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π Economics

Economics: why Europe is falling behind the USA

Patrick Artus
Head Economist at Natixis
Key takeaways
  • Between 2010 and 2023, the cumulative GDP growth rate reached 34% in the United States, compared with just 21% in the European Union.
  • This gap can be explained by insufficient investment in new technologies in Europe.
  • Another reason is the low level of spending on research and development.
  • The case of the United States shows that investment in this sector is correlated with an increase in productivity.
  • The risk is that this European deficit will have an impact on tax revenues and on Europe's attractiveness to foreign investors.

Between 2010 and 2023, the cumu­la­tive growth rate of GDP reached 34% in the Unit­ed States, com­pared with just 21% in the Euro­pean Union and 18% in the euro­zone. This mea­sure of GDP in vol­ume does not depend on changes in exchange rates. Over the same peri­od, labour pro­duc­tiv­i­ty grew by 22% in the Unit­ed States and 5% in the euro­zone. Europe’s gap with the Unit­ed States has there­fore been clear since the ear­ly 2010s and can­not be explained by the dif­fer­ence in growth in the work­ing-age population.

Most of this gap is due to the dif­fer­ence in pro­duc­tiv­i­ty gains. And this gap is still present in the recent peri­od (labour pro­duc­tiv­i­ty rose by 1.7% in the Unit­ed States and fell by 0.6% in the euro­zone over the four quar­ters to 2023). Under­stand­ing the rea­sons for this dif­fer­ence between the Unit­ed States and Europe is an impor­tant area of research, on which opin­ions differ.

For some, the stag­na­tion and then decline in pro­duc­tiv­i­ty in the euro­zone is due to the high lev­el of hir­ing dif­fi­cul­ties, which began to appear in 2017 at the same time as the stag­na­tion in pro­duc­tiv­i­ty. Hir­ing dif­fi­cul­ties would have encour­aged com­pa­nies not to make redun­dan­cies, even if they had an over­sup­ply of staff. How­ev­er, it is hard to believe this the­sis, since the Unit­ed States has also expe­ri­enced very sig­nif­i­cant hir­ing dif­fi­cul­ties, with­out see­ing any stag­na­tion in productivity.

Oth­ers believe that the stag­na­tion and then decline in pro­duc­tiv­i­ty in Europe is due to the rise in the employ­ment rate of the least qual­i­fied. This would have caused the aver­age skill lev­el of the work­ing pop­u­la­tion to fall. But this argu­ment is not con­vinc­ing, since the employ­ment rate in Europe has risen almost iden­ti­cal­ly at all skill lev­els, and so the aver­age skill lev­el of those in work has not fallen.

The two rel­e­vant and fac­tu­al expla­na­tions for Europe’s falling labour pro­duc­tiv­i­ty lev­els are insuf­fi­cient invest­ment in new tech­nolo­gies (com­put­ers, arti­fi­cial intel­li­gence, soft­ware, etc.) and the low lev­el of spend­ing on research and development.

When we com­pare OECD coun­tries, we see that these two vari­ables have a strong influ­ence on pro­duc­tiv­i­ty dif­fer­ences between coun­tries. The econo­met­ric esti­mate leads to the fol­low­ing effects: a 1 point increase in the rate of invest­ment in new tech­nolo­gies leads to a 0.8 point increase per year in pro­duc­tiv­i­ty gains. Sim­i­lar­ly, a 1‑point increase in GDP for research and devel­op­ment expen­di­ture leads to a 0.9‑point increase per year in pro­duc­tiv­i­ty gains.

The fear is that Europe will be drawn into a vicious circle

By 2022, invest­ment in new tech­nolo­gies will rep­re­sent 5% of GDP in the Unit­ed States and 2.8% of GDP in the euro­zone. Research and devel­op­ment spend­ing in 2022 will amount to 3.5% of GDP in the Unit­ed States and 2.3% of GDP in the euro­zone. What’s more, from 2016–2017 onwards, the invest­ment and R&D effort in the Unit­ed States increased sig­nif­i­cant­ly com­pared to that of the euro­zone. At the same time, pro­duc­tiv­i­ty began to grow much faster in the Unit­ed States than in Europe. It is there­fore the lag in tech­no­log­i­cal invest­ment and R&D that explains a large part of Europe’s lag behind the Unit­ed States in terms of labour pro­duc­tiv­i­ty and GDP.

How can Europe hope to catch up with the Unit­ed States in terms of pro­duc­tiv­i­ty and growth? The first step would be to change the nature of busi­ness invest­ment. The rate of busi­ness invest­ment is vir­tu­al­ly the same at the start of 2024 in the Unit­ed States and the euro­zone (13.5% of GDP), but the pro­por­tion of this invest­ment in tech­nol­o­gy is much high­er in the Unit­ed States (5% of GDP com­pared with 2.8% in the euro­zone). We there­fore need to cor­rect the fact that busi­ness invest­ment in the euro­zone is too mun­dane and not suf­fi­cient­ly high-end.

The sec­ond mea­sure is to increase R&D spend­ing and uni­ver­si­ty bud­gets in the euro­zone. The resources avail­able for uni­ver­si­ty and cor­po­rate research are much high­er in the Unit­ed States. And, as men­tioned ear­li­er, these resources are an impor­tant and sig­nif­i­cant deter­mi­nant of pro­duc­tiv­i­ty gains.

It is to be feared that Europe will be drawn into a vicious cir­cle of low invest­ment in new tech­nolo­gies and research and devel­op­ment, and hence low pro­duc­tiv­i­ty gains and growth. First­ly, these declines could have a neg­a­tive impact on Europe’s attrac­tive­ness to for­eign investors. Sec­ond­ly, they could reduce tax rev­enues and the abil­i­ty of Euro­pean gov­ern­ments to pur­sue poli­cies to sup­port inno­va­tion and boost Europe’s attractiveness.

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