Europe’s economic underperformance has long worried politicians. But the problem has climbed to the top of the debate agenda now that the development gap with the US has widened, following the twin shocks of the coronavirus pandemic and Russia’s war in Ukraine.
Last month, French President Emmanuel Macron warned that Europe faces a “mortal” threat from economic decline caused by growing liberalism and war on its eastern borders. US gross domestic product proved more resilient to shocks and recovered faster, growing +8.7% above pre-pandemic levels in Q1 2024. This is more than double the 3.4% increase in GDP Eurozone and even ahead of the corresponding increase of 1.7% in the economy of the United Kingdom.
This transatlantic divergence has become so acute that it has caused a monetary policy rift between the US and Europe. With growth and inflation expected to remain stronger in the US than in Europe, investors expect the Federal Reserve to cut interest rates fewer times this year than the European Central Bank or the Bank of England.
The combination of high European energy costs and attractive subsidies offered by Washington for green energy and semiconductor projects is tempting a large number of European companies to shift their operations to the US.
The EU asked Mario Draghi, Italy’s former prime minister and former head of the ECB, to find ways to boost the bloc’s competitiveness. The former central banker is expected to recommend deepening capital markets and more funding for defense and other sectors from Brussels. It is recalled that he had recently warned that “without strategically planned and coordinated actions it is logical that some of our industries will stop their production or relocate outside the EU”.
Even the head of Norway’s insurance fund, one of the world’s biggest investors, says it’s “alarming” how much harder-working, ambitious and less regulated companies in the US are than those in Europe.
Faced with an aging population and a lack of leading companies in the fastest-growing technology sectors, European policymakers are looking for ways to energize their economies. Paolo Gentiloni, the EU’s economy commissioner, says the question now is how to address the need for critical investment in areas such as the “green transition” and defense given the subdued backdrop.
“The scandal for Europe is not low growth, because unfortunately we are used to it,” he says. “The problem is how to maintain an adequate level of investment, attracting private capital and supporting with public investment the needs of these new challenges.”
Europe’s economy was soaring in the early 1990s, boosted by the EU’s single market, before it expanded eastward after the end of the Cold War. But since then the combined economies of the 27 countries that make up the EU have steadily lost ground to the US – particularly since the Eurozone debt crisis a decade ago.
The Covid-19 pandemic and Russia’s war in Ukraine have caused much more economic damage in Europe than in the US.
According to the IMF, average per capita income in Europe has fallen to about a third below that of the US. In addition, per capita income in the US has surpassed all major advanced economies in the EU, and the Fund predicts that this gap will widen further in the remainder of this decade.
The weak investments
Part of the problem for Europe is a lack of demand, weak investment and a labor pool, with companies holding on to more workers than they need out of concern that they will struggle to rehire them once demand recovers. Some of these effects are due to a lack of consumer confidence.
Also, house prices have fallen in many countries and governments are cutting back on spending. On the other hand, rapid wage growth in the US helped Americans regain purchasing power lost due to high inflation earlier than Europeans. US households also benefited from stock market investments, which have risen sharply in recent years.
In the Eurozone, people are still saving more than 14% of their earnings – well above the historical average.
On the other hand, US consumers have spent almost all the extra money they had during the pandemic, reducing their savings to less than 5% of their income.
Europeans are also choosing to work less – a trend that has intensified since the pandemic – a fact highlighted by German train workers who are pushing to reduce working hours per week from 38 to 35 hours by 2029. Steelworkers are also demanding that they are paid more, even though they only work 32 hours a week.
The ECB estimated that at the end of last year the average Eurozone worker was working five hours less than just before the pandemic hit in 2020, equivalent to a loss of 2 million full-time workers a year, while the average US worker remained steady.
There is a difference in work life balance in the US and Europe. People’s preferences are very different. Labor shortages in Europe are also exacerbated by demographics. It may be offset by migration from Eastern Europe, but young people from this region return home or do not move at all.
An additional burden on Europe’s economy comes from its aging population and declining birth rates, which are causing widespread labor shortages as the baby boomer generation retires. Currently, in the EU there are three people of working age for every person aged 65 and over. But by 2050, the ratio is projected to be less than two working-age people for every older person.
According to the relevant statistical authorities, the US population will age more gently, from just under four working-age people for every person over the age of 64 today to just under three by 2050. The US is considered a more business-friendly environment for businesses.
The Eurozone has lost about 20% of productivity relative to the US since the mid-1990s, attributing this to the continent’s inability to reap the benefits of digital technology. Many European companies are very small and constrained by regulations.
Companies with more than 250 employees account for nearly 60% of private sector jobs in the US, but in the EU this falls between 12% in Greece and 37% in Germany. Bigger companies invest more and are more productive.
Europe’s productivity lag is long-standing and extremely costly in terms of living standards. If the five largest European economies—Germany, the United Kingdom, France, Italy, and Spain—had matched America’s productivity growth rate between 1997 and 2022, their GDP per capita would have averaged nearly $13,000 higher in purchasing power of strength.
The differences are stark when looking at larger companies. Europe’s biggest listed companies with more than $1 billion in annual revenue, including those in the U.K., Norway and Switzerland, invested about $395 billion less than their U.S. counterparts in 2022, Trust Economics found.
Fiscally
Most EU economies have started to shrink their budget deficits ahead of the activation of the Stability Pact.
But US spending continued to rise. This trend is expected to continue, whoever wins the November US presidential election. The Congressional Budget Office projects that deficits will remain at about 6% for each fiscal year over the next decade. US productivity was boosted by the temporary rise in unemployment after the pandemic hit in 2020, which brought about a realignment.
Instead, Europe chose to protect jobs. In the EU, the labor market froze, with the result that both zombie companies and zombie jobs are maintained.
Perhaps the only encouraging news is that there are signs that vacancy levels are falling, while wages and working hours continue to rise in the EU.
