But some economists warn Europe risks misdiagnosing its own strengths.

Bernardo Pimentel, associate professor at the University of Roehampton and co-author of the 2022 paper Davids and Goliaths: Hidden champions in an age of state capitalism, argues Europe’s industrial edge has often come not from corporate “goliaths”, but from “nimble Davids”: highly specialised smaller firms embedded in local supply chains, universities and engineering cultures.

The challenge then, as he sees it, is whether Brussels can support scale without undermining Europe’s smaller firms that drive much of its technological edge.

“My point is that these Davids already have the scale they need to compete in global markets,” he told EUobserver.

Why are economists often wary of mergers between larger companies? 
Generally speaking, because they likely reduce competition, increase prices, and stifle new market entry: it becomes harder for new players to enter the market if it is dominated by a really large one. In that way M&As can reduce industry innovation as a whole, even if they continue to innovate themselves. And a more concentrated market is seldom good news for consumers.  

What are Goliaths and Davids? 
Goliaths are typically well established industrial or service companies that have a big market share in the market they’re in. So the Coca Colas or Apples of this world. Bayer-Monsanto after their merger [in 2018] would be another one. So it’s a very large industrial conglomerate. Ironically, I think the bits they had to carve out were research and development divisions for seeds and pesticides. 

And Davids? 
I’m simplifying, but David’s tend to be smaller exporting companies in specialized sectors. Germany, Italy and Japan all have a lot of companies that fit that bill. This type of specialisation tends to drive innovation. Not radical innovation, but for incremental improvement. They only do one thing, but they do it incredibly well. Better than anyone else in the business. In Europe they’re not usually world-beating in terms of cost, but in quality or being on the cutting edge.  

What is the case for smaller companies in a world where Chinese giants gobble up entire supply chains in a matter of years? 
I am mindful of the argument of geopolitical autonomy and national security. It’s just that national security should not be seen as a blanket that covers everything. A world where we support Davids with better tax conditions, grants for SMEs, and universities doing open innovation that spreads across networks of companies, large and small, giving them access to the same breakthroughs, is, for me, a better world than one dominated by a few Goliaths. 

Why? 
I’m perhaps more naturally suspicious of large companies that acquire others as a way to signal growth to shareholders, even if they cannot grow on their own merit. And very few companies have become extremely successful as a result of acquisitions condoned by governments. But there are also benefits from mergers and acquisitions. There can be knowledge retention, and letting companies fail or disappear can also carry costs, including the loss of expertise. So it is not a black-and-white issue.  

The new draft guidelines have introduced the ‘innovation shield' to help steer merger activity towards those the commission believes can strengthen supply chains and innovation. What’s your take?  
Brussels historically struggles to scale domestic tech firms. The new shield tries to correct this by stopping legacy ‘Goliaths' from buying nascent tech companies simply to protect their own existing products. That keeps the market open for fresh ideas. 

How do you see these guidelines protecting smaller innovative companies?  
One of the key changes is how the commission assesses market power now. Instead of focusing mainly on current market shares, regulators would be using “dynamic counterfactuals” to model what a market would look like if a merger did not happen. If a small target company appears to be on a trajectory to disrupt the market on its own, Brussels would likely block the acquisition. 

Thinking of incremental but world-beating “David” companies, I’m reminded of the kind of suppliers on which Dutch chip machine maker ASML relies. Hyper-specialised German lens-makers, for example, that do things no one else can.
You’re absolutely right. Strategy scholars call this “difficult-to-redeploy assets”: just-in-time supply chains, and close links to universities that can train engineers to very specific needs. That is why highly specialised industries often remain fragmented. The knowledge base is so deep and specific that larger companies tend not to want to spend the money to do the in-house R&D.

And Europe specifically needs to support those companies, not necessarily the formation of bigger ones?  
The advantages you really want to keep are things that you cannot download onto a flash drive: people who meet every morning at seven on the factory floor to improve a process that same day, or relationships with suppliers built on trust that make supply chains highly dependable. This tacit knowledge takes a long time to build and cannot easily be replicated or transferred. You can reverse-engineer a machine, but not the process or the people behind it. China has been trying to do this for a long time, but they haven’t been able to do it. 

What's freaking Europeans out, is that China can field a near-endless supply of tooling engineers, allowing entire supply chains to be replicated in production hubs like Shenzhen.
We thought we could rely on the fact that we had a lot of grown-up talent, proportionally to the workforce. And we have English as a common language, so we thought the world was our oyster. We can always recruit the best software engineers out of India or Mexico. They all speak English. China doesn’t have that. The thing is, there’s a population point where a national market becomes a global market. China has enough homegrown talent. And they’re not bound by debt and funding constraints in the same way, or they rely on 16-hour, seven-day working weeks to cover losses. This may be too cruel for us to replicate, and it may not be sustainable in 20 years, but it does allow China to catch up and build a capital base.

Do you think scale can help European companies counter competition from China and the United States? 
It's better to have larger companies that can compete in a global market, there is no doubt about that. And M&A is the fastest way to create large firms. But it's not that easy. European companies are often not keen at all. Think of the cultural clashes in Franco-German projects such as the Eurofighter — almost like a forced marriage. My fear with these guidelines is that large firms may end up lobbying for rules that protect their own position on home turf, rather than addressing genuine concerns around national security or loss of knowledge. 

How? 
I am a big defender of public servants. But public competition authorities — lawyers and economists —get public clerk salaries. Lawyers on the other side working for law firms that get a 1 percent cut on a $60bn deal are incentivised differently, which means the quality working on either side tends to be different. 

That’s where the innovation shield comes in? 
This is where the real crux will lie. If it is used to protect EU innovation and supply chains, it could be effective. If it becomes a discretionary tool to shield specific firms, we may end up supporting the formation of second tier companies.

This piece was amended to reflect that a commission official, not Teresa Ribera, raised the issue of “looking more favourably on monopolies."