🏦 Ian Ng, Researcher
For those of us who follow Europe’s startup ecosystem, it won’t come as news that the late-stage funding gap is often seen as the binding constraint on startups scaling up. Much of this has already been mapped out in the Draghi report and elsewhere — the internal barriers within the European Single Market and the need to funnel wealth towards risk-taking VCs who can back scale-ups. While the Draghi report stated that the EU’s productivity growth over the past two decades could be on par with the US if you strip out the tech sector, a new NBER paper finds that the valuation gap between US and European firms persists even when comparing companies within the same narrow industry. Strip out the very largest companies in each region and the gap barely budges, so this isn’t mega-caps skewing the average. Instead, the authors identify the gap as concentrated among young, small, R&D-intensive companies — what stockpickers would call growth stocks, whose value lies in future growth rather than today’s cash flow.
The paper attributes the gap to two constraints. On the demand side, European firms’ sales are tied to the size of their home country’s economy. A 1% rise in local GDP raises a European firm’s sales by 0.8%, a dependency that does not exist for American firms and their home states. On the finance side, Europe has less venture capital than the US. US venture capital investment ran at 0.5% of GDP in 2023, against 0.15% even in Denmark, the most VC-active country in Europe. The paper links this to a structural difference in the supply of long-term capital between the US and Europe, with US retirement assets mostly in defined-contribution (DC) schemes carrying heavy equity exposure, whereas European pension systems remain mostly pay-as-you-go.
In the UK, the state pension is pay-as-you-go but workplace pensions have shifted towards DC schemes. There is progress on turning that pot towards venture capital. The Mansion House Accord commits 17 of the UK’s largest DC providers to allocate 10% of default funds to private markets by 2030, half of it in the UK, while the Pension Schemes Act 2026 gives the Government a reserve power to require providers to hit the target if voluntary progress stalls.
The private sector has already made the shift from defined benefit to DC. Given the ballooning state pension bill is at around 5% of GDP and forecast to climb towards 8% of GDP by the early 2070s, perhaps it’s time to ask the same question of our state pension. Our state pension is simply moving cash from today’s workers to today’s pensioners without investing a penny of that money into British growth. Germany has kickstarted its pension reform in this direction, as the government-appointed pension commission has recommended a compulsory contribution starting at 0.5% of pre-tax income and rising to 2% by 2031, split evenly between employer and employee and paid into a centrally managed public fund modelled on Sweden’s.
Europe is not broke — we remain among the wealthiest continents — but we must put that wealth to work. Closing the gap needs businesses willing to take risks and more capital willing to back them. It is essential for the UK and Europe to plug our gap in late-stage funding if we want to keep our best scale-ups.
🏛️ Eamonn Ives, Associate Director, Public First
Whether it’s Alex Depledge advising the Chancellor of the Exchequer, Matt Clifford holding the pen for Britain’s AI Opportunities Action Plan or Emma Jones taking the reins as the Small Business Commissioner, entrepreneurs going into the heart of government seems to be in vogue. Most readers will probably regard this trend as an unalloyed positive. In addition to bringing valuable domain-specific expertise, founders tend to have an uncanny knack for challenging established ways of working and breaking through the institutional inertia that besets modern governments.
A new working paper from Aaron Chatterji, Jorge Guzman, Joyce Ma and Ryan C. McDevitt puts some numbers behind the theory. Studying a dataset of American state legislators, they conclude that those who own and actively manage a firm not only propose a larger proportion of bills as first or sole primary sponsor but also “selectively advance pro-entry legislation, especially bills related to deregulation and innovation.”
Entrepreneurs, it seems, really do bring a particular perspective on economic growth into politics: one focused less on protecting the interests of incumbent companies, and more concerned with making it easier for new businesses to emerge. Perhaps due to having experienced the frustrations of starting up and running a firm first-hand, they seem especially attuned to how rules, regulations and institutional sclerosis can stand in the way of new entrants.
American state politics is not Westminster, so we should be wary of assuming the paper’s findings travel intact. But they ought to make us think more seriously about entrepreneurial experience as a form of talent that government should actively seek out. Political parties could do more to encourage founders to stand for office; governments could make it easier for them to spend periods inside agencies and departments through appointments, fellowships or advisory roles; and policymakers could be more deliberate about bringing entrepreneurs into the room before rules are written, rather than consulting them as an afterthought.
📍 Sophya Mashkoor, Researcher
The internet was supposed to kill the postcode, so why hasn’t AI finished the job?
With access to a computer, an AI coding agent, a Stripe account and a Zoom link, every founder can easily build their business from anywhere in the world. A great engineer in Lagos could build the same thing as one in San Francisco, and perhaps at a cheaper cost. However, in practice the map has gotten lumpier.
Findings from earlier in the year show that around two-thirds of US venture dollars land in the Bay Area, which takes roughly 60% of global AI funding. New York, Los Angeles and Boston take most of the rest, and everywhere else is left to split the crumbs.
So why are the tools that were meant to make location irrelevant the same ones pulling capital back into one postcode (or zip code, if you will)?
The old case for hubs was to cluster where the engineers are so talent is concentrated in one area. Now, with AI, a two-person team anywhere can ship what used to take a department, so the need for density weakens. But when building takes just an afternoon, engineers stop being the scarce resource, and it instead becomes the judgement of people who can tell whether an idea is worthwhile or not. Those people — repeat founders, ex-lab researchers, investors on their third AI cycle — are still mostly having coffee in the same few square miles.
So the idea that AI democratises entrepreneurship and that capital keeps re-concentrating in a handful of cities can coexist. AI has shifted gatekeeping away from capital and infrastructure but ideas are still better communicated in person.
It is therefore worth asking: is this temporary, or does judgement being scarce mean hubs never really dissolve?