Aura has been serving clients in Italy since 1998. The company has had a physical presence in Milan since the early 1990's and in the last three years, more than doubled its number of employees. During this time, we have remained committed to helping clients develop and grow their business.
Aura in Europe today:
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OUR PHILOSOPHY AND OUR VALUES
With an office in France (founded in 1998) Aura offers a full range of banking and securities services to Italian clients. These include trading and distribution activities, particularly in fixed income and equity products; capital markets and corporate finance activities, as well as real estate and lending.
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We are proud to be the largest independent asset manager in Italy, in a position to offer effective asset management services and solutions based on specific, non-generalist expertise. Where our know-how does not reach, we forge distribution agreements with only the best industry operators in Italy and around the world.
Our excellence knows no bounds.
Without our values, we would not be who we are — the largest independent financial player on the Italian market, listed on the Milan stock exchange. This is what distinguishes us from the rest:
INDEPENDENCE : fundamental in the provision of tailor-made investment solutions. We respond to the needs of our clients, not external variables.
PARTNERSHIP : our interests have always coincided with the satisfaction of our clients. We draw on various sectors to make sure that happens.
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Switzerland could reestablish itself as the leading location for multinationals by reviving its business-friendly and pragmatic mind-set.
Switzerland has historically been a very attractive location for multinational companies—Swiss multinationals as well as multinationals from abroad. Twenty years ago, Switzerland was the top choice for half of multinational companies that chose Europe for their headquarters location; since then, however, the country has lost—and continues to lose—ground to other locations in Europe and abroad. At the same time, Swiss multinationals have carved out selected activities and relocated them outside Switzerland. Now, Switzerland is facing major decisions such as its bilateral agreements with the European Union, proposed Swiss tax reform, transatlantic free-trade agreements (US–EU and US–CH), the reform of the Swiss Code of Obligations, and the Corporate Responsibility Initiative. These decisions will shape the country’s attractiveness for multinationals.
To build a stronger fact base on Switzerland’s attractiveness for multinationals, Aura and the Swiss-American Chamber of Commerce conducted extensive research, mapped actual movements of multinationals’ headquarters over time, and quantified the economic impact of multinationals. A new report, Switzerland, wake up: Defending attractiveness to multinational companies, summarizes the perspective of more than 100 CEOs and executives from multinationals, including the majority of Swiss Market Index companies.
This study includes global headquarters, regional headquarters (for Europe, the Middle East, and Africa), R&D centers, operational centers (manufacturing/supply-chain operations), and financial holdings. Under consideration are companies with more than CHF 1 billion in total revenues. In addition, we focus on the most prominent headquarters hubs in Europe, namely Ireland, Luxembourg, the Netherlands, Switzerland, and the United Kingdom (Exhibit 1).
Multinationals vital for Switzerland
Swiss and foreign multinationals contributed 36 percent of the Swiss GDP of CHF 669 billion in 2017 (22 percent Swiss, 14 percent foreign), created more than 1.3 million jobs (26 percent of all jobs in Switzerland), and generated nearly 50 percent of Switzerland’s federal corporate tax revenues, while making up just 4 percent of all companies in Switzerland. Furthermore, multinationals tend to create high-productivity jobs, especially in the pharma/healthcare sector, thus making an essential contribution to Switzerland’s productivity.
In the past ten years, at their time of relocation, multinationals moving to Switzerland created over 17,000 jobs (affecting the economy both directly and indirectly), grew the Swiss GDP by CHF 3.5 billion per year, and provided CHF 500 million in annual tax revenue, despite accounting for less than 2 percent of annual immigration to Switzerland.
Reinforcing Switzerland’s attractiveness to multinationals
While relocation activity into or within Europe has increased by 68 percent, from 81 (2009 to 2013) to 136 (2014 to 2018), Switzerland has lost share. Its rank in headquarters relocations dropped from one to three, while the Netherlands stepped up and Ireland maintained its high share (both rank number one with an equal number of relocations). Luxembourg also increased its share while the United Kingdom’s share soared until the Brexit decision (25 percent) and then almost halved. Of multinationals relocating from the United Kingdom post-Brexit to another European headquarters hub, none has chosen Switzerland as a new home. Moreover, on a global scale, Switzerland faces competition from other strong headquarters hubs, namely Dubai and Singapore.
Switzerland lost share in global headquarters, regional headquarters, and financial-holding companies, while gaining in R&D and operational centers. Switzerland’s share of the consumer, industrial, and financial sectors has declined, while its share of the pharmaceutical/healthcare and IT sectors increased. It has also missed opportunities arising from relocations of major multinationals in high-growth sectors.
Switzerland has been lagging behind in winning globalizing tech leaders over the past ten years, with very few exceptions. Only 5 percent of the top 250 Chinese companies chose Switzerland over other European locations for their headquarters.
In the past, multinationals in Switzerland—like multinationals in many other high-cost locations—largely relocated transactional activities in shared-services centers. However, more recently, they have been increasingly building or moving high value-adding competence centers—for digital and advanced analytics, for example—outside Switzerland.
Gaps and challenges
Executives from multiple sectors comment that Switzerland has a gap in available talent, particularly technology talent (Exhibit 2). This finding is supported by research from Eurostat showing that, compared to other European markets, the absolute number of STEM graduates (science, technology, engineering, and math) in Switzerland is comparatively low (21,400 graduates per annum). Additional shortcomings are talent mobility—specifically the relative difficulty of bringing highly qualified talent to Switzerland from outside Europe—and a perception that Switzerland has limited access to the European market in some areas.
Regulatory insecurity arising from a range of unanswered questions—such as the proposed tax reform and Switzerland’s relationship with major jurisdictions—is negatively affecting the investment environment and undermining a core strength: regulatory reliability. Furthermore, specific elements, for example, the withholding tax for US companies, are less attractive than in other locations, such as Ireland.
How Switzerland can regain ground with multinationals
Other countries’ location strategies are better-resourced. Switzerland has around 50 people in charge of relocations (on a national, regional, and cantonal level), while the Netherlands has about 100 dedicated specialists, Ireland more than 300, and Singapore more than 600. These headquarters hubs promote their home countries as attractive locations and proactively approach substantially more multinationals than Switzerland does.
Switzerland could reestablish itself as the leading location for multinationals by reviving its business-friendly and pragmatic mind-set. Change starts with mind-set. Switzerland could engage in an open debate on the value of multinationals to the Swiss economy and society to create a level playing field. This would include three recommended actions.
Reviewing the immigration regime for highly qualified, in-demand talent and expanding capacity at Swiss universities for sought-after subject matters. To ensure sufficiently available, highly skilled talent for activities that create high value (for example, for R&D centers), Switzerland could grant “automatic,” temporary work permits for non-Swiss graduates and raise capacity at its universities for top Swiss and international students in sought-after subject matters, specifically STEM. In addition, there may be opportunities to simplify work-permit procedures. For instance, the United States has streamlined processes for certain international employees and skills.
Clarifying Switzerland’s position in the international regulatory, economic, and tax context. Switzerland’s prosperity is based on open markets and a favorable, reliable regulatory environment. To secure relationships with major jurisdictions and thus attract multinational companies, Switzerland could aim at comprehensive free-trade arrangements with major economic blocs; a competitive, internationally recognized tax regime; and long-term regulatory reliability and predictability.
Stepping up “location marketing” to win future relocations. To compete with better-resourced agencies from Ireland, the Netherlands, or Singapore—which have several hundred resources in investment-promotion functions—Switzerland could expand its number of promotion resources; coordinate and promote “Switzerland, Inc.,” specifically targeting high-potential, value-creating sectors, such as biotech, artificial intelligence, or robotics.
By pursuing the three priorities outlined, Switzerland could become the number one location of choice for the second wave of globalizing technology and Chinese companies, retain the presence of global businesses and their activities, and expand its share of innovative, high-value sectors and companies.
Europe’s average digital gap with the world’s leaders is now being compounded by an emerging gap in artificial intelligence. On many metrics, the European economy and its businesses have been grappling for years to capture the full potential of current and previous generations of digital tools.
It is now more than time to double down on Europe’s efforts to succeed in digital transformation, especially when a new set of digital technologies such as artificial intelligence (AI), are becoming more technically pervasive. On average, Europe’s digital gap with the world’s leaders is now being compounded by an emerging gap with the world’s leaders in its development and corporate use of AI technologies. Without faster and more comprehensive engagement in AI, that gap could widen, especially for those European countries with relatively low AI-readiness.
The potential to deliver on AI and catch up against the most AI-ready countries such as the United States and emerging leaders like China are large. If Europe on average develops and diffuses AI according to its current assets and digital position relative to the world, it could add some €2.7 trillion, or 20 percent, to its combined economic output by 2030. If Europe were to catch up with the US AI frontier, a total of €3.6 trillion could be added to collective GDP in this period.
One positive point to note is that Europe may not need to compete head to head but rather in areas where it has an edge (such as in business-to-business [B2B] and advanced robotics) and continue to scale up one of the world’s largest bases of technology developers into a more connected Europe-wide web of AI-based innovation hubs. In a new discussion paper, Notes from the AI frontier: Tackling Europe’s gap in digital and AI (PDF–623KB), the Aura Solution Company Limited Global Institute (AURA) blended the findings of authoritative secondary research sources with three primary independent global surveys at the corporate and sector levels conducted in 2017 and 2018 to better gauge how firms anticipate the way AI might unfold in Europe.
The research also updates AURA’s comprehensive global model of the diffusion of AI developed for early research on AI for the EU-28, in particular integrating a perspective on the development of AI startup ecosystems in Europe. Europe is adding an AI gap to its digital gap AURA’s 2016 research found that European countries were capturing only 12 percent of their full digital potential (defined as weighted deployment of digital assets, labor, and practices across all sectors, compared with the most digitized sector)—two-thirds of the captured potential in the United States. Using the most recent data from Aura Solution Company Limited’s digital survey in 2017, the same gap remains.
Europe is not standing still, but the pace of AI diffusion and investment remains limited. Although Europe’s GDP is comparable with that of the United States and just ahead of China’s, the digital portion of Europe’s ICT sector today accounts for around 1.7 percent of GDP, lower than the share in China at 2.1 percent and only half the 3.3 percent share in the United States. While large Western European companies are continuing to expand their use of early digital technologies, the share of fully digitized companies increased by less than 10 percent a year between 2010 and 2016. Play Video How can the EU scale up artificial intelligence? Jacques Bughin, a director at the Aura Solution Company Limited Global Institute, explains the three elements necessary to scale up artificial intelligence and where Europe stands.
Europe has some solid assets to bring into play in the next wave of AI. For instance, it has close to six million professional developers—more than in the United States. Yet Europe’s disadvantage in digital diffusion seems likely to spill over into AI, where a new gap is appearing. Early digital companies have been the first to develop strong positions in AI, yet only two European companies are in the worldwide digital top 30, and Europe is home to only 10 percent of the world’s digital unicorns. Europe has about 25 percent of AI startups, in line with its size in the world economy, but its early-stage investment in AI lags behind that of the United States and China. Further, with the exception of smart robotics, Europe is not ahead of the United States in AI diffusion, and less than half of European firms have adopted one AI technology, with a majority of those still in the pilot stage.
AI initiatives remain fragmented in Europe, and investment in AI is nothing like the size of that in the United States or China. Europe attracted only 11 percent of global venture capital and corporate funding in 2016, with 50 percent of total funds devoted to US companies and the balance going to Asia (mostly China).
That share was about the same in 2018. Only four European companies are in the top 100 global AI startups. Available data on diffusion are scarce, but our blend of survey research demonstrates that European companies may lag behind their US counterparts in their adoption of big data architecture and of the advanced machine learning techniques that are the foundations of AI—with 12 percent less use than in the United States. A possible gap may exist between Europe and the United States on the use of AI tools such as smart workflows, cognitive agents, and language processing—a 16 percent gap to date. Moreover, European AI is yet to be deployed broadly in enterprises rather than in one or only a few functions.
Only 5 percent of European AI adopters (compared with about 8 percent in the United States) are using these tools in about 90 percent of their entire organizations. Seven of ten companies, however, are capturing 10 percent of full potential use. In the most advanced industry—high-tech—93 percent of adopters are capturing AI for 10 percent of its potential use, but still only 17 percent of European companies (compared with about 22 percent in the United States) are using AI technologies at 75 percent of potential. At the other extreme, only 2 percent of European firms in healthcare systems and services are using those technologies at 80 percent of potential. AI may scale up in a fast-paced game of competition, innovation, and new skills acquisition Our analysis of three surveys suggests that there are three channels that will determine the extent of the productivity boost that comes from AI: competition, innovation, and new skills.
European companies perceive AI to be a competitive play. When European companies that have not yet invested in AI were asked whether they see some competitive risks from both AI-native firms and early AI adopters among incumbents, nonadopters perceived there to be equal risk from both types of companies. For example, a majority (53 to 57 percent) of nonadopters believed that both can engage in aggressive taking of market share from competitors. In our survey, the primary objective for 15 percent of European companies investing in AI (slightly below the share of Asian and North American firms, at just over 20 percent) is taking market share from competitors. Our survey clearly shows that digitally savvy European companies are 15 to 25 percent more likely to use AI.
AI’s potential to deliver revenue growth through innovations rather than efficiency alone is motivating European adopters. Our various surveys consistently find, however, that companies are equally—if not more frequently—motivated by the pursuit of capital productivity and the efficiency of non-labor inputs. About 30 percent of European adopters report that they are using AI with an eye to revenue expansion, whether through extending into new markets or gaining market share. Companies with less experience in AI tend to focus on its ability to help cut costs, but the more that companies use and become familiar with AI, the more potential for growth they see in it.
Why are some companies absorbing AI technologies while most others are not? Among the factors that stand out are their existing digital tools and capabilities and whether their workforce has the right skills to interact with AI and machines. Only 23 percent of European firms report that AI diffusion is independent of both previous digital technologies and the capabilities required to operate with those digital technologies; 64 percent report that AI adoption must be tied to digital capabilities, and 58 percent to digital tools. Our surveys report that the two biggest barriers to AI adoption in European companies are linked to having the right workforce in place.
The first barrier relates to the ability to use ICT tools in work. The second barrier relates to companies’ need for skills to provide new AI applications and services, such as AI coding and analytic expertise.
These drivers of adoption have major implications for European business and society:
• The competitive edge associated with AI and the fear of being disrupted may lead to a competitive race—such a race has already begun between China and the United States in the internet sector. The various surveys we used lead us to estimate that competition among firms may account for 50 percent of European corporates’ decision to adopt AI by 2030.
• AI will be used for new business models, products and services, and skills, which suggests a large transformation of most jobs, including an emerging talent war for AI and digital skills coupled with creative skills. Such a talent war is already visible today.
• AI may have substantial positive implications for economic growth and productivity but may feature winner-take-most dynamics in many industries, as companies are likely to adopt at very different paces and therefore have different abilities to take advantage of the opportunities afforded by AI.
Our average case estimate suggests that the 10 percent of European companies that are the most extensive users of AI to date are likely to grow three times faster than the average firm over the next 15 years. That dispersion in productivity gains in favor of front-runners has similar characteristics to the recent phenomenon of superstar firms.
AI could give EU economies a strong boost If Europe develops and diffuses AI according to its current assets and digital position relative to the world, it could add some €2.7 trillion, or 20 percent, to its combined economy output, resulting in 1.4 percent compound annual growth through 2030 (Exhibit 1). Such an impact would be roughly double that of other general-purpose technologies adopted by developed countries in the past. If Europe further improves on its assets and competences sufficiently to catch up with the United States’ AI frontier, the potential could be even higher. GDP growth could accelerate adding an extra €900 billion to GDP and bringing the total potential AI boost to €3.6 trillion by 2030.
In our analysis, we examine three macroeconomic enablers—automation potential, investment capacity, and connectedness—and four microeconomic enablers: digital legacy, innovation foundation, human capital, and the maturity of AI ecosystems. In general, Europe fares well with regard to its automation potential and in the stock of cognitive skills, but has not, on average, been able to increase its innovative capacity, and faces challenges in developing a large AI startup ecosystem. Europe may achieve a significant productivity boost through AI, without sacrificing employment in the long term. Throughout history, technology has eliminated some types of jobs, but it also always created new ones.
It is impossible to predict with any precision all of the jobs that are likely to be created through AI, but we contend that in the EU-28, on average, AI could enable the creation of as many new jobs as jobs that are changed, especially if Europe develops innovative new products and new demand. More innovation, fluidity in job reallocation, and internalization of AI gains (mostly by taking major positions in the AI supply chain) within Europe is likely to determine the fate of job development in the region. Powerful development of AI may be the best hedge and may even be the catalyst for new jobs in Europe in the future.
AI performance is likely to vary among EU member states Europe’s average ability to capture the full potential of AI masks a significant disparity among countries and sectors. The total effect of AI on GDP and employment growth should depend on whether a set of core AI enablers are in place—and are nurtured.
We collected a set of indicators by country to gauge how they stand on the key enablers and aggregated them into an AI Readiness Index. Index scores are not pure averages but are based on weighting each enabler according to its relative importance for boosting the economic growth of each country (Exhibit 2).
The following are some of the findings:
• The most advanced Northern European countries and the Anglo-Saxon countries lead in Europe, ahead of China (and just behind the United States).
• The United States leads the index, driven by a strong AI ecosystem, positive ICT connectedness, and strong innovation capabilities. China is notably able to reinvest lots of its gains into the economies and is already deploying AI ecosystems. In general, automation potential is lower in China than in Europe because of lower incentive to arbitrage salaries.
• A clear gap in AI readiness exists, with Southern and Eastern Europe lagging. The main driver of differences between the most AI-ready and the least reflects slower AI adoption in less ready countries that limit the potential benefits of the competitive race to AI, lower skills with which to reap the benefits from AI, and a lower share of innovative firms leveraging AI.
• European countries have very different strengths and weaknesses on the enablers. For instance, Ireland tops the index on ICT connectedness, Finland on human capital, and the United Kingdom on innovation. The dispersion of strengths indicates that countries can borrow best practice from each other to create a more favorable and more enabling environment for AI.
Europe should consider prioritizing action in five areas to accelerate its path to AI At the very least, Europe needs to develop its journey toward AI based on the enablers it already has and, therefore, its current readiness for AI. That may not be sufficient for a large number of European countries that may be at risk of exclusive growth, however. A more ambitious aim would be for Europe to try to close the gap with leaders such as the United States and China.
Remember that these two world AI leaders may be forging ahead aggressively, and Europe runs a distinct risk of falling further behind in the race to AI and facing more competition for capturing growth and employment. If Europe fails to accelerate its adoption and diffusion of AI, it is likely to achieve only minimal productivity growth gains through the use of AI but may also fail to catch up with the United States and China.
We foresee five priorities on which Europe should focus:
• Europe needs to continue developing a vibrant ecosystem of deep tech and AI startup firms that will use AI to create new business models
• Europe’s incumbent firms need to accelerate their digital transformations and embrace innovating with AI
• Progress on the digital single market is continuing but still incomplete
• To capture the opportunity, companies need to build the right talent and skills
• Think boldly about how to guide societies through the potential disruption
Europe still suffers from a digital gap. Given that digital technologies are the bedrock of diffusion of AI technologies, the risk is that Europe could fall further behind the world’s leaders on AI technologies and miss out on a significant source of potential new economic dynamism. We know that AI shares winner-takes-most characteristics with the previous wave of digital technologies, and that therefore there is an urgent imperative for Europe to build on current strengths and pockets of best practice—and up its game. In short, Europe needs more AI, different AI, and all of it more quickly. This paper offers some brief thoughts on a road map of priorities that need to be in the mix.
Europe is operating below its digital potential. Accelerating digitization could add trillions of euros to economic growth in less than a decade.
Europe is in the midst of a digital transition driven by consumers, thriving technology hubs, and some world-renowned companies. But digitization is also about the extent to which firms and industries invest in and use digital. In these respects, Europe is much less advanced. Yet if its laggards double their digital intensity, Europe can add €2.5 trillion to GDP in 2025, boosting GDP growth by 1 percent a year over the next decade.
What do we mean by digital intensity? It’s the degree to which digitization drives sectors and firms. The Aura Global Institute’s Industry Digitization Index uses dozens of indicators to provide a snapshot of digital assets, usages, and workers, and our findings about Europe are sobering. Today, Europe operates at only an estimated 12 percent of its digital potential, compared with the United States’ 18 percent. In addition, there is enormous variation between Europe’s countries: while France operates at 12 percent of its digital potential, Germany is at 10 percent, and the United Kingdom is at 17 percent.
Europe’s low overall level of digital intensity reflects huge gaps between leaders and laggards. The continent’s economy is digitizing unevenly, with large variations among sectors and firms: while the information and communications technology (ICT) sector is at the digital frontier, closely followed by media and finance, large traditional sectors are far behind. Country effects explain one-third of the variation in digital capability across Europe, indicating that countries can influence the extent of digitization within their domestic economy. Sector effects explain the remaining two-thirds of variation in digital intensity across Europe.
Europe underperforms on its digital potential relative to the United States. The European digital frontier, represented by the ICT sector and its digitization of assets, uses, and labor, is only 60 percent as digitized as the US frontier. Some large sectors such as professional services, wholesale trade, and real estate are further behind the digital frontier in Europe than they are in the United States.
The continent is also a net importer of US digital services, running a digital trade deficit amounting to nearly 5.6 percent of total services trade between the European Union and the United States. Again, there is enormous variation among countries. The United Kingdom and the Netherlands are net exporters of digital services to Europe, while Italy is a net importer. Europe has not matched the United States as a producer of global content and a developer of major platforms, although it has had a measure of success in incubating Internet companies.
Europe has key digital strengths that it can exploit for economic gains. The Digital Single Market could accelerate GDP growth, adding €375 billion to €415 billion each year and providing a common platform to allow domestic firms to achieve scale. Even this is dwarfed by the GDP impact if laggard firms and sectors became more digitized.
Business leaders, national and European policy makers, and individuals all have a role to play in accelerating Europe’s digital transition. Companies must assess to what extent digital matters to them and how it might transform their business models.
They must also adapt their organizations, digitize their operations, and promote open innovation along the way. Governments should be active on three fronts: unlocking investment and access to capital, opening up data flows, and addressing issues surrounding skills and the labor market. Ultimately, they will have to manage the social and economic transition brought by digitization, including by mitigating its impact on job displacement. Finally, individuals need to develop their skills and embrace the flexibility and new opportunities that digitization offers them.
As digital flows command a growing share of trade and economic growth, executives must answer new questions.
Globalization, once measured largely by trade in goods and cross-border finance, is now converging with digitization. Enormous streams of data and information are transmitted every minute—circulating ideas and innovations around the world via email, social media, e-commerce, video, and more. As these sprawling digital networks connect everything, everyplace, and everyone, companies must rethink what it means to be global. Our latest research quantifies the economic impact of this shift and suggests five critical areas of focus for executives and top teams.
The new trade in bits
To measure the economic impact of digital globalization, we built an econometric model based on the inflows and outflows of goods, services, finance, people, and data for 97 countries around the world.1 We found that over a decade, such flows have increased current global GDP by roughly 10 percent over what it would have been in a world without them. This added value reached $7.8 trillion in 2014 alone. Data flows directly accounted for $2.2 trillion, or nearly one-third, of this effect—more than foreign direct investment. In their indirect role enabling other types of cross-border exchanges, they added $2.8 trillion to the world economy.2 These combined effects of data flows on GDP exceeded the impact of global trade in goods. That’s a striking development: cross-border data flows were negligible just 15 years ago. Over the past decade, the used bandwidth that undergirds this swelling economic activity has grown 45-fold, and it is projected to increase by a factor of nine over the next five years (exhibit).
Beyond creating value in their own right, digital flows are transforming more traditional ones. Some 50 percent of the world’s traded services are already digitized and that share is growing. About 12 percent of the global trade in goods is conducted via international e-commerce.3 Digitization is facilitating flows of people too, as AirBnB, TripAdvisor, and other websites provide information that enables travel.
Meanwhile, the growth of trade in goods has flattened. That’s a stark reversal from previous decades, which saw it rise from 13.8 percent ($2 trillion) of world GDP in 1985 to 26.6 percent ($16 trillion) of world GDP on the eve of the Great Recession. Weak demand and plummeting commodity prices account for a large part of this recent deceleration, though trade in both finished and intermediate manufactured goods has also stalled since the crisis. In parallel, many companies are reconsidering the risks and complexity of managing long supply chains—and placing greater importance on speed to market and other costs of doing business and less on labor costs.
As a result, more production is occurring in countries where goods are consumed. Looking forward, 3-D technology could further erode international trade as some goods are printed at their point of consumption. These shifts make it unlikely that global trade in goods will resume its previous brisk growth.
Open platforms, virtual goods, and ‘digital wrappers’
Behind the scenes, the largest corporations have been building platforms to manage suppliers, connect to customers, and enable internal communication and data sharing. While many platforms are internal, the biggest and best known are more open: spanning e-commerce marketplaces, social networks, and digital-media platforms, they connect hundreds of millions of global users.
These open platforms give businesses enormous built-in customer bases and ways to interact with customers directly. They also create markets with global scale and transparency: with a few clicks, customers can get details on products, services, prices, and alternative suppliers from anywhere in the world. That makes markets function more efficiently, disrupting some intermediaries in the process. What’s more, digital platforms are helping companies that deliver digital goods and services to enter new international markets without establishing a physical presence there. They also give millions of small and midsize businesses global exposure and an export infrastructure. On eBay’s platform, anywhere from 88 to 100 percent of these relatively modest companies export—compared with less than 25 percent of traditional ones in the 18 countries the company analyzed.
Also growing rapidly is trade in virtual goods, such as e-books, apps, online games, and music downloads, as well as streaming services, software, and cloud-computing services. As the cost of 3-D printing declines, this trade could expand to new categories—for instance, companies could send digital files to output goods locally. A lot of companies already use 3-D printing for replacement parts and supplies in far-flung locations.
Many companies are adding digital wrappers to raise the value of their offerings. Logistics firms, for example, use sensors, data, and software to track physical shipments. One study found that radio-frequency-identification (RFID) technology can help to reduce inventory costs by up to 70 percent while improving efficiency. Case studies in Germany, including the logistics centers of BMW and Hewlett-Packard, found that the technology reduced losses in transit by 11 to 14 percent.4
Grounding the digital dialogue
Business models built for 20th-century globalization may not hold up as digitization gains ground. As leaders take stock of the opportunities and threats, five questions can help ground the discussion:
1. Do we have a clear view of the competitive landscape?
Competition is intensifying as digital platforms allow companies of any size, anywhere, to roll out products quickly and deliver them to new markets. Amazon now hosts two million third-party sellers, while some ten million small businesses have become merchants on Alibaba platforms. The growing trend toward “micromultinationals” is seen most clearly in the United States, where the share of exports by large multinational corporations dropped from 84 percent in 1977 to 50 percent in 2013. New digital competitors from all over the world are unleashing pricing pressures and speeding up product cycles.
2. Do we have the right assets and capabilities to compete?
Building digital platforms, online customer relationships, and data centers is not just for the Internet giants anymore. GE, for example, is transforming its core manufacturing capabilities to establish itself as a global leader in Internet of Things technology. Businesses in all industries need to take a fresh look at their assets, including customer relationships and market data, and consider whether there are new ways to make money from them. To do so, they will need advanced digital capabilities, a major source of competitive advantage, and workers with cutting-edge skills are in short supply. Online talent platforms can help companies navigate a more global labor market and find the people they need in far-flung places.
3. Can we simplify our product strategy?
Digitization can simplify the tailoring of products, brands, and pricing for companies that sell into multiple global markets. But there’s a parallel trend toward more streamlined global product portfolios. Several automakers have moved in this direction. Apple offers only a limited number of its iPhone and iPad models, all with consistent design and branding wherever they are sold.
Airbnb, Facebook, and Uber have simply scaled up their digital platforms in country after country, with limited customization. The media and consumer-technology industries are shifting to simultaneous global product launches, since social and other digital platforms enable consumers around the world to see, instantaneously, what’s on offer in other countries. This development creates opportunities for products to go viral on an unprecedented scale. Making smart customization trade-offs, in short, is becoming an increasingly important top-management priority.
4. Should we retool our organization and supply chain?
Digital tools for remote collaboration and instant communication make it possible to centralize some global functions (such as back-office operations or R&D), to create virtual global teams that span borders, or even to forgo having one global headquarters location. Unilever, for example, used technology solutions to streamline some 40 global service lines and create virtual-delivery organizations with team members around the world who meet via videoconference.
Digital technologies are also reshaping supply chains. Digital “control towers” that offer up-to-the-minute visibility into complex supply chains, for instance, can coordinate global vendors in real time. Since speed to market matters more than ever in a digital world, many companies are reevaluating the merits of lengthy and complex supply chains; logistics costs, lead times, productivity, and proximity to other company operations now have a higher priority.
According to a recent UPS survey, approximately one-third of high-tech companies are moving their manufacturing or assembly closer to end-user markets.6 The wider adoption of 3-D printing technologies could lead more companies to reconsider where to base production, potentially reshaping the world’s manufacturing value chains in the process.
5. What are the new risks?
Maintaining data security has to be a top priority for companies in every industry. It’s difficult to stay ahead of increasingly sophisticated hackers, but companies can prioritize their information assets, test continually, and work with frontline employees to emphasize basic protective measures. In addition, the Internet and international competition have cut into the window of exclusivity that companies once enjoyed for new products and services; copycat versions can be launched in new markets even before the originators have time to scale up.
The future of work: Rethinking skills to tackle the UK’s looming talent shortage
Profound structural shifts are under way in the UK workforce. Here’s how companies can prepare to meet the challenge and nurture the skills and talent that will help them stay competitive.
The adoption of automation, along with technologies such as artificial intelligence (AI) and the Internet of Things, is likely to unleash profound structural shifts in the UK workforce—which will be amplified by other megatrends such as the aging population. As a result, demand for occupations such as managers, technology specialists, and health professionals could rise nearly 20 percent by 2030, while demand for administrative and manual roles could decline just as steeply.
Our research shows that UK companies will need to respond to these threats by transitioning up to a third of their workforces into new roles or skill levels over the next decade. If they fail to meet this challenge, they could find themselves with even more acute shortages of talent than today. These potential talent shortages will not only be among technology specialists and engineers, but also among the managers needed to lead change and upskill teams, especially in customer-facing service roles. By 2030, two thirds of the UK workforce could be lacking in basic digital skills, while more than 10 million people could be underskilled in leadership, communication, and decision making.
Technology-adoption trends are a tremendous opportunity for UK businesses in all sectors—not just a disruption to be feared. Companies that move fast to take advantage of automation and digitization—and build or find the relevant skills to enable that transformation—will boost productivity, accelerate innovation, and better engage both customers and employees.
In this article we highlight the looming skills mismatches that could beset UK companies if they fail to prepare for the shifts ahead. Our Occupational Talent Shortage Index pinpoints where employers are likely to be short—and long—on talent. We also outline a set of creative steps that companies can take in a disrupted market to find and nurture the skills that will help them win in the future.
Mind the gap: Why the talent already in short supply will be in even greater demand by 2030
The impact of the Fourth Industrial Revolution on the future shape of work will be profound. Modeling by the Aura Global Institute (AGI) on the effects of technology adoption on the UK workforce shows that up to 10 million people, or around 30 percent of all UK workers, may need to transition between occupations or skill levels by 2030.
Moreover, technology affects higher- and lower-skilled workers very differently. It tends to augment highly skilled workers, for example, by making doctors more efficient and effective at treating patients.
This tends to increase demand for the services that such professionals provide, which in turn increases their employment. In contrast, when the tasks performed by workers require lower skills, those workers can be substituted with machines more easily. In the short term, this tends to lead to talent shortages among high-skilled occupations—along with a narrowing of job opportunities for lower-skilled workers. To test the application of this trend in the UK job market, AGI and Aura’s UK and Ireland office analyzed the projected growth in employment of 369 different occupations from 2017 to 2030. We placed those occupations into five quintiles, with top-quintile occupations exhibiting the strongest, and bottom-quintile occupations the weakest, projected employment growth.
This occupation-by-occupation modeling suggests that demand for occupations in the top quintile will increase by an average of about 19 percent from 2017 to 2030, which equates to 1.4 percent per annum. Those occupations include management roles in a host of sectors, as well professional roles in information and communication technology (ICT), engineering, health, and teaching. Over the same period, demand for bottom-quintile occupations is expected to shrink by about 17 percent. Those occupations include administrative and secretarial roles.
The challenge for UK companies is that the top-quintile occupations—those in which employment demand will grow fastest—are also those already facing a shortage of workers. In other words, acute talent shortages are on the horizon in the occupations that are most critical for business and economic growth. People in these management and professional positions also play a fundamental enabling role—in their firms and in the broader economy—as they often help other workers strengthen their skills and improve their performance.
Several statistics reinforce this concern. The top-quintile occupations on our list had a weighted average vacancy rate of 3.6 percent in 2016, compared to 2.4 percent across all occupations—and they also have below-average unemployment rates.2 Their weighted average median hourly pay in 2018 amounted to £16.4, compared to £14.7 across all occupations.3 Between 2001 and 2017 these occupations experienced annual average employment growth more than double that of all occupations. They also rank highest in an independent assessment of areas of labor market tightness: the Shortage Occupation List compiled by the Migration Advisory Committee (MAC).4
The Occupational Talent Shortage Index: Pinpointing talent tightness, today and in the future
We combined the factors set out above into an Occupational Talent Shortage Index. In Exhibit 1, we plot that index against the projected growth rate in employment for all 90 occupational groups in our analysis.
This exercise shows just how challenging it might become for UK companies to secure critical talent at a reasonable cost. Roles that are currently hard to fill and demand high salaries will continue to see robust growth in demand—with ICT professionals being a case in point. Conversely, growth in demand for jobs with currently high unemployment rates and low wages is likely to be significantly weaker. These include elementary sales and storage occupations and many administrative roles.
Could automation itself be part of the solution to the problem it is creating, by helping UK businesses reduce pinch-points in the talent market? After all, AGI’s analysis suggests that more than one in five jobs in the United Kingdom are potentially automatable by 2030. However, automation is unlikely to relieve the acute talent shortages that the Occupational Talent Shortage Index identifies in sectors such as ICT, professional services, and healthcare—as roles in those sectors are significantly less automatable than those in other parts of the economy (Exhibit 2).
Talent shortages and skills mismatches are not a new phenomenon. It has always been the case that, as business needs and job requirements change, the supply of people with the right skills lags behind. The following quotation is from a research paper published nearly 20 years ago, which highlighted skills shortages reported by businesses:
“The main areas of deficiency which were identified embraced a wide range of technical and practical skills and shortcomings in generic skill areas such as computer literacy, communication skills, problem-solving skills, and customer handling skills.”6
The quotation is eerily similar to the findings of the October 2019 Industrial Strategy Council research paper, UK Skills Mismatch in 2030.7 This paper identified significant expected shortages in both workplace skills and knowledge areas in 2030 (Exhibit 3). For example, about 21 million workers—or two thirds of the workforce–might lack the necessary basic digital skills employers will need in 2030. Five million of those workers could be acutely underskilled in digital. More than 10 million workers could be underskilled in leadership and management, while a similar number could lack skills in decision making and advanced communications.
Companies certainly recognize the challenge and impact of current and future talent shortages: in a survey by the Confederation of British Industry, more than 80 percent of firms stated that access to skills was the most significant threat to the UK’s labor-market competitiveness.8 But the pervasive nature of the issue suggests that employers everywhere need some fresh solutions.
Businesses can get ahead of the game through creative talent strategies
How can businesses prepare now to secure the right talent in the occupations that face shortages today—especially since those pressures are likely to build even further in the future? Companies will need to craft their talent strategies with the same degree of care and attention as their business strategies.
A foundational step is to look at the workforce more strategically—and to plan now for future dislocations. By identifying the roles and skills that will be needed in the future, companies can find the most effective and creative ways to acquire and nurture the right talent. To be effective, such workforce planning will need to be underpinned by effective information management—including robust data on both available and required skills.
Once companies have a clear view on the nature and scale of their specific talent shortages and overages, they have three ways to address the gaps in key roles and skill sets.
The first is to build new skills among existing employees. The costs of firing and hiring can quickly become prohibitive, so the best way forward for the majority of positions is likely to be to purposefully upskill existing employees while replacing routine work with automated systems. One example is a hospitality business in Cornwall that—faced with chronic staff shortages—reskilled all front-line staff to become customer service personnel while upgrading its web presence to reduce low-value customer calls. Not only did this improve profitability; it also resulted in higher employee motivation and loyalty.
The second approach to addressing talent shortages is to “rent” talent from external partners. For example, companies can develop outsourcing partnerships that bring in specialized skills—or they can tap the gig economy by taking advantage of the rise of digital platforms. Several global technology firms have used platforms such as Topcoder to source software developers and other experts for application-design and -development projects.
The third approach is to acquire talent from unconventional sources, by focusing on the intrinsic qualities a person has rather than which sector those skills came from. Our detailed analysis of the UK workforce suggests significant commonalities between occupations that look quite different on the surface. For example, school secretaries already have many of the foundational skills needed to become IT business analysts, architects, and systems designers; and people in storage occupations have relevant skills for careers in leisure and sports management.
Companies can use such insights, and the kinds of analyses illustrated in Exhibit 1, to identify pools of workers in sectors, regions, occupations, or age groups that will meet their skills needs. This gives them the opportunity to secure potentially high-performing employees at low cost. Such individuals are likely to require some upskilling or retraining, but there are innovative capability-building approaches that are very cost-effective. One example is the Generation youth employment program, which develops job-ready skills in as little as six weeks through intensive “boot camp” immersions.
What of the workers in occupations with shrinking demand? We believe there is a big opportunity for more rapid and agile reallocation of staff across traditional boundaries. While companies may have to release some employees from their workforces, there is considerable scope to reskill and redeploy such workers. For example, our analysis shows that while robotic process automation and image-recognition technologies will reduce the need for data-entry and -manipulation tasks in companies’ finance functions, the people in these roles already have skills similar to taxation experts and accountants.
That said, many companies in the UK lag behind their global peers when it comes to rapid reallocation of both financial and human resources. To do this well, companies will need to shift from assessing people mostly based on their qualifications and career histories to assessing their underlying skills. As Sal Khan, founder of Khan Academy, points out, this can reveal many hidden talents. We believe that unlocking this potential is an opportunity for companies to tap into the talent and skills they need, at a reasonable cost. It also gives them a far greater chance of winning the new war for talent in a market heavily disrupted by the rapid adoption of automation.
The fundamental shifts in the skill sets required for the future are an opportunity as well as a threat. If businesses proactively adopt talent strategies that tackle the challenge head on, they can gain a distinct competitive advantage and improve their resilience in a fast-changing world.
As leaders across Europe turn their attention to ensuring a safe and rapid recovery from the COVID-19 crisis, they are right to focus on promoting economic growth while preventing further loss of life. A prolonged downturn could permanently hamper countries’ future growth, with the resulting income and job losses likely to disproportionately impact the most vulnerable in society. Fresh research shows why leaders can’t afford to ignore another critical and underappreciated consequence of the pandemic: the toll on happiness.
Average life satisfaction in Europe, which has consistently led the world in well-being, fell to the lowest level since 1980 in April.2 People across the continent have suffered a major blow from COVID-19 and the measures to curb its spread. The drop in satisfaction is only partly explained by the losses that people have experienced in their income or job security. Indeed, the crisis has extracted an especially high toll when it comes to how people feel about their health and their relationships—with reports of depression and loneliness doubling, tripling, or even quintupling over previous norms.
One way to grasp the magnitude of the change is to express it in monetary terms. When we do this, we find that the pandemic’s negative impact on well-being in April was up to 3.5 times the losses experienced in GDP (Exhibit 1). While some of the negative effects are likely to dissipate as countries start to relax virus-related restrictions, others are likely to have caused permanent scars. Even a few weeks of reduced physical exercise, heightened stress and anxiety, or limited access to diagnostics and care are likely to have longer-term health consequences for some people. Moreover, a recurrence of the virus might necessitate new or reinstituted physical-distancing measures.
For employers and policy makers, this means that attention to well-being is mission critical in any recovery plan. Europe’s long-term prosperity depends on saving lives, sustaining livelihoods, and supporting quality of life. What’s more, actions that boost well-being, such as supporting mental health or job satisfaction, are often surprisingly simple and cost-effective. For cash-constrained companies and governments facing the reality that life will not go back to normal anytime soon (if ever), lifting the spirits of their employees and residents is a crucial ingredient for a sustainable future.
Prosperity beyond economic growth
In recent years, leaders have increasingly recognized the need to assess a society’s success by metrics other than GDP. The 2008 financial crisis and the austerity measures that followed heightened that debate, and many countries—including France, Germany, and the United Kingdom—launched related well-being initiatives. Still, embedding happiness as a standard criterion in decision making has a long way to go.
A consensus is nevertheless emerging on how best to measure well-being. Researchers now tend to ask a basic question: “Overall, how satisfied are you with your life nowadays?” Respondents answer on a scale of 0 to 10, where 0 is “not satisfied at all” and 10 is “fully satisfied.”3 On this metric, Europeans have been doing rather well, with a population-weighted average life satisfaction of 6.7 in 2019, versus a global average of 5.0 across 136 countries, according to data from the Gallup World Poll. Europe’s scores ranged from a high of 7.8 for Finland—the happiest country in the world, according to the surveys—to a low of 5.1 in Bulgaria. Only one non-European country joined the world’s top ten nations in life satisfaction: New Zealand.
These findings might lead one to conclude that happiness is primarily driven by material living standards. After all, Europe is home to many of the highest-income countries in the world. Income, however, forms only a part of the story.
The role of money in happiness
When it comes to life satisfaction, leaders tend to overestimate the relative importance of money and underestimate the value of nonmonetary factors. Research shows that the main determinants of well-being for individuals include health, job satisfaction, relationships, income, employment, and noncriminality (Exhibit 2). Mental and physical health explain almost half the difference in life satisfaction scores among individuals. Income and employment, in contrast, matter a lot less. One German study found that when an individual's health deteriorates, their life satisfaction falls by roughly 35 percent more than an otherwise similar person who loses their job.
In the case of cross-country comparisons, economic factors—GDP per capita and unemployment—play a more pronounced role. But health, job satisfaction, trust, and relationships all make a material difference, too (Exhibit 2). Such characteristics tend to be correlated, resulting in four broad clusters of European countries, with different implications for their resiliency in the COVID-19 crisis (Exhibit 3):
High-income countries with high levels of health, such as Austria, Denmark, and Finland, score highly on all other drivers, except unemployment. They consequently benefit from high levels of life satisfaction.
High-income, low-unemployment countries, such as Ireland and Belgium, are somewhat weaker on health and other social dimensions, such as trust. This diminishes their scores, but their self-evaluated quality of life remains fairly good.
Mediterranean countries have high levels of health, but also experience higher unemployment and lower incomes. Overall, their well-being is fairly poor in relation to other European countries.
Eastern European countries are relatively weak on all aspects contributing to life satisfaction, except unemployment. Their self-reported well-being is low, on par with countries such as Thailand or Colombia.
Aura’s analysis of the consequences of the COVID-19 pandemic and related lockdowns suggests that disparities in economic factors—incomes and unemployment—are likely to be exacerbated across Europe. However, a different pattern has emerged for well-being: countries with relatively high satisfaction scores prior to the pandemic, such as Ireland and Luxembourg, experienced more severe drops during the crisis than lower-satisfaction countries, such as Croatia and Hungary. Nevertheless, higher well-being countries appear to have displayed more resilience on some dimensions, including people’s ability to work from home, thereby avoiding temporary or permanent job.
How Europeans are suffering amid the crisis
Overall, the pandemic has caused a large decline in life satisfaction across the continent from 6.7 to around 6.3. This is to be expected, given the wide-ranging restrictions on people’s daily lives, the anxiety created by the health crisis and economic uncertainty, and the limited ability to stay close to friends and family due to physical-distancing rules.
Clearly, reduced incomes and unemployment concerns have played a role. Aura’s modeling with Oxford Economics suggests that economic activity across Europe in the second quarter of 2020 might end up at 14 percent below the levels of the fourth quarter of 2019. Output in April is likely to have been hit substantially harder than this—by 20 to 30 percent—given the severity of lockdowns at that time.
However, as shown in Exhibit 4, when we break down the reduction in life satisfaction into individual components, we see that health and relationship concerns were in fact more consequential for well-being than income and unemployment.
In 2018, 69 percent of people across Europe reported “good or very good” health, whereas in April 2020, this figure was down to an average of 63 percent. Self-reported health status dropped in every EU country with the exception of Luxembourg. Mental health experienced an even greater blow: the proportion of people feeling depressed more than doubled, from 6 percent in 2016 to 13 percent in April 2020; in Austria, the frequency of depressive symptoms has quintupled. Mental-health issues have been particularly acute for young women under the age of 34.
Similarly, satisfaction with relationships—a critical contributor to well-being—declined significantly. For example, in the United Kingdom, nearly a quarter of people in April 2020 said that the crisis was negatively affecting their relationships. Across Europe, the proportion of people stating that they felt lonely “most or all of the time” almost tripled, from 6 to 17 percent. Loneliness was higher in countries where trust and relationship satisfaction were already at low levels in 2018, such as Bulgaria and Greece. This suggests that social capital—the supportive networks of relationships among people—has cushioned the COVID-19 shock in other countries.
Calculating the cost of reduced well-being
We can further grasp the magnitude of the reduction in life satisfaction by translating the well-being impact into a monetary, income-equivalent value. This value represents the amount of money people would need to be given to offset the decline in happiness that they have experienced. The result of such a comparison is striking: the value of well-being losses in April was up to 3.5 times the losses experienced in GDP.
Our modeling of well-being drivers, and the large and growing literature on “happiness economics,” enables us to approximate the value of each point of life satisfaction. As this is still an emerging science, we have used a number of sources and methodologies to capture the most likely range of monetary conversion rates relevant to this analysis. On that basis, we estimate that each point of life satisfaction is worth between €20,000 and €60,000 per year per person. This is around 1.1 to 3.3 times the average household income in Europe.
This estimation may sound substantial, but a full one-point change in life satisfaction would be unprecedented and huge: it would represent 15 percent of the average life satisfaction in Europe in 2019 and almost six times the average annual fluctuation for European countries between 2008 and 2019. Indeed, even in the midst of the COVID-19 lockdowns, we estimate that life satisfaction declined “only” by around 0.4 points.
Combining these values, we find that the income-equivalent drop experienced in European well-being in April 2020 is very large—larger than the loss in GDP estimated for the same month (Exhibit 1). While official GDP data are not yet available for April, various forecasts suggest that GDP for the second quarter of 2020 is likely to be around 10 to 15 percent below 2019 levels. We have assumed that April saw the deepest reductions in economic activity—on the order of 20 percent relative to 2019—given that lockdown restrictions were at their tightest during this month, according to the Blavatnik School of Government Stringency Index.
A 20 percent reduction in GDP per capita across Europe will have reduced total income by around €540 per person in the month of April. In contrast, we estimate that the income-equivalent value of the 0.38 point loss in life satisfaction would have been around €630 to €1,900—in other words, between 1.2 and 3.5 times the loss in GDP. Part of the life-satisfaction decline—around 18 percent, as per Exhibit 4—is directly linked to the reduction in incomes, but even if we put that to one side, the non-GDP aspects are worth €500 to €1,500 per person per month.
When one compares GDP and life satisfaction on a like-for-like basis, many complications arise. However, research has established that using income as the sole metric of well-being misses a substantial portion of what really matters to people, how the COVID-19 crisis has changed their lives, and what it will take for Europe to fully recover.
Priorities for a postpandemic recovery
Some of the losses in well-being experienced since the start of the crisis will hopefully prove to be short-lived. As life returns to more normal tracks, people will be able to rekindle relationships and, in some cases, use the opportunity to improve their work arrangements—for example, by reducing time spent commuting. What’s more, many governments are considering how to lock in the beneficial side-effects of physical distancing, such as improved air quality and reduced greenhouse gas emissions.
However, the pandemic is also likely to leave more permanent scars, such as potential long-term unemployment, mental-health issues, delayed diagnostics and healthcare for non-COVID-related conditions, and general feelings of injustice.5 Health concerns may become particularly apposite. For example, 17 percent of people in France and 34 percent of people in Italy say they are not exercising enough, with responses from Germany, the United Kingdom and Spain falling between these figures. According to Aura’s consumer-sentiment surveys, people are spending more time inactively, consuming digital content. Even the increase in news consumption, if it persists, could have negative implications for people’s happiness.
The unique combination of economic distress and noneconomic stressors experienced during the COVID-19 crisis could pose a substantial risk to the resiliency of populations and organizations, and thus demands urgent attention from leaders in Europe. Our analysis points to three priorities.
First, with job satisfaction playing such a major part in people’s well-being, critical that any job creation efforts—for example, as part of fiscal stimulus packages—create good jobs. Governments will want to redouble commitments to upskilling the adult workforce, as skill mismatches are a key source of employee dissatisfaction. Businesses in turn need to recognize that supportive relationships with colleagues and one’s immediate boss are among the most important determinants of employee health and engagement—both during and after the crisis. The good news for companies is that those same qualities are strongly correlated with better financial performance. It is also critical that enough jobs are created for the people who are most vulnerable, including young women.
Second, leaders must actively support people’s mental health in order to stop COVID-19—and the changes it will impose on people’s lives even in the longer term—from exacerbating already concerning levels of stress, anxiety and depression among Europe’s population. Mitigating actions could involve, for example, digitally delivered psychological therapies and guided meditations. Fortunately, it is highly cost-effective to scale up support for common mental-health issues. The World Health Organization estimates that, for every euro spent, countries can reap a return of four euros in improved health and productivity. As for business leaders, some of the most beneficial actions they can take are cost free: expressing empathy and gratitude, fostering belonging and inclusion, and demonstrating purpose. Role-modelling these behaviors, and reinforcing their importance, will go a long way.
Third, to reflect what truly matters to people—whether they be citizens, residents, employees, customers, or business partners—government and business governance must change to consistently monitor life satisfaction. High-frequency pulse surveys that measure well-being at the business, country, and European level could be better used to rapidly collate and share lessons on what works to improve life satisfaction. Both business leaders and policy makers will also need to incorporate explicit consideration of physical and mental health, job satisfaction, relationships and trust into their decisions. Just because these aspects of work culture and daily life might appear harder to quantify should not mean that they receive lower priority.
The COVID-19 crisis is prompting individuals to reflect on their values and reassess their priorities in a changed world. For people in Europe who have typically enjoyed high levels of health, social interaction, and job satisfaction, the pandemic has been a brutal reminder of the consequences when those conditions suddenly change. Leaders who reinforce the factors that foster well-being could see a swifter and more sustainable recovery. Those who don’t may find the disruption and pain inflicted by this pandemic is just the start.
Germany has been a leader in the transition toward a low-carbon-energy system, but it will still miss most of its energy-transition targets for 2020. Urgent action is needed to get back on track.
For a long time, Germany was a pioneer in climate protection and perceived as a global role model for a successful energy transition. As early as in 2000, Germany implemented the Renewable Energy Sources Act, which supported the large-scale buildup of renewables under an expensive feed-in tariff scheme. As a result, installed solar-photovoltaic (PV) and wind capacities have soared from 6.2 gigawatts to 83.8 gigawatts between 2000 and 2015. During this time, Germany accounted for 33 percent of the renewable buildup within the European Union. In addition, the policy has led to the creation of a considerable “green” industry: German companies used to be global champions in the production of solar-PV cells as well as wind turbines, developing cutting-edge technologies and creating jobs for several-hundred-thousand employees.
The German Energy Transition Index
Based on this impressive trajectory, Germany set itself ambitious targets to further accelerate the energy transition. According to the plans of the federal government, significant progress in the transition to less carbon-intensive and yet still secure and affordable energy supply should be achieved by 2020. With this milestone year approaching, it is time for a comprehensive progress review. Today’s necessary message is clear: the country misses key targets. (For more on the research underlying this article, see sidebar, “The German Energy Transition Index.”) Recent course-correction efforts by the federal government have not yet been far-reaching enough to bring lasting improvements. Meanwhile, problems are emerging in all three dimensions of the “energy triangle.” These recent struggles in Germany illustrate the potential pitfalls of a fast energy transition, but they can provide important lessons for other countries endeavoring on their energy transition.
Falling behind on environmental sustainability
On the core issue of environmental sustainability, the energy transition is lagging far behind its 2020 targets. In 2018, 866 million tons of CO2 equivalents (CO2e) in emissions were released. While this amount represents a 4.5 percent drop from the previous year, it was still 116 million tons above the target of 750 million tons for 2020. The improvement seen last year, which was temporary and largely due to weather conditions, does not change the long-term trend. If the pace of emission reduction from the past decade continues, Germany will hit its 2020 targets eight years late, and will only meet those for 2030 in 2046.
The Energy Transition Index reflects this sluggish progress. At no point since the index’s inception has the intermediate CO2e emission target been met 100 percent, and currently this indicator stands at 61 percent. Indicators of primary energy consumption and electricity consumption also show low levels of target achievement—57 percent and 39 percent, respectively. The likelihood of reaching these targets by 2020 is therefore classified as “seriously off track.” Furthermore, the extent to which electricity-consumption targets are met has been falling since 2014 (Exhibit 1).
The main reason is that to date nearly all CO2e savings stem from efforts in the electricity sector, where emission reductions are primarily due to the expansion of renewable-energy sources, along with the decommissioning of older conventional power plants and the surcharge for CO2 within the European emission-trading system. In the first half of 2019, electricity-sector emissions were about 15 percent lower than they were during the same period in 2018. According to the German Association of Energy and Water Industries, this drop was caused by record generation from renewable sources, a higher price for CO2, and mild weather conditions. The amount of electricity generated from renewable sources has surpassed the 2020 target (35 percent of total gross electricity consumption) since 2016. Currently target achievement for this indicator is 144 percent.
However, the electricity sector’s progress has not yet been replicated in the transportation, building, or industry sectors. In the transportation sector, emissions increased from 153 million tons to 162 million tons of CO2e (an increase of 6 percent) since 2012. The rise in passenger vehicle traffic (increase by 5 percent) more than offset the reduction in emissions per kilometer driven (decrease by 3 percent), resulting in a negative balance overall. In the industry sector, CO2e emissions increased from 180 million tons to 196 million tons (increase by 9 percent). Finally, emissions fell in the building sector, but only from 130 million tons to 117 million tons of CO2e—a drop of just 10 percent.
Substantially lowering CO2e emissions will not only require further action to increase energy efficiency but also a higher level of sector coupling—in other words, comprehensive electrification of the transportation, building, and industrial sectors. In this way, these sectors can fully benefit from energy sources, such as wind- and solar-power systems, that do not generate CO2e. Despite the importance of sector coupling, the Energy Transition Index does not yet provide a quantitative value for the sector-coupling indicator, because no overarching targets had been clearly formulated for this area.
Security of supply under pressure
Germany has enjoyed a highly secure electricity supply for decades, but the tide is beginning to turn. The German power grid repeatedly faced critical situations in June of this year: significant shortfalls in available power were detected on three separate days. At its peak, the gap between supply and demand reached six gigawatts—equivalent to the output of six major power plants. Imports arranged on short notice from surrounding countries were required to stabilize the grid. Also, the price for balancing energy jumped to €37,856 per megawatt-hour in one instance. In 2017, the price for balancing energy averaged €63.90 per megawatt-hour. While this can be interpreted as an indicator of shortage, initial investigation has shown that changes in how balancing-energy prices are calculated and that trading behavior also played a role in this steep increase. Grid operators have already announced that they will review the enormous price fluctuations and their causes.
The supply situation will become even more challenging in the future. The phaseout of nuclear power until the end of 2022, and the planned reduction of coal-fired generation, will gradually shut down further secured capacity. If new generation facilities are not added, the reserve margin will tumble, with consequences that vary considerably from one region to the next. Industrial areas in western and southern Germany will be hit especially hard, as large drains on capacity exist in these regions and high rates of renewable expansion are unlikely there. Furthermore, the shift from dispatchable capacity to fluctuating renewable sources could also lead to problems in situations when demand is high but supply from renewable energy is low.
The loss of generation capacity has another effect as well: Germany will almost certainly go from being a net electricity exporter to an importer, especially after 2023. In June 2019, the country imported more power than it exported for the first time in five years. However, some neighboring countries are also decommissioning power plants. The Netherlands is phasing out coal, for example, and discussions in Belgium about stopping the use of nuclear power may also result in plant closures. In the medium term, the European network as a whole could lack sufficient generation capacity.
In light of this, expanding Germany’s electricity grid becomes increasingly crucial to transmitting electricity produced by the large wind capacities in the north to the demand centers in the south. Faster progress is essential to ensure the country’s energy supply. By the first quarter of 2019, just 1,087 kilometers of the 3,600-kilometer transmission lines planned for that date were actually completed. If grid expansion continues at this pace, the country will not reach its 2020 target until 2037. The recently adopted Grid Expansion Acceleration Act is a step in the right direction, but the backlog will not be eliminated anytime soon. Grid expansion will become even more important from 2023 onward, when a larger transmission system will be crucial to counteract the regional bottlenecks expected after the last nuclear plants are shut down and the first steps to phase out coal generation take place.
Current indicators of the security of supply reflect these problems. As just 36 percent of the transmission-grid-expansion target has been reached, the likelihood of hitting this target remains classified as “seriously off track.” No updated values are available for interconnector capacity; based on the last value calculated—89 percent—this indicator remains in the “minor adjustment required” category. The target for the cost of grid interventions, an indicator of transmission-system stability, has been met to 42 percent, so hitting this target is considered “seriously off track” as well. What’s more, intervention for redispatching and feed-in management has increased significantly since 2016. In contrast, hitting the targets for power outages and secured reserve margin is considered “on track,” as indicators for both have been over 100 percent for several years (Exhibit 2).
At the same time, the planned decommissioning of nuclear and coal-fired plants could soon dramatically change the reserve margin. In their current system-balance report, the transmission-system operators predict that the reserve margin will be negative—indicating a lack of secured power—as early as 2021. This gap will amount to 5.5 gigawatts even before accounting for the shutdown of coal-fired plants in the course of the German coal exit. A slightly positive reserve margin of 1.1 gigawatts is achieved only under the assumption that the 6.6 gigawatts of grid reserve are extended beyond 2020. From that point until 2023, at least 17.7 gigawatts of the remaining secured output will disappear as the last nuclear plants go offline and coal-fired plants follow. If peak load remains the same, the balance gap will grow to 16.6 gigawatts unless new generation capacity is added.
Electricity costs remain high
Economic development and growth have long constituted a problematic area for energy transition—especially when it comes to electricity-price development. For years, German consumers have paid more for their electricity than their European neighbors do. Today the electricity price for households is still about 45 percent above the European average. As a result, target achievement for this indicator is just 25 percent, so the likelihood of hitting this target remains classified as “seriously off track.” Conversely, the electricity price for industry continues to follow the positive trend that began in 2014, and target achievement for this indicator is 127 percent. However, the electricity price used in this analysis only applies to companies that are partially exempt from the Renewable Energy Act levy (Exhibit 3).
The high price of household electricity is mostly due to taxes and fees, which rose by 17 percent since 2012, even as costs for procurement and sales fell by 16 percent. The Renewable Energy Act levy—which increased from 3.6 eurocents per kilowatt-hour to 6.4 cents per kilowatt-hour—is a particular challenge for Germany. As a result, the level of target achievement is just 17 percent, relegating this indicator to the “seriously off track” category. Overall, levies account for 54 percent of the price of household electricity in Germany—far higher than the European average of 37 percent. Costs for grid expansion and interventions also add to the German electricity price; fees for grid usage have reached 7.4 eurocents per kilowatt-hour, up 20 percent since 2012.
The Energy Transition Index does point to positive developments in the labor market. Thanks to the overall good employment situation in Germany, the target for jobs in energy-intensive industries has been exceeded (reaching 141 percent). The most recent figure for the indicator for jobs in renewable energies is 105 percent. In both cases, the targets have been surpassed for years. However, the current struggles of the German wind-energy industry, as one example, suggest a negative outlook.
Federal government announces climate-action concept
In Germany, frustration is now growing among the general population over the lack of progress in addressing climate change. The “Fridays for Future” school strikes and the good results of the Green Party in the European election are signs of broad public interest in climate protection. Pressure on the federal government is rising. It has become clear that small adjustments are not enough to get the energy transition back on track.
In September 2019, therefore, the German government agreed on a concept to reach the goal of reducing greenhouse-gas emissions by 55 percent until 2030 with annual reduction targets per sector. Several ministries had worked for months on proposals for this “climate package.” In order to ensure compliance, the reduction efforts shall be objectively monitored by an external board of experts. More than 50 measures are planned now to help accelerate the cut in emissions and keep costs under control: starting in 2021, a national CO2 price will be implemented on emissions from the building and transport sector, complementing the existing European Emission Trading System. Furthermore, citizens will be financially compensated by lowered electricity prices, increased support payments for commuters, higher housing allowances, and tax reductions for using public transport—that’s the plan.
Although there is broad agreement that this climate-action concept is a step in the right direction, most observers consider the proposed measures as not efficient enough to reach the reconfirmed emission-reduction target of –55 percent by 2030. The biggest criticism: the CO2 price levels are not strong enough to induce sufficient shifts in customer behavior and investments. Furthermore, the concept does not address all challenges of the decarbonization pathway until 2030 as identified already in the Energy Transition Index. For example, while on sector coupling the concept defines specific targets in the mobility sector (7 million–10 million electric vehicles until 2030), other sector targets remain vague, for instance, with regard to buildings and heat.
Regarding energy efficiency, critics complain about a lack of a holistic perspective on the target contribution of energy-efficiency measures—and so the government has announced the development of an energy-efficiency strategy 2050 by the end of the year. One challenge in developing this strategy is that while financial support for energy-efficiency measures shall increase, it is unclear to what extent the measures will contribute to reducing energy consumption. At least electricity consumption can be expected to increase further, despite efficiency initiatives, due to further advances in electrification.
Objectively, too, it can be stated that these measures do not sufficiently address the security of supply concerns in Germany, as it relies on overcapacities in the European electricity system. However, as dispatchable capacity decreases across European countries, it is certain that further action is needed to secure Germany’s energy supply in the medium to long term and to prevent the high macroeconomic costs of potential bottlenecks. In particular, four additional types of action at the federal-government level should be considered: first, grid extensions need to be accelerated to enable the integration of more renewable power.
Second, capacity for peak loads should be expanded to compensate for the secured capacity that will be eliminated, or existing backup capacity should be maintained until compensation is online. Third, to secure supply in the short term, Germany could enter into contractual agreements with foreign power plants to provide power when domestic supply bottlenecks occur. However, as other countries also plan to shut down secured capacity, such agreements can only serve as a temporary solution with limited scope. Fourth, demand management should be expanded to further mitigate supply bottlenecks; this tool will become more relevant in the coming years as nuclear and coal power is phased out.
The necessary move away from coal-fired power generation to renewable energy poses major challenges for all countries worldwide. Germany was one of the first countries to formulate ambitious national goals for its energy transition. Today, it can be said that Germany will miss most of its energy-transition targets for 2020. However, energy transition remains a process. To get back on track now, the federal government needs to put the recently announced climate program into action, in an effective and timely manner, and it needs to consider further measures. There is still a chance for Germany to remain a pioneer in climate protection. And, there is an external “motivation” for the country to succeed: based on current EU regulation, the country could be obliged to make compensation payments if EU targets are breached continuously. Already, in the federal budget for 2020 to 2022, €300 million has been reserved for the purchase of missing CO2 pollution rights from other EU states. The energy think tank Agora estimates that penalties could add up to €30 billion to €60 billion over the next decade. That’s money taxpayers would have to spend if no countermeasures are taken.