EUROPEAN COMMISSION Brussels, 5.5.2021 SWD(2021) 352 final COMMISSION STAFF WORKING DOCUMENT Strategic dependencies and capacities Accompanying the Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions Updating the 2020 New Industrial Strategy: Building a stronger Single Market for Europe's recovery {COM(2021) 350 final} - {SWD(2021) 351 final} - {SWD(2021) 353 final}



COMMISSION STAFF WORKING DOCUMENT Strategic dependencies and capacities Accompanying the Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions Updating the 2020 New Industrial Strategy: Building a stronger Single Market for Europe's recovery Executive Summary The COVID-19 pandemic has tested the resilience of economies worldwide. Despite severe disruptions in production, transport and people’s mobility, most value and supply chains have shown remarkable resilience. Still, the crisis has also highlighted that while the EU gains resilience from world markets being open and integrated in global value chains, disruptions in these global value chains can affect specific essential products and inputs that are particularly critical for society and the EU economy. One of the key lessons of the crisis is that there is a need to get a better grip and understanding of where Europe’s current and possible future strategic dependencies lie. This can provide the basis for the development of facts-based and proportionate policy measures informed by anticipation to address such strategic dependencies while safeguarding the open and trade-based EU economy. In this context, the European Council invited the Commission to “identify strategic dependencies, particularly in the most sensitive industrial ecosystems such as for health, and to propose measures to reduce these dependencies, including by diversifying production and supply chains, ensuring strategic stockpiling, as well as fostering production and investment in Europe”. Strategic dependencies affect the EU’s core interests. They notably relate to areas as regards security and safety, the health of Europeans as well as the ability to access goods, services and technologies that are key for the green and digital transitions at the core of the EU’s priorities. Such strategic dependencies are more likely to be found in the most sensitive ecosystems, which are the focus of this staff working document. This staff working document provides a further step towards a more structural, systematic and cross-sector monitoring of the EU’s possible strategic dependencies and an additional basis to consider when taking measures to address them. Bottom-up mapping of strategic dependencies in the area of products (chapter 2) A bottom-up (quantitative) mapping using external trade flows for more than 5,000 products as its starting point identifies 137 products in the most sensitive ecosystems where the EU can be considered highly dependent on imports from third countries (representing about 6% of the extra-EU import value of goods). The three main foreign sources of EU import value for these dependent products are China (representing about half of import value), Vietnam and Brazil. The identified dependent products are situated mainly in the energy intensive industries ecosystem (with 99 dependent products identified, including raw/processed materials and chemicals), as well as in the health ecosystem (including active pharmaceutical ingredients and other health-related products) and other inputs and products that are relevant to support the green and digital transformation. Out of the 137 products identified as dependencies in the most sensitive ecosystems, 34 (representing 0.6% of extra-EU import value of goods) could be considered as potentially more vulnerable given their possibly low potential for further diversification as well as substitution with EU production. At the same time, the EU can also be a source of dependency vis-à-vis important trading partners. The analysis provides examples of products where the US is highly dependent on the EU (“reverse dependencies”) and vice-versa. Furthermore, “common dependencies” that the EU and the US share vis-à-vis China and the world can also be identified. Reliance on international trade is not a vulnerability but rather helps to sustain diversified supply and demand. Still, some of the identified dependencies could be considered of potential strategic importance. Discussing the results of this bottom-up mapping with Member States and industry (e.g. in the context of the Industrial Forum) will allow assessing the exact nature of identified dependencies in more detail, including the risks they entail to the resilience and functioning of the EU’s industrial ecosystems as well as possible prospects for reducing these dependencies in the future including through the development of alternatives. Also internal dependencies may exist within the Single Market whereby the EU relies on a limited number of sources within the Single Market, linked to a concentration of supply or activities at the level of individual firms. This underlines the importance of a well-functioning Single Market – especially during times of crisis – that also remains open to the global economy. Strategic dependencies in the area of key technologies (chapter 3) The Industry Strategy of March 2020 highlighted that the EU should build competitiveness for technologies that are strategically important for Europe’s industrial future. Complementary to the analysis of trade flows done in chapter 2, an assessment of the EU’s performance as regards the generation and uptake of certain key technologies shows both strengths and weaknesses. The EU faces particular challenges in comparison with its global competitors for technologies in the digital ecosystem such as cloud and micro-electronics. This provides important indications of risks concerning future dependencies with regard to these technologies, while not precluding possible technological dependencies in other ecosystems. If left unaddressed, dependencies in the area of these technologies could further materialise and possibly new ones might emerge. Finally, when it comes to the renewables ecosystem, the EU has a strong competitive position in several technologies that are of key importance to achieve Europe’s climate ambitions (e.g. in the area of hydrogen). Still, there are indications of risks concerning possible (future) dependencies in this area as well and continued efforts are needed to facilitate scaling up and deployment of these technologies. Possible policy measures to address strategic dependencies (chapter 4) For several of the dependencies identified in the bottom-up analysis of this staff working document, work has already been initiated since the March 2020 Industry Strategy to address these dependencies or assess them in more detail together with relevant stakeholders. Such actions notably include the Action Plan on Critical Raw Materials and the European Raw Materials Alliance, the structured dialogue taking place in the context of the Pharmaceuticals Strategy, strengthened foresight in the context of the Chemicals Strategy as well as other specific actions with regard to essential products or inputs necessary for the green and digital transition (e.g. batteries, semi-conductors). Any possible additional measures to address strategic dependencies need to be tailored to the specific nature of the dependency and ecosystem concerned. They would need to build on in-depth discussion and dialogue with Member States and industry, be proportionate and consider all available options and tools. Policy measures can, on the one hand, reinforce the EU’s position in global value chains by strengthening and diversifying external trade. Actions under the EU’s Trade Policy Review will promote a level playing field and enable international trade and investments to ensure more diversified sources of supply and demand to cushion future shocks and enhance competitiveness. On the other hand, the EU can strengthen its own capacity in strategic areas where necessary with targeted tools and investments in key strategic areas, building on the strengths of a fully functioning Single Market and competition policy facilitating open and dynamic markets that promote innovation. When it comes to possible internal dependencies on a limited number of firms within the Single Market, the COVID-19 pandemic has shown that the Single Market and its unhindered Treaty freedoms should be at the core the Union’s readiness for potential crises. Competition policy, as an enabler of strong business dynamics within the Single Market, as well as the EU’s integration into diversified global value chains and undistorted access to export markets are also important in mitigating possible risks related to such internal dependencies. As regard possible strategic dependencies identified in the area of key technologies, the Recovery and Resilience Facility provides an important step-up in investments in digital technologies, together with other programmes such as Digital Europe. Relevant actions to identify and address strategic dependencies are being taken also in the context of the Communication on the Digital Decade and the Action Plan on synergies between civil, defence and space industries (through an observatory on critical technologies and technology roadmaps). Tools such as Important Projects of Common European Interest where proved well targeted, justified and efficient as well as industrial alliances can continue to play an important role in specific sectors. Targeted research and innovation efforts (such as through Horizon Europe and the European Defence Fund) are also key in addressing the EU’s R&I gap in comparison with its global competitors and thereby reducing strategic dependencies. Existing capacities (including those under the EU space programmes) contribute strongly to the EU’s open strategic autonomy and act as a positive lever for multilateral cooperation.

In-depth reviews of strategic dependencies (chapter 5) The in-depth reviews presented in this staff working document provide a selected number of analyses across a number of key areas that can be considered strategic, notably raw materials, batteries, active pharmaceutical ingredients, hydrogen, semiconductors and cloud and edge technologies. These assessments provide further insights on the origin of strategic dependencies and their impact as well as relevant (ongoing) policy measures. They provide a first set of analyses for a limited number of specific areas. As a follow-up to this staff working document, further such detailed reviews of possible dependencies can be carried out covering other strategically important areas, including products, services or technologies key to the twin transition, such as renewables or energy storage.



Contents 1. Context and approach 1.1 Terminology and the concepts of “dependencies” and “strategic” 1.2 Approach of the staff working document 2. Mapping of EU dependencies in the most sensitive ecosystems 2.1 Context 2.2 Methodology to identify foreign dependencies 2.2.1 Core Dependency Indicators 2.2.2 Identifying foreign dependencies 2.3 Results 2.4 Assessing the further vulnerability of dependent products: potential for diversification and substitution 2.5 Single Market dependencies linked to concentration of economy activity 3. EU performance in key technologies and research & innovation 3.1 Key technologies for (future) competitiveness 3.2 Europe’s research and innovation performance 3.3 Conclusions 4 Policy measures with a potential to address strategic dependencies

4.1 Relevant measures to address external and internal strategic trade dependencies 4.2 Relevant measures in the area of key technologies 5 Reviews of a selected number of strategic areas 5.1 Raw materials 5.2 Active pharmaceutical ingredients 5.3 Li-ion batteries 5.4 Hydrogen 5.5 Semiconductors 5.6 Cloud and Edge Computing 6 Conclusions 1.Context and approach The EU economy is both a major importer and exporter on the international stage. Ensuring an open and fair trading system is of key importance for the prosperity and future growth of EU industry and to the benefit of European consumers and citizens. The EU plays a central role in developing a more resilient and open global economy with undistorted trade, investments and mutually beneficial bilateral relations. The COVID-19 crisis demonstrates how the Single Market’s integration into global value chains not only maximises economic efficiency but is also essential in times of crisis to absorb shocks, offer options to adjust and speed up recovery. At the same time, the Industrial Strategy of March 2020 already underlined the importance for the EU of “reducing dependence on others for things we need the most: critical materials and technologies, food, infrastructure, security and other strategic areas”. The COVID-19 crisis further emphasised the relevance of this issue in turbulent and challenging times, as it exposed further some strategic dependencies and specific disruptions caught Europe by surprise. One of the key lessons of the crisis is that there is a need to get a better grip and understanding of where Europe’s current and possible future strategic dependencies lie. The European Council, highlighting that “Achieving strategic autonomy while preserving an open economy is a key objective of the Union”, invited the Commission to “identify strategic dependencies, particularly in the most sensitive industrial ecosystems such as for health, and to propose measures to reduce these dependencies, including by diversifying production and supply chains, ensuring strategic stockpiling, as well as fostering production and investment in Europe”. The Commission’s 2020 Strategic Foresight Report provided a broad assessment of the EU’s and Member States’ resilience. It also introduced resilience dashboards as a possible tool allowing to monitor for the social and economic, geopolitical, green, and digital dimensions of resilience. The Commission’s Communication on the Trade Policy Review makes the case for an open, sustainable and assertive trade policy that contributes to more resilient and sustainable value chains by providing a stable rules-based trading framework, opening up new markets to diversify sources of supply, and developing cooperative frameworks for fair and equitable access to critical supplies. Identifying and addressing the EU’s strategic dependencies is an essential step to increasing resilience. In addition, it is equally important to ensure competitiveness and stimulate investments in technologies that are of key importance for the EU’s future. The Communication on the Digital Decade presents a vision, targets and avenues for a successful digital transformation of Europe by 2030. Finally, this staff working document should also be seen in relation with the upcoming 2021 Strategic Foresight Report on Europe’s open strategic autonomy.

The assessment of strategic dependencies involves not only the identification of dependencies, but also an assessment of whether they are of a strategic nature that leads to a vulnerability for the EU, taking into account the risks such dependencies may represent to the EU’s core strategic interests. This assessment can contribute to the development of facts-based and proportionate measures while at the same time safeguarding the open and trade-based EU economy. The staff working document takes both a bottom-up and a top-down perspective. A bottom-up (quantitative) analysis taking trade statistics in products as its starting point, while characterised by data limitations and caveats, can provide first and indicative insights into areas where the EU’s dependence on a limited number of suppliers is most prominent in particular for a number of more sensitive ecosystems. A top-down assessment needs to complement this bottom-up approach, taking into account (at a more detailed level) other risks and possible dependencies of strategic nature (e.g. related to services, infrastructures, technologies, skills, etc.) that cannot be captured by relying on quantitative trade statistics and data. A first qualitative assessment for selected areas is presented. The analysis presented provides a contribution and a first step to a more systematic monitoring of strategic dependencies in the EU’s most sensitive ecosystems. It complements actions that have already been initiated on the analysis and identification of the EU’s strategic dependencies in specific policy fields. It is also worthwhile highlighting that other countries (including notably the US) are in the process of carrying out similar types of analyses to identify possible risks and vulnerabilities in global supply chains as well as ways to address them. 1.1Terminology and the concepts of “dependencies” and “strategic” Key concepts used for the purposes of this staff working document are set out in box 1. Box 1 – Terminology and definitions The following concepts and definitions are used for the purposes of this staff working document: -Resilience: the ability not only to withstand and cope with challenges but also to undergo transitions in a sustainable, fair, and democratic manner. Resilience is necessary in all policy areas, also to undergo the green and digital transitions, while maintaining the EU’s core purpose and integrity in a dynamic and at times turbulent environment; -Open strategic autonomy: the ability to shape the new system of global economic governance and develop mutually beneficial bilateral relations, while protecting the EU from unfair and abusive practices, including to diversify and solidify global supply chains to enhance resilience to future crises; -Strategic capacity: a certain level of capabilities held within the EU allowing to produce, provide or rely on strategic goods, services, data, infrastructures, skills, industrial know-how and technologies; -Dependencies: reliance on a limited number of actors for the supply of goods, services, data, infrastructures, skills and technologies combined with a limited capacity for internal production to substitute imports; -Strategic dependencies: dependencies that are considered of critical importance to the EU and its Member States’ strategic interests such as security, safety, health and the green and digital transformation. External and internal dependencies Both external and internal dependencies co-exist. External dependencies concern the EU’s reliance on external partners (third countries or firms). Internal dependencies are dependencies within the EU Single Market, notably related to the possible concentration of activity at firm level. The risks related to external dependencies are different from the risks related to internal dependencies. This is the case, for example, in relation to political tensions and geo-political uncertainty, which can be important risks for the EU at an international level. At the same time, dependence on a very limited set of companies for supplies in a specific sector can result in vulnerabilities even if these companies are based in the EU. Such internal dependencies linked to a concentration of supplies can have a potentially important impact on the functioning of EU value chains within the Single Market (e.g. in the case of natural disasters or closing down of production). There are different types of shocks that play a role when assessing the impact of dependencies. Such shocks can be supply-related (e.g. a given supplier within a value chain no longer producing or delivering certain goods and services, or in reduced quantities; or the country where the supplier is based imposing certain export restrictions) as well as demand-related (e.g. a sudden important drop in EU or global demand for goods and services, or a sudden global rise in market demand for certain goods or services) and they can have multiple origins (man-made, natural, etc.). Scarcity of resources (e.g. related to critical raw materials) is also an important element to be taken into account when considering the impact of dependencies and shocks. Companies, through their own corporate decisions and corporate policies, play a key role in mitigating and adapting to possible shocks, as they have the ability to diversify supply and demand sources to become more resilient. At the same time, they cannot always accommodate all types and magnitudes of unanticipated demand or supply shocks. Box 2 – Demand and supply shocks during COVID-19 The EU experienced the impact of different types of shocks to global value chains during the COVID-19 crisis. These shocks were both demand and supply related. On the one hand, the pandemic has caused significant effects on the demand side. The most important impact from the crisis across many ecosystems has been the sudden and very significant reduction of demand within the EU and on export markets. At the same time, other ecosystems saw large peaks in demand. Most notably, the crisis led to a global surge in the demand for medical supplies and devices. This led to shortages in this sector, including for example with regard to personal protective equipment and ventilators. Another example of a positive demand shock has been the global surge in demand for semi-conductors that resulted in shortages during the first months of 2021, entailing risks of a slowed down recovery in sectors that are dependent on the supply of these semi-conductors (e.g. the automotive industry). The crisis has also seen important supply related shocks, notably in the health sector. For example, for some key medical supplies, several foreign countries introduced measures restricting or banning exports. This worsened the situation of acute under-capacity due to an exploding global demand in these products in addition to the aggravating factor of reduced production capacity due to the fact that many businesses active across global value chains were forced to reduce or halt production due to the spread of the virus and health precautions such as lockdowns, quarantines and social distancing. Restrictions concerning the movement of people and their impact on international transport networks represented another important supply shock. Disruptions were also experienced within the EU Single Market. Several Member States introduced exports bans in particular during the early stages of the pandemic. In addition, border restrictions, quarantine requirements and other measures limiting free movement of persons, goods, services also hampered the functioning of supply chains within Single Market. Strategic nature of dependencies Determining the specific areas and dependencies that are “strategic” for the EU requires a careful assessment of the current and future interests at stake and potential risks, building on a collective understanding of what matters most and what is critical for Europe. Dependencies that are strategic can be identified by taking into account the extent to which they affect these core interests. This can only be done on a case-by-case basis, taking into account not only quantitative data but also qualitative, ecosystem-specific elements and expert knowledge. Firstly, dependencies are likely strategic when they impact the security and safety of Europeans or limit the possibility for the EU to exercise a foreign and security policy in line with its values and strategic interests. The EU framework for screening of foreign direct investment provides a reference in this regard, outlining specific infrastructure, technologies and inputs that are considered to be critical. Dependencies with an impact on security and safety are of particular relevance for the aerospace and defence ecosystem and may also exist in various other ecosystems (such as for example digital and electronics). Examples of actions which already address strategic dependencies in this area include the Space Strategy for Europe aimed at reinforcing Europe's autonomy in accessing space in a safe and secure environment, the European Defence Action Plan towards a strong, competitive and innovative defence industrial base, the European Defence Fund as well as strengthening the competitiveness of EU security industry through investment in civil security research and innovation in the Horizon Europe Programme and most recently the Action Plan on synergies between civil, defence and space industries. Secondly, the impact on the health of EU citizens is another important driver to define dependencies as strategic. For example, the COVID-19 crisis exposed a number of strategic dependencies in the area of health (e.g. access to medical supplies such as personnel protective equipment). The European Council has also asked the Commission to “identify strategic dependencies, particularly in the most sensitive industrial ecosystems such as for health”. The Commission has already initiated work in the context of the Pharmaceuticals Strategy for Europe with concrete actions to ensure accessibility, availability and affordability of medicines, including an assessment of security of supply chains. Thirdly, in certain cases dependencies can also be considered strategic when they significantly impact the EU’s access to inputs, technologies and services that are key for the green and digital transitions at the core of the EU’s priorities. The Commission has recently reconfirmed the importance of these green and digital ambitions in the context of the Recovery and Resilience Facility, requiring that each national recovery and resilience plan includes a minimum of 37% of expenditure related to climate and 20% related to digital. Dependencies that have a significant negative impact on the ability of the EU to remain at the edge of innovation and transformation towards an increasingly green and digital economy and society will ultimately be detrimental to the functioning of the EU economy and the welfare of its citizens. The Commission has already recognised the strategic nature of third country dependencies in relation to its green and digital ambitions in several recent initiatives. Such dependencies are mainly related to critical inputs needed to support the digital and green transition as well as the ability of the EU to access key enabling technologies. Within these areas, the individual nature of the dependency and the degree of risks involved need to be assessed. It is important to underline that a certain reliance on international trade and commercial relations and partnerships with companies in third countries do not necessarily give rise to an external dependency that would result in a vulnerability for the EU economy. To the contrary, such relations and partnerships help to strengthen the EU’s resilience to supply and demand shocks, in addition to the substantial efficiency gains that help to sustain the competitiveness of the EU economy over time. Only those dependencies that significantly affect the EU’s core interests and limit the EU’s freedom to analyse, make decisions and act according to its own priorities can be considered strategic. Box 3 – FDI screening Regulation, critical raw materials list and Action Plan on synergies between civil, defence and space industries The strategic nature of certain areas and dependencies has already been established in the EU framework for screening of foreign direct investment, the EU’s critical raw materials list as well as the recent Action Plan on synergies between civil, defence and space industries. Regulation (EU) 2019/452 establishing a framework for the screening of foreign direct investments into the Union created a cooperation mechanism for Member States and the Commission to screen foreign investment. The mechanism (operational as of 11 October 2020) establishes cooperation and the exchange of information between EU Member States and the Commission and provides the possibility to raise concerns related to specific foreign investments, where warranted. The Commission may issue opinions when an investment poses a threat to the security or public order of more than one Member State or when an investment could pose a risk to a project or programme of Union interest. The screening framework also establishes core requirements for Member States who maintain or adopt a national screening mechanism. In Article 4, the Regulation outlines certain factors that may be taken into consideration by Member States or the Commission in determining whether a foreign direct investment is likely to affect security or public order. These include potential effects on critical infrastructure, critical technologies and dual use items and supply of critical inputs. Several of the criticalities defined in this Regulation are of particular relevance for the analysis in this staff working document including critical technologies (e.g. artificial intelligence, robotics, semiconductors, cybersecurity, aerospace, defence, energy storage, quantum and nuclear technologies as well as nanotechnologies and biotechnologies) as well as critical inputs (e.g. raw materials). The EU’s critical raw materials list provides an overview of the raw materials that are considered to be most important economically and having a high supply risk. The list is reviewed every three years by the Commission, based on a comprehensive screening and assessment methodology. The Commission takes it into consideration when developing and implementing policies relating to raw materials, including when negotiating trade agreements and seeking to eliminate trade distortions. It also helps to identify investment needs and guide research and innovation. The Commission’s Action plan on synergies between civil, defence and space industries identifies a list of examples of critical technologies relevant across the civil (including security), defence and space industry domains. Using this list as a basis, a new EU Observatory of Critical Technologies will start, in 2021, regular monitoring and analysis of critical technologies, their potential applications, value chains, needed research and testing infrastructure, desired level of EU control over them, and existing gaps and dependencies. Every second year, the Observatory, in consultation with key stakeholders, will produce a classified report on critical technologies, dependencies, value chains and testing infrastructure for the defence, space and related civil industries. On the basis of these reports, the Commission will develop technology roadmaps to boost innovation on these critical technologies. These technology roadmaps may lead to the launch of new flagship projects taking into account their likely impact on the technological sovereignty and leadership of the EU, their sources of financing and their governance. In general, the existence or risks of strategic dependencies are more probable in a few “sensitive ecosystems”. Ecosystems such as tourism, textiles and proximity and social economy might be unlikely to hold important risks for strategic dependencies as a whole. On the other hand, dependencies within the aerospace and defence as well as the health ecosystem are more likely to be of a strategic nature. In addition, certain dependencies within ecosystems such as digital, electronics, renewable energy and energy intensive industries can also be strategic when they impact health or security interests or significantly affect the EU’s ability to achieve the green and digital transformation. Furthermore, some ecosystems are also more closely related to critical areas already listed in the FDI screening Regulation (e.g. aerospace and defence ecosystem), the EU’s critical raw materials list (e.g. energy intensive industries ecosystems) as well as the critical technologies outlined in the Action Plan on synergies between civil, defence and space industries (e.g. digital and electronics ecosystem). Therefore, the bottom-up mapping of dependencies developed in chapter 2 will focus on a number of these more sensitive ecosystems (see Graph 1 ) when considering the question of identifying possible strategic dependencies. This also follows the Council conclusions of 16 November 2020, which specifically highlighted health, defence, space, digital, energy and critical raw materials as examples of sensitive industrial ecosystems and areas. Nevertheless, this does not exclude the existence of possible risks or dependencies in other ecosystems not covered by the analysis in this staff working document. Graph 1: More sensitive ecosystems for the purposes of this staff working document Source: European Commission Note: Circles represent a selection of more sensitive ecosystems for the purpose of this staff working document

1.2Approach of the staff working document The staff working document combines a number of elements to address the objective of identifying and addressing strategic dependencies. Firstly, Chapter 2 develops a bottom-up (quantitative) analysis of trade dependencies in goods, taking as its starting point a detailed assessment of the EU’s trade flows, following a step-by-step approach: -In a first step, the analysis identifies goods where the EU is dependent on a limited number of sources, based on the concentration of suppliers, the relative importance of extra EU imports as well as their possible substitution with internal EU production; -In a second step, the dependencies identified in step 1 are narrowed down to more sensitive ecosystems with a higher risk of dependencies being of a possible strategic nature (as outlined in chapter 1.1); -In a third step, consisting of a qualitative assessment, specific dependencies are identified that might be strategic for the EU (in line with the different elements set out in chapter 1.1 concerning the concept of “strategic”) or that require further in-depth analysis to assess their impact and strategic nature. For each of the identified product dependencies spotted in the more sensitive ecosystems the analysis also gives an indication of the potential to further diversify the EU’s import sources for these products as well as the potential for substitution with EU production (see chapter 2.4). This bottom-up analysis faces a number of data limitations and caveats as to the conclusions that can be drawn. The first relates to the level of aggregation. While the analysis covers more than 5,000 traded products or product groups, in some cases the level of detail is not sufficient to capture dependencies on specific or specialised products or inputs. Second, sufficiently detailed trade statistics are not available for services and trade statistics cannot (clearly) identify dependencies in the area of complex technologies including those that are of a more emerging nature. Third, the analysis only looks at trade dependencies at one point in time and cannot capture changing or emerging trends. In addition, the assessment whether dependencies are strategic (step 3) is a qualitative exercise and this staff working document can only provide a first indication, which needs to be complemented through further dialogue with industry on the exact nature and impact of identified dependencies. As a consequence, the bottom-up mapping cannot be considered to be an exhaustive screening of all possible product dependencies. In addition, it needs to be complemented by discussions with industry and Member States on the strategic nature of the identified dependencies taking into account the specific ecosystems concerned. Despite these limitations, the analysis offers a methodical screening giving preliminary insights into individual products and inputs where the EU has a higher level of dependence on third countries including some with a possible strategic character. This analysis is dynamic by nature and requires regular updating and refinement, given the changing nature of dependencies. Further details on the approach and methodology of the bottom-up mapping are set out in chapter 2. Secondly, the Industry Strategy of March 2020 highlighted the importance of developing key enabling technologies that are strategically important for Europe’s industrial future. In addition, the recent Communication on the Digital Decade underlined that digital technologies are currently mostly developed outside of Europe and highlighted the importance of reinforcing internal strengths and capacities for the EU to achieve digital leadership. The EU’s performance in comparison with its global competitors in the area of these key technologies cannot be clearly captured by an analysis of trade statistics as performed in chapter 2. In this context, chapter 3 aims to complement the assessment done in chapter 2 by considering the EU’s position in comparison with its global competitors in the area of key technologies that will drive future competitiveness. It does this on the basis of a range of indicators (considering e.g. research, investments, innovation and business dynamics), looking into the EU’s relative performance in comparison with its global competitors. These provide important indications, albeit not complete, as to possible risks of potential (future) dependencies in the area of such technologies. For example, comparatively low levels of innovation and investments may result in Europe becoming more dependent on other countries for access to state-of-the-art technologies. Chapter 3 relies on information obtained from different sources, including the Advanced Technologies for Industry project as well as other data and analyses on the EU’s performance in research and innovation. Thirdly, chapter 4 provides indications of relevant possible measures that might be able to mitigate strategic dependencies and related risks. Such measures would need to build on in-depth discussion and dialogue with and between Member States and industry. They should build on the opportunities of international trade to diversify and strengthen sources of supply as well as, where needed, the strengths of the Single Market to build up adequate EU capacity. Measures would need to be carefully examined with a view to maintain the competitiveness of the EU, choosing to address dependencies and increase resilience in the most cost-efficient manner. Finally, for those specifically identified dependencies of strategic importance, possible policy intervention would need to build on a thorough understanding and detailed analysis of the functioning of relevant value chains as well as the underlying drivers of Europe’s current and possible future strategic dependencies. Chapter 5 presents a selected number of in-depth reviews of possible dependencies identified in chapters 2 and 3 that can be considered strategic across a number of key areas (including health, digital, green). These reviews provide an overview of the origin of strategic dependencies, their impact on the EU economy as well as possible relevant (ongoing) measures. They provide a first stage of assessments in strategic areas and should not be considered to be an exhaustive analysis of all the EU’s strategic dependencies. Further key areas, including products, services or technologies key to the twin transition such as renewables or energy storage, might be considered in the future.

2.Mapping of EU dependencies in the most sensitive ecosystems The COVID-19 crisis showed the importance of obtaining a more comprehensive understanding of the EU’s strategic dependencies as a first step to strengthening resilience. This chapter provides a bottom-up mapping of the EU’s ecosystems and their reliance on international trade. It covers trade flows for some 5,000 products classifying goods as dependent based on various meaningful and objective economic criteria. While this assessment faces a number of data limitations and caveats, it provides a first indication of goods (final products and inputs) where the EU might have a higher level of dependence on a limited number of suppliers, including those with a possible strategic character in more sensitive ecosystems. 2.1Context Over the last decades, production processes and supply chains have become increasingly interlinked across countries and continents. The drivers explaining the continuous integration of Global Value Chains (GVCs) include, among others, cost reduction, greater market openness (lower tariff and non-tariff barriers), changes in the political environment, as well as multiple technological innovations. GVCs enable firms to improve their market position through delocalisation strategies and generate benefits from a more efficient production process (including in some cases lower prices for final consumers) and help firms to reduce risks. In addition, when firms become geographically closer to their final customers, they may also gain from a better consumer knowledge. While global value chains are highly efficient from a cost, growth, and a diversification perspective, they could also entail vulnerabilities to external demand and supply shocks. Reliance of EU firms on international trade is a strength for the resilience of the EU economy and it is fundamental to safeguard the wealth and competitiveness of the EU through efficiency and productivity gains, as well as to sustain demand for EU output. In that regard, private firms have the ability, the incentive and the information to diversify supply and demand sources sufficiently to absorb normal discontinuities in trade flows. However, not all of them might be able to accommodate unanticipated demand and/or supply shocks exceeding by far what normal business operations would dictate. In such instances, the collective cost of a potential demand and supply shock to the general EU public may exceed the lost profits to the market operator importing specific goods or services. Given the result, akin to a market failure, policy action addressing strategic dependencies may be justified. While the majority of value chains have shown resilience during the pandemic, the crisis has shown that disruptions in GVCs might affect specific products, some of which are particularly critical for society. For instance, the greatest disruptions have been felt in medical (e.g. personal protective equipment) and medical-pharmaceutical supplies. These products have been under severe strain due to the enormous surge in demand compared to supply. Export restrictions imposed by some countries on these specific products or their components have worsened the situation. At the same time, other measures adopted by governments cut import duties, facilitated customs-clearance and streamlined approval requirements for medical supplies.

While observing significant differences across sectors, overall, the EU is an important supplier and customer for extra EU countries. Using GVC data, national and international links between sectors along value chains can be tracked, by looking for each sector at both upstream links (which shape supply chains) and downstream links (which contribute to final demand). Graph 2 shows the exposure of EU industry to extra EU markets both in terms of demand and supply, which are then used in the production process of each sector. It shows that the sectors with the highest upstream and downstream foreign links are Computer & electronics, Chemicals and Pharmaceuticals, Basic Metals and Electrical equipment. Sectors above the 45 degree line rely more on extra EU demand than on the supply from extra EU countries. With few exceptions, extra EU demand is relatively more important for the EU aggregate than extra EU supply. However, foreign supply from certain sectors still plays a significant role for EU production. Graph 3 ranks sectors according to the extent to which EU production depends on foreign supply. The EU relies on extra EU countries particularly in raw materials and electronics, but also textiles, financial activities, as well as chemicals and active pharmaceutical ingredients. Consequently, this highlights the need for the EU to continue being integrated in the global economy. EU trade diversification is high and stable over time. At a macro level, extra-EU trade is diversified. Both extra-EU exports and extra-EU imports concentration have not varied much in the last decade (see Graph 4 ). Compared to other countries, while extra-EU import concentration has remained broadly constant over the last two decades, concentration decreased significantly in China and increased in the US. For example, US imports at an aggregate level are currently around twice as concentrated as EU imports. Macro and sectoral trade give an overview of dependencies, but a more granular detail is required to identify specific products where the EU has strong external dependencies. Ideally, the identification of dependent products would use product information at a 8-10 digit level on the Harmonised Standardisation (HS) system or firm level data. However, comparable data sources across all countries in the world are not available. This would jeopardise the calculation of the dependency indicators proposed in this chapter and their comparison across countries. Thus, a 6-digit level of disaggregation is used, which already provides informative results of the level of dependency across products. The following section outlines a methodology to identify existing dependencies of the EU, including dependencies of a possible strategic nature in more sensitive ecosystems. This exercise has certain limits dictated by the information sources available as already outlined in Chapter 1.2. Graph 2: Downstream and upstream exposure to extra EU markets Source: Commission elaborations based on OECD 2016-AMNE data. Note: on the horizontal axis, the indicator measures for each EU sector the share of value added that depends on intermediate inputs generated by extra EU supply chains; on the vertical axis the indicator measures for each EU sector the share of final demand absorbed by exports to extra EU countries. These figures are based on the most recent available data (2016). As the share of value added has stayed rather stable over time, more recent figures are not expected to substantially depart from this illustration. Graph 3: Foreign (extra EU) dependency for EU production Source: Commission elaborations based on OECD-AMNE 2016 data. This graph shows the share of value added embedded in the production process that comes from non-EU countries for 20 sectors in decreasing order. Note that this level of aggregation is not suited to identify dependencies in some sectors/ecosystems such as defence and aerospace. Graph 4: Foreign (extra EU) trade is very diversified and has remained stable over time Source: Felbermayr presentation to Informal Meeting of Trade Ministers Berlin, Sept. 21, 2020 “Fostering the Resilience of EU Trade Links”. Data source: BACI (CEPII). The Herfindahl index takes a value of 100 if trade is fully concentrated on 1 foreign country, 2.2Methodology to identify foreign dependencies The bottom-up mapping of foreign dependencies relies on an agnostic, data-driven perspective with the objective of identifying products with extra EU dependency. The bottom-up mapping follows a step-by step approach. In a first step, the analysis identifies traded products where the EU is more dependent on third countries based on three economic indicators. Then, the identified dependencies are narrowed down to the most sensitive ecosystems. On this basis, a further qualitative assessment consists in spotting dependencies in the most sensitive ecosystems, with a possible strategic nature (in line with definition of “strategic” outlined in Chapter 1.1). Graph 5: Approach bottom-up analysis Source: European Commission 2.2.1Core Dependency Indicators The bottom-up approach classifies products as highly foreign dependent if the levels of import diversification and potential substitutability with EU supply are low. This mapping of dependencies builds on the approach used by Bonneau and Nakaa (2020), but it extends their analysis by considering potential substitutability with EU production. Data covering the universe of country trade in goods is used, including more than 5,000 products defined at the six-digit level using the international nomenclature of the Harmonized System (HS6), across all industrial ecosystems. Given that the level of dependency cannot be characterised by a single metric, the bottom-up approach combines three complementary economic indicators that are referred to as the core dependency indicators (CDIs) as presented in Graph 6 . Source: European Commission 1.Concentration of EU imports from extra EU sources: The first indicator aims at quantifying the concentration of EU imports with respect to the rest of the world, in order to capture the risk of disruptions faced by the EU due to low diversification of extra EU sources. In particular, this indicator identifies products for which EU imports (in values) are highly concentrated in a few extra EU countries. To this end, the Herfindahl-Hirschman Index (HHI) index is used, computed as detailed below:

where is the market share of the extra EU supplying country i in EU’s imports, and n is the total number of extra EU supplying countries. 2.Importance of extra EU imports in total demand: The second indicator measures the importance of extra EU imports in total EU imports (i.e. extra and intra EU imports), so as to identify the products for which the EU mainly relies on foreign sources. It is computed as the share of extra EU imports in total EU imports (in values): 3.Substitutability of extra EU imports with EU production: The third indicator aims at capturing whether the EU production can cover the extra EU import needs in the event of trade disruptions. For this purpose, EU total exports, including intra and extra EU exports, are used as a proxy for the EU internal production capacity. For each product, the ratio between the extra EU import value and the total EU export value (i.e. extra and intra EU exports) is computed as detailed below: 2.2.2Identifying foreign dependencies The narrowing down of foreign dependencies is based on the application of thresholds on the three indicators. As depicted in Graph 5 , the whole sample of around 5000 products is considered, with the objective of narrowing the number of products down to most dependent goods, satisfying the following thresholds for each indicator: I. The indicator suggests that the higher the concentration, the lower the diversification of EU imports from extra EU sources. Consequently, this threshold implies that the EU import value originates mainly from 2.5 foreign countries. It is important to acknowledge that the diversification of imports could be complemented with additional information on the trading partner in question, so as to assess the overall level of risk. II. The indicator suggests that the higher the share, the higher the importance of extra EU imports in total EU imports. Hence, this threshold implies that the value of extra EU imports accounts for the majority (> 50%) of the value of total EU imports. III. The indicator suggests that the higher the ratio, the less able the EU is to substitute extra EU imports with EU production in case of a trade disruption. Therefore, this threshold implies that the value of extra EU imports is higher than the value of total EU exports. A sensitivity analysis is conducted, based on the whole distribution of the three indicators. More precisely, all 5000 products are ranked based on each indicator. The ranks of these three indicators are combined in a composite indicator measuring the overall foreign dependency of each product. Broadly, the results of the approach based on thresholds corresponds to the most dependent products based on a composite indicator.

Source: European Commission 2.3Results As highlighted in chapter 2.2, the bottom-up mapping consists in the application of three economic indicators and their respective thresholds to the whole sample of about 5,000 products to identify foreign dependencies ( Graph 7 ). The mapping exercise first identifies around 390 dependent products across all ecosystems. In a second step, the list of products identified as dependent is narrowed down to the most sensitive ecosystems. Finally, in the third step, only the most dependent products in the most sensitive ecosystems are considered. The bottom-up mapping identifies 137 products in the most sensitive ecosystems where the EU can be considered highly dependent on imports from third countries. These pre-identified products represent about 6% of the EU’s total import value of goods. The three main foreign sources of EU import value for the 137 products identified as highly dependent are China, Vietnam and Brazil ( Graph 8 ). China represents around 52% of the total value of imports of the most foreign dependent products and it is among the top three suppliers for around 54% of these goods. In terms of stages of processing, around 16% of the most foreign dependent products are raw materials, around 57% are intermediate goods and around 27% final goods. At the same time, the EU can also be a source of dependency for other countries (see Box 4 for an example of reverse dependencies of the EU and US and their common dependencies vis-à-vis important trading partners). Source: European Commission based on BACI database The strategic nature of these identified dependencies needs to be assessed on a case-by-case basis, relying on in-depth discussions with Member States and relevant industries. Further discussions with Member States and relevant industries would be needed to assess the possible strategic character of these dependencies, as well as their impact and the risks that they entail on the functioning of the more sensitive ecosystems (including e.g. taking into account risks linked to the specific trading partners in question). In what follows, a preliminary description of the dependencies identified in the more sensitive ecosystems as well as a number of considerations on the possible strategic nature of the identified dependencies is provided. A large group of identified dependencies are raw and processed materials and chemicals that can be classified in the energy intensive ecosystem but that have also wider importance and implications across several other ecosystems. The bottom-up mapping exercise highlights foreign dependencies for 99 products related to raw/processed materials and chemicals (e.g. beryllium, cobalt, antimony, lithium, aluminium, tungstates, chromium, nickel, molybdenum, manganese, ferro-alloys, steel, various chemical products). Several of these identified raw materials have already been assessed as critical in the context of the EU’s regular monitoring of critical raw materials. The mapping also highlights dependencies regarding imported energy products (e.g. petroleum products and fossil fuels), which are important to consider in the context of the decarbonisation of EU industry. Chapter 5 of this staff working document provides more in-depth reviews of the EU’s dependencies and possible vulnerabilities in the areas of raw materials as well as hydrogen as a key contributor to the EU’s future decarbonised economy. A second important group of dependencies belongs to the health ecosystem, including active pharmaceutical ingredients (APIs), other medicines and COVID-19 related goods in the health ecosystem. Access to medical products and pharmaceuticals is crucial for the health of Europeans and the EU’s open strategic autonomy, as evidenced by the COVID-19 crisis. The bottom-up mapping identifies 14 products as foreign dependent, some of which have been of high relevance during the COVID-19 crisis (e.g. part of protective garments). Others include chemical substances known as APIs (i.e. antibiotics, vitamins, hormones, heterocyclic compounds), which are particularly important in the manufacturing of medicines. The mapping indicates for a range of APIs that they are concentrated in a few sourcing countries, with little potential for substitution with domestic production as the EU produces different products compared to the ones imported. In this regard, given that APIs are potentially essential inputs for producing a wide range of medicines, Chapter 5 of this staff working document provides a more in-depth review of the EU’s potential strategic dependencies in the area of APIs. An important number of dependent products are also identified in the renewables, digital and electronics ecosystems as they are directly related to the green and digital transition. The bottom-up analysis notably reveals that that the EU has a high level of foreign dependency with respect to 17 products related to renewable energy production, green mobility and digital/electronics (e.g. permanent magnets, electric accumulators, electric motors, radio broadcast receivers, laptops, mobile phones). The production of many green and digital products relies on various (critical) raw materials. As highlighted above, several of these raw materials are identified by the bottom-up mapping as dependent (e.g. lithium, cobalt, nickel, copper, chromium, molybdenum). For example, the production of permanent magnets, which are used in different types of wind turbines, is reliant on various raw materials. The bottom-up mapping indicates that not only the relevant raw materials but also the permanent magnets themselves are foreign dependent goods. As for green mobility, the dependent electric accumulators might use raw materials on which the EU is foreign dependent as well. More broadly, in the renewable ecosystem, several dependencies may have an impact on the decarbonisation and continued proper functioning of the EU electricity system. For example, several hydrogen related technologies depend on imports of raw materials for key components such as electrolysers and fuel cells. In the area of digital, for example, some of the identified dependent raw materials are used in the production of semi-conductors, the basic building blocks of all digital products and services. Chapter 5 of this staff working document provides more in-depth reviews concerning Li-ion batteries and hydrogen technologies. The bottom-up product mapping faces a number of limitations when it comes to identifying dependencies within the defence and aerospace ecosystem and can only provide tentative insights. Identifying foreign dependent products within this ecosystem through a bottom-up mapping faces a number of challenges given the lack of complete data (notably for confidentiality reasons) and the required level of detail. For these reasons, in this ecosystem in particular, the bottom-up methodology relying on trade data should be complemented with other more qualitative, ecosystem-specific assessments (at a more granular level). This specific assessment will be tackled through the EU Observatory on Critical Technologies for civil, defence and space industries. Box 4 – Reverse and common dependencies in products The main trading partners of the EU (notably the US and China) are also conducting comprehensive reviews of the resilience of their own strategic supply chains. The US issued an Executive Order on America’s Supply Chains with the goal of strengthening supply chain resilience and security, building capacity and diversifying sources. Concerning China, a review of strategic supply chains is part of the Chinese 5-year plan (5YP) which, among other objectives, aims at minimising external dependencies. Given the current global environment, this box intends to shed light on the foreign dependencies in goods that the EU and the US have with each other, as well as their common dependencies vis-à-vis the rest of the world and China specifically (being the main source of dependencies for both the EU and the US). As a starting point, the analysis identifies the general foreign dependencies in goods of the EU and the US based on two out of the three the economic indicators detailed in Section 2.2.1. More precisely, in this context, a high level of foreign dependency is associated with a low diversification of import sources (i.e. high concentration) and a limited domestic capacity (i.e. low substitutability of imports with domestic production) as defined above. Then, relying on the identified general foreign dependencies, the analysis identifies those products where the US is highly dependent on the EU (“reverse dependencies”) and vice-versa. Furthermore, “common dependencies” that the EU and the US share vis-à-vis China and the world can also be identified. These identified reverse and common dependencies are then further assessed by evaluating their potential for diversification using the existing global trade networks as a proxy. Note: This table focuses on potentially sensitive ecosystems; The chart shows products where the US can be considered dependent on the EU (first row); the EU dependent on the US (second row); common dependencies for the EU and the US on China (third row); and common dependencies for the EU and the US on the world (fourth row) Source: Commission analysis based on BACI database The EU is less dependent on the US than vice-versa and both countries have important dependencies vis-à-vis China. The US appears more dependent on imported products from the EU than vice-versa. This is in line with the aggregate finding that the US has more concentrated sources of imports compared to the EU (see Graph 4). In addition, the EU and the US have an important amount of common dependencies vis-à-vis China. Furthermore, for many of these common EU/US dependencies vis-à-vis China, the potential for trade diversification to other countries (beyond China) appears limited given the current structure of world trade where China takes up a very central position for these dependent products. These common dependencies of the EU and the US on China include various goods in sensitive ecosystems. Notable examples include products in the Health ecosystem (e.g. various Covid-related goods and APIs including vitamins, antibiotics, hormones) and goods belonging to the ecosystems relevant for the EU’s twin transition (e.g. permanent magnets, electric accumulators, cell phones, radio broadcast receivers). Similarly as for the bottom-up mapping carried out in chapter 2 of this staff working document, these analytical findings would need to be further corroborated with qualitative analysis and discussion with Member States and industry. Note: chart shows examples of products in sensitive ecosystems where the US can be considered dependent on the EU (first row); the EU dependent on the US (second row); common dependencies for the EU and the US on China (third row); and common dependencies for the EU and the US on the world (fourth row). These examples might not be representative of the overall level of dependency. Source: European Commission based on BACI database. 2.4Assessing the further vulnerability of dependent products: potential for diversification and substitution Out of the 137 products identified as dependencies in the sensitive ecosystems, a lower number could be considered as possibly more vulnerable given that their potential for diversification is low. To evaluate the diversification potential, a measure for concentration of world exports is used. Thus, the HHI index computed at the world level for each product (based on the total export flows of each third country) captures the concentration of production in the world outside the EU. A high level of concentration of world exports of a given product could indicate that the EU has limited potential for further diversification of imports (e.g. in case of an unexpected trade disruption). For about half of the identified dependent products world export values outside the EU are concentrated in 2-3 countries. To identify products with low potential of diversification, a threshold of 0.4 for the HHI index is used (i.e. world export value outside the EU being concentrated in 2-3 countries). It is important to acknowledge that the diversification capacity could be complemented with a risk analysis of the trading partner in question so as to assess the overall level of vulnerability. About 50% of the 137 products previously identified as dependent, have an index higher than 0.4, representing around 4.5% of total imports. These products could be considered possibly more vulnerable as the potential for diversification is low. To evaluate the potential for substitution of imports with domestic production across the dependent products, the average price of exports is compared with the average price of imports. The underlying idea is that the higher the price differences, either positive or negative, the more difficult it is to substitute foreign goods with domestic goods even if internal capacity is available.

Another layer of possible vulnerability is a price difference between extra-EU imports and total EU exports of at least 30%. The distribution of price differences between extra-EU imports and total EU exports shows that the median price difference is 30%. This suggests that for half of all identified dependent products, the goods produced within the EU are significantly different compared to the ones imported from third countries, representing around 1.2% of total import value. While the analysis cannot point to specific reasons behind these price differences (e.g. quality differentiation, efficiency or other), the fact that the goods produced are different from the ones imported reveals another layer of possible vulnerability for this half of the identified dependent products. Together, a low potential of diversification and high price differences between extra-EU imports and total EU exports might point to a subset of 34 particularly vulnerable products. This subset of 34 goods has an HHI higher than 0.4 (i.e. possibly low potential for diversification) and a price difference of at least 30% (i.e. possibly low potential for substitution). This final subset represents 0.6% of total import value. Among the 34 products identified, 22 products are classified as raw materials and intermediates goods (e.g. some APIs including alkaloids or heterocyclic compounds and some ferro-alloys including ferro-tungsten and ferro-niobium) and 12 as final goods (e.g. Turbo-propellers, COVID-19 related products such as part of protective garments, types of radio-broadcast receivers and some types of medicines). 2.5Single Market dependencies linked to concentration of economy activity The Single Market per definition relies on an open exchange of goods and services between Member States. The Single Market is key for the economic resilience of the EU as a whole, since Member States can rely on the capabilities and strengths of each other. One of the main advantages of the Single Market is the possibility of enabling economies of scale, through specialisation, with notable benefits for the overall economy, i.e. contributing to the overall economy growth, creating jobs and adding value to consumers. Still, it is important to consider that activity concentration in firms within the Single Market brings about various risks. As highlighted in Chapter 1.1, risks related to internal dependencies, arising from an important concentration of activity, are of a different nature compared to external dependencies. Possible internal dependencies might emerge when the EU relies on the provision of key products and inputs originating from a relatively limited number of sources within the Single Market. For instance, a natural disaster affecting activities concentrated in one or a few firms could affect the well-functioning of EU value chains within the Single Market. Relying on very few firms within the Single Market for supply of specific goods can also lead to reduced capacity to respond to demand surges. Identifying risks across firms originating from production concentration within the Single Market requires detailed and comprehensive information. Such analysis should be based on data including the location of production facilities at a very granular product level. This data would allow to explore whether there are important levels of economic concentration at a product level, which can create risks for the EU as a whole in case of an unexpected shock. Currently, such granular data on production locations at a very detailed product level is not available across the EU. Further work would be needed (e.g. in the form of ad-hoc surveys, case studies, use of existing national firm level databases) to collect information on firm production facilities at a product level across Member States. A smooth functioning of the Single Market is a key asset to ensure the resilience of the EU economy and mitigate risks of possible internal dependencies. The COVID-19 pandemic has shown that a well-functioning Single Market should be at the core of the Union’s assets to tackle future potential crises. Structural solutions are needed to safeguard free movement during crisis times. This is particularly important where concentration of activities within the Single Market may exist. Furthermore, competition policy can also play a major role in addressing possible risks related to such internal dependencies, by diversifying sources of supply, promoting innovation and fostering an open competitive industrial fabric that prevents overreliance on a few players or products, be it within or outside the Single Market.

3.EU performance in key technologies and research & innovation Strengthening the EU’s capacity to develop and take up technologies that are important for the industrial future of the EU is of key importance to enhance future competitiveness and avoid possible (future) strategic dependencies. The Industry strategy of March 2020 specifically highlighted that the EU should support the development of key enabling technologies that are strategically important for Europe’s industrial future. The Communication on the Digital Decade underlined the importance of reinforcing internal strengths and capacities in the area of digital technologies in order for the EU to be a stronger international partner. This chapter aims to complement the assessment done in chapter 2 by considering the EU’s position in comparison with its global competitors in the area of key technologies that will drive future competitiveness. The EU’s performance in comparison with its global competitors in the area of these technologies cannot be clearly captured by an analysis of trade statistics as performed in chapter 2. In this context, this chapter assesses the EU’s relative position in the area of key technologies on the basis of a range of indicators (considering e.g. research, investments, innovation and business dynamics). These provide important indications (or early warnings) as to possible risks of (future) dependencies in the area of such technologies. For example, comparatively low levels of research, innovation, investments and entrepreneurial activities are key drivers of Europe becoming potentially more dependent on other countries for access to state-of-the-art technologies. The analytical basis for this chapter consists of a number of different quantitative and qualitative sources. It first considers the EU’s position in the development and uptake of certain key technologies, based on information developed through the Advanced Technologies for Industry project. This provides an indicative overview of the EU’s performance in key technologies compared to its global competitors, using indicators and proxies of technology generation, entrepreneurial activities, investments and available skills. In addition, as regards green technologies, information is used from the Commission report on progress of clean energy competitiveness. Secondly, the EU’s performance in research and innovation (R&I) is a key driver of technological performance. For this, the analysis mainly relies on available Eurostat statistics on R&I and the 2020 EU Industrial R&D Investment Scoreboard. 3.1Key technologies for (future) competitiveness Technologies that will drive the EU’s future competitiveness include both those that are already at a more mature stage of development as well as emerging and breakthrough technologies that will gain importance in a more long-term perspective. Key technologies (based on Advanced Technologies for Industry project)

In the context of extensive monitoring of technological trends in the area of key enabling technologies for industry, a number of technologies have been identified as being of strategic importance for the EU’s industrial future. These key technologies are expected to substantially alter the business and social environment. The focus of this section will be on technologies that are part of the Advanced Technologies for Industry project, including Advanced materials, Advanced manufacturing, Artificial Intelligence, Big data, Cloud, Industrial biotechnology, the Internet of Things, Micro-and nanoelectronics (including semi-conductors), IT for Mobility, Nanotechnology, Photonics, Robotics and Cybersecurity. These technologies are also part of the list of critical technologies highlighted in the Action plan on synergies between civil, defence and space industries. Several are also closely linked to the six key strategic value chains identified in the Strategic Forum on Important Projects of Common European Interest.



Graph 9: Indicator of overall EU performance in key technologies Source: Advanced Technologies for Industry project Note: The graphs provides a ranking of performance in key technologies in terms of technology generation, start-up creation and skills comparing EU with US, China and Japan The EU has both strengths and possible weaknesses across these technologies. An overall assessment – based on a number of elements including technological generation and uptake, entrepreneurial activities and available skills – shows that the EU has a relatively strong position for some technologies ( Graph 9 ). For example, the EU currently maintains sound technological leadership in Advanced Manufacturing, with European firms delivering a wide range of advance manufacturing equipment that are key enablers to production lines across the world. The EU also shows some strengths for related technologies such as in the area of Advanced materials. At the same time, some indicators appear to suggest that the EU faces certain challenges in comparison with its global competitors for several other technologies including AI, Big Data, cloud, cybersecurity, industrial biotech, robotics and micro-electronics (including semi-conductors). Looking in more detail at technology generation confirms important differences in performance across technologies. In some areas, the EU holds the highest share of worldwide patent applications (e.g. advanced manufacturing technologies, Internet of Things and in the area of IT for mobility) showing strengths in technology generation ( Graph 10 ). Such strong performance in technology generation has a positive impact on business performance. In fact, European firms that own intellectual property rights (IPRs) have on average 20% higher revenue per employee than firms that do not. The impact is even higher for SMEs, among which the revenue per employee is 68% higher for SMEs that own IPRs.



Graph 10: Share in world transnational advanced technology patent applications Source: Advanced Technologies for Industry project Note: Based on EPO Worldwide Patent Statistical Database (PATSTAT, 2017) At the other side of the spectrum, the EU has been gradually losing leadership in many technologies in terms of its share in worldwide patent applications. This is largely due to the rise in Chinese patents but also patent activity in Taiwan and South Korea. Currently, the EU is lagging behind both China and the US in a number of the areas. This is the case for AI and Big Data, although the EU is showing some increasing dynamics in AI-related patenting. The EU share in worldwide patenting has significantly dropped in Robotics, now showing a large gap compared to China. When it comes to semi-conductors, the EU’s technology generation approximated by the number of patent applications is significantly below Japan and also lower than China and the US. Overall, this indicates that while the EU is positioning itself well when it comes to the ‘factory of the future’, it might be falling behind its main competitors in terms of scientific leadership and technology generation in other key areas that have important spill-over effects to many other ecosystems. The growth of venture capital backed start-ups and scale-ups provides for another indication of the EU’s comparative position across key technologies. It equally shows a divergent picture on performance across technologies ( Graph 11 ). For example, in fields such as Internet of Things, Nanotechnology and Industrial biotechnology the EU appears to have a relative advantage compared to the US. At the same time, in other areas including AI, cloud, cybersecurity and micro-electronics the number of EU venture capital backed start-ups and scale-ups is lagging behind the levels seen in the US. Even larger differences are seen when considering total capital investments, with important gaps in investments compared to the US.



Graph 11: Number of active venture capital backed start-ups and scale-ups established since 2009 (left); total capital investments in advanced technologies (right, 2010-2019) Source: Advanced Technologies for Industry project Note: Based on Crunchbase and Dealroom An analysis of the uptake of key technologies by EU businesses shows that while some are becoming more established, others are still only relevant in very specific sectors. Relatively more established technologies such as cloud computing, cybersecurity and advanced manufacturing appear to play an important role supporting the EU’s digital transformation. Other technologies are showing lower but still promising adoption levels. This is the case, for example, for technologies such as AI or Internet of Things. A relatively high share of companies appear willing to invest in such technologies in the near future, although the COVID-19 crisis might have a negative impact on these expectations. Technologies such as Industrial biotechnology show low adoption levels, as there are largely still used only by EU businesses in very specific sectors.

Graph 12: Advanced Technologies current uptake in the EU (2019) Source: Advanced Technologies for Industry project In addition to technology generation, entrepreneurial activity and uptake of technologies, it is also important to consider whether EU industry has access to the relevant technical and digital skills to fully capture the potential of technological advances. An approximation of available skills in the EU across different fields of technologies provides for a rough indication of this. Compared to the US, the EU has a higher relative share of professionals with skills in advanced manufacturing technologies, advanced materials, industrial biotechnology and nanotechnology. Nevertheless, the EU appears to lag behind the US when it comes to available skills in areas such as cloud technologies, big data, AI, cybersecurity and micro-electronics.

Graph 13: Weighted share of professionals with advanced technology skills (proxy) Source: Advanced Technologies for Industry project. Note: Analysis relying on (online) self-reported skills by professionals The EU’s performance in green technologies This Commission’s annual progress report on clean energy competitiveness has assessed the state and competitiveness of the EU as regards clean energy technologies. It includes a focus on six key technologies that are expected to play an increasing role in the EU’s 2030 and 2050 energy mix: offshore renewables (wind and ocean), solar photovoltaics (PV), renewable hydrogen, batteries and grid technologies. On the one hand, the report highlights the importance of regaining and strengthening EU’s competitive edge in the solar photovoltaic industry and the battery sector. In the solar photovoltaic industry, the EU has lost market share in some of the upstream parts of the value chain (such as solar PV cell and module manufacturing). Considerable market opportunities exist in the segments of the value chain where specialisation or high value products are key. Building a sizeable EU PV manufacturing industry would also reduce the risk of supply disruptions and quality risks. Regarding batteries, there is an ongoing competitive recovery by the EU, which is further assessed in chapter 5 of this staff working document. The EU holds a first mover advantage in the wind, renewable hydrogen and ocean energy industries. At the same time, large increases in the capacity size of these markets are expected. This will require scaling up and realising economies of scale. The EU offshore wind industry has strong innovative capacity, while needing the perspective of a growing home market as well as sustained R&I funding to benefit from growth in global markets. Also in renewable hydrogen, European companies are well-placed to benefit from market growth (including thanks to their leading position on the electrolysers market). Still, large efforts to scale up are needed to achieve a significant renewable hydrogen production capacity by 2030. Renewable hydrogen is further assessed in chapter 5. As regards ocean energy, technologies have yet to become commercially viable and further efforts are needed to maintain and expand the EU’s current leading position. Finally, the EU smart grid industry is relatively small but also competitive. Given its regulated nature, governments and regulators in the EU play a key role in developing the benefits of this industry. Emerging break-through technologies A horizon scanning of potentially important, disruptive innovations over the coming 15 to 20 years reveals the expectation of high diffusion potential mainly in digital but also green innovation, making disruptive innovation key for the twin transition. The main expectation is that digital technologies, which have gained importance in the COVID-19 crisis, have the highest diffusion potential in the 2038 horizon by increasing efficiency, effectiveness and convenience everywhere. With a somewhat less ubiquitous role, innovations in biology, energy and materials are expected to diffuse into highly digitised and automated industrial ecosystems and to bring massive improvements in (competitive) sustainability. Emerging break-through technologies with a high likelihood of maturity by 2038 exist across different ecosystems. In the digital ecosystem, for example, important emerging technologies include areas such as speech recognition and computational creativity. In the electronics ecosystem, examples of technologies with important potential include nano-leds, flexible electronics, 2D material based technologies and bio-degradable sensors. Also in ecosystems such as health (e.g. gene editing and therapy) and renewables (e.g. bioplastics), there are several important break-through technologies with a high likelihood of maturity by 2038. While limited data is available to assess the EU’s performance in many of such emerging technologies, it is clear that they deserve attention from industry and policymakers. 3.2Europe’s research and innovation performance

The EU’s performance in R&I gives insights in possible future developments of the EU’s competitive position in key technologies. R&I is a key driver that will define Europe’s performance when it comes to key technologies to support competitiveness, match the EU’s green and digital ambitions and safeguard the security and health of Europeans. The EU’s R&I performance compared to its global competitors is creating concerns over (future) technological dependencies. While the EU is a global R&D powerhouse, accounting for almost 20 % of R&D worldwide, it is threatened by global competitors in a number of innovation key indicators. Graph 14: BERD in EU and its main global competitors in bln EUR (left axis) and BERD intensity (%, right axis) Source: JRC elaboration based on Eurostat data Business expenditure on R&D is far below the US and has been caught up by China as well ( Graph 14 ). EU business expenditure on R&D (BERD) was around 200 billion EUR in 2019, accounting for about 1.5% of GDP. Despite its 50% growth over the last decade EU BERD has been caught up by Chinese BERD also in monetary terms and it is significantly lower (by 45%) than the amounts that US businesses spend on R&D. Manufacturing BERD in the EU is performed mostly in the high tech (HT) and medium high tech (MHT) sectors. In 2018, these sectors accounted for more than half of total BERD (56%) and for 83% of total manufacturing BERD. The main industrial sectors for BERD include the automotive industry, computer & electronic & optical and pharmaceuticals. The decade long changes in these shares have been minor.

Graph 15: Medium high tech and high tech manufacturing BERD as a share of total manufacturing BERD in EU Source: JRC elaboration based on Eurostat data Still, the share of EU high tech BERD is only less than half of that of the US. The US invests significantly more in HT compared to the EU (57% vs 27%) and less in the automotive and other MHT manufacturing. China’s HT BERD has only a slightly lower share (24%) than that of the EU. The EU’s scaling-up performance also lags behind the US and China: for each EU private unicorn in 2018 there were eight in the US and four in China. Graph 16: Medium high tech (MHT) and high tech (HT) manufacturing BERD as a share of total manufacturing BERD in the US (left) and China (right) Source: JRC elaboration based on Eurostat data The EU (as well as the US) is also losing ground in favour of China with respect to scientific excellence and patenting. Regarding scientific output measured by the top 1% highly cited publications, the EU is behind the US and also overtaken by China in 2015. Regarding world shares in transnational patent filings, the EU remains world leader, but the gaps between the EU, US, Japan and China are narrowing. Technological specialisation has deepened given similar R&D trends observed for over 10 years, shaping specialisation patterns and increasing differences across regions, particularly between the EU and the US. Companies’ R&D investments in the EU and the US have increased significantly over the past ten years in the top four R&D investing sectors. In 2010, EU companies in the automotive industry were investing more in R&D than their US counterparts, whereas US companies in the health and the ICT industries (both services and producers) invested the most in R&D. These differences have increased further in 2019, particularly in both ICT sectors. The ratio of R&D investment between the EU and the US remained constant in the health sector, increased significantly in the automotive sector and substantially decreased in both ICT sectors.

Graph 17: R&D investment in 2010-2019, comparison of selected sectors in the EU and US Source: The 2020 EU Industrial R&D Investment Scoreboard, European Commission A closer look to the EU and US data at the sub-sector level shows even more striking differences in R&D investment, for example in biotechnology and software & internet. In 2019, the US had many more companies in both sub-sectors (8.6 times more in biotechnology and 8.8 times more in software & internet) as well as significantly higher R&D investments (EUR 34.3 billion vs EUR 2.6 billion in biotechnology and EUR 92.7 billion vs EUR 7.5 billion in software & internet).

Graph 18: R&D investment in 2010-2019, comparison of selected sectors in the EU and China Source: The 2020 EU Industrial R&D Investment Scoreboard, European Commission In the past 10 years, the R&D investment of Chinese companies operating in the ICT sectors has overtaken that of EU companies. By contrast, the EU retained its lead in the health and automotive sectors. The average R&D investment per company in the EU Industrial R&D Investment Scoreboard has grown significantly in China in 2019. However, it has still remained little more than half of the average EU company (EUR 509.6 million). Thus, while overall EU firms’ R&D investments remain well ahead of that of Chinese firms, the gap is continuously decreasing. Finally, when it comes to green technologies, it is crucial that the EU maintains its strong position. R&I as well as the development and uptake of eco-innovations will be key to achieving the climate goals. Existing technology will not be able to deliver the full emissions reduction required to achieve EU climate objectives and new technologies should ideally become commercialised by 2030, to allow for timely scaling and deployment across the EU by 2050. At the same time, in the case of more mature techniques, necessary investment into large-scale demonstration and deployment will require increased pooling of resources. The EU makes too little use of its world-leading R&D in industry and must ensure a better transfer of that R&D into the economy, especially when it comes to green innovations. The EU currently has a higher share in clean energy technologies in overall patenting activity than most other major economies. The EU is also the global leader on high-value green patents (protected in at least two patent authorities), with Japan and the US following closely. Nevertheless, the green transition will depend on the degree to which the corresponding green innovations are created and deployed. In addition, there is an overall decrease in national budgets devoted to R&I in clean energy technologies and a lack of national objectives and funding targets that show concrete pathways to 2030 and 2050. Even though some Member States have been increasing efforts, overall, national budgets for clean energy research have been in slight decline in recent years. The R&I budget allocated to energy in the EU represents 4.7% of total spending on R&I. In 2018, the EU public R&I investment in clean energy technologies as a share of GDP was less than 0.03%, against around 0.05% in Japan or China. Estimates of private investment in the same areas have also been decreasing in recent years and amount to around 10% of the companies’ total expenditure in R&I. This is higher than the US, but lower than China.

Graph 19: Estimated public and private R&I financing in the Energy Union R&I priorities Source: JRC based on IEA, Mission Innovation, Eurostat/OECD 3.3Conclusions This snapshot assessment of the EU’s performance in key technologies and R&I shows that the EU has certain strengths but is also at risk of falling behind in other areas that will drive future competitiveness. While the EU still has a sufficient technological base, it is exposed to strong global competition. In some areas such as advanced manufacturing the EU seems to be performing well. Also in the area of certain green technologies (such as hydrogen, see chapter 5.4) the EU is highly competitive, while overall efforts are needed for the EU to maintain and further build its strong position. At the same time, the increased technological capacities of the EU’s competitors highlight the risk of the EU not being able to create and grow a sufficient number of firms in certain key technology sectors. Furthermore, the EU’s R&D efforts in the digital ecosystem fall significantly behind those of the US and have been overtaken by China as well. Such lagging performance provides at least indications as regards possible (future) dependencies with regard to these technologies. If left unaddressed, strategic dependencies in the area of these technologies could further materialise and possibly new ones might emerge.

Particular technologies where the EU’s competitive position appears to be weaker compared to its global commercial competitors include AI, High Performance Computing, Big Data, cloud, industrial biotech and micro-electronics (including semi-conductors). These key technologies in the digital ecosystem deserve particular attention, as key enablers and sources of transformation for many other ecosystems (such as the defence and aerospace, automotive, agri-food and health ecosystems). Chapter 5 of this staff working document provides in-depth reviews of the EU’s position and potential strategic dependencies in the areas of semi-conductors and cloud technologies.

4Policy measures with a potential to address strategic dependencies Any measures addressing strategic dependencies would need to be designed and applied on a case-by-case basis, taking into account the specific nature of the dependency, the global situation and the policy objectives pursued within the ecosystem concerned. They would need to build on in-depth discussion and dialogue with Member States and industry. Dialogue with industry (e.g. in the context of the Industrial Forum) is particularly important when it comes to better understanding the impact of certain dependencies and the drivers of current supply patterns. A detailed understanding of the functioning of relevant value chains as well as the potential risks that specific strategic dependencies entail to the EU’s core interests allows building policy measures that would aim at address dependencies in a targeted manner. This would allow taking proportionate measures, without compromising the open and trade-based EU economy and ensuring competition is not distorted. Addressing strategic dependencies requires targeted measures depending on the dependency concerned and its potential risks. Different alternatives should be carefully examined with a view to maintaining the competitiveness of the EU and choosing to address dependencies in the most cost-efficient manner. 4. 4.1 Relevant measures to address external and internal strategic trade dependencies There are differences between external and internal (concentration of activity at a firm level within the Single Market) dependencies also when it comes to identifying relevant types of policy measures. Different types of measures may play a role when it comes to considering how to mitigate risks of external and internal dependencies. Measures to address external trade dependencies considered strategic Policy measures to address external strategic dependencies can be diverse. On the one hand, they should ensure that the EU reinforces its position in global value chains by strengthening and diversifying external trade. On the other hand, the EU should strengthen its own capacity in strategic areas where necessary, building on the strengths of a fully functioning Single Market with open and competitive markets. On the external side, the diversification of import sources is a key element when it comes to increasing the EU’s resilience in a context of global uncertainty and growing international tensions. A strong EU engagement in multilateral cooperation and coordination mechanisms is important for this, including when it comes to preparing for a future crisis. At the same time, companies themselves play the key role in this regard as they are able to assess risks and take action so that they are able to tap into a sufficiently diversified and environmentally sustainable set of suppliers. Public policy can facilitate the process of diversification to alternative sources of supply and strengthening of existing supply chains. The recent Trade Policy Review provides the basis and direction for this. A reinforced use of the EU’s trade policy tools can contribute to obtaining access to new and improve access to existing global markets as well as ensuring an undistorted functioning of existing supply chains, based on a stable, rules-based trading framework. This requires building partnerships with like-minded partners and further engaging with a range of markets and countries around the world. In addition, trade policy also plays an important role in allowing EU businesses to compete on an equal footing with third country businesses. Better enforcing existing trade agreements and ensuring effective defence against unfair trade practices are key in this regard, including in those areas where the EU currently faces possible strategic dependencies. Likewise, the Commission plans to adopt as a follow-up to the White Paper on foreign subsidies a proposal for a new instrument to address possible distortive effects of foreign subsidies in the Single Market particularly in relation to concentrations and public procurement. On the internal side, the EU can address strategic dependencies by increasing or diversifying domestic production and where necessary and possible also consider strategic stockpiling. In addition to diversifying sources of imports (or where the potential of such diversification is limited), the EU can also develop or improve its own capacity in strategic areas. In addition, a crisis preparedness strategy (including e.g. the building of stocks or the development of alternatives, possibly together with international partners) can also be of relevance for certain strategic areas, including when it is not fully possible or efficient to substitute foreign goods with domestic production. Achieving increased EU capacity in areas considered strategic requires a fully functioning and competitive Single Market. Actions taken to facilitate a better functioning Single Market are key when it comes to ensuring increased strategic capacity in specific areas. Fostering the growth of firms and increasing industrial dynamics both via the ecosystems and the Single Market is key to achieving the twin transition. The EU would need to ensure that regulatory frameworks are fit for purpose and provide legal certainty to facilitate large-scale investments. Unnecessary or disproportionate barriers to the Single Market that hinder innovative businesses from exploiting opportunities of scale should be removed, particularly for areas of strategic importance. The Single Market Programme can be a key facilitator in this regard. Furthermore, open and competitive markets support resilience. Competition policy is key in this regard as a tool to promote innovation and foster a competitive industrial fabric, including in areas of strategic importance. The use of existing tools such as Important Projects of Common European Interest have already shown to offer important potential benefits in specific areas where the market alone cannot deliver breakthrough innovation, while ensuring that the benefits are shared across the EU economy. Industrial alliances can also serve as a platform to convene and rally a wide range of stakeholders in a given area to uncover opportunities and address bottlenecks in achieving the EU policy objectives. Finally, the COVID-19 crisis has also indicated that in exceptional cases, specific solutions (such as advance purchase agreements) allow investments to be made in a context of high cost and high failure rates. Modern, well-managed and efficient procurement by public authorities can also play an important role in increasing resilience. Smart procurement already today takes up a central part in enabling the achievement of key priorities (e.g. related to the green transition, innovation and social objectives) across many ecosystems. The role of public procurement and specific criteria in reducing dependencies and thus strengthening the resilience of different ecosystems can be further explored and developed. Targeted funding geared towards strategic priorities and investments in research can also provide a key contribution to building capacity and in