Europe Has Fallen Behind the U.S. and China. Can It Catch Up?

Europe Has Fallen Behind the U.S. and China. Can It Catch Up?

Europe's share of the global economy is shrinking and fears are growing that the continent can no longer keep up with the USA and China.

“We are too small,” said Enrico Letta, a former Italian prime minister who recently presented a report to the European Union on the future of the single market.

“We are not very ambitious,” Nicolai Tangen, head of Norway's sovereign wealth fund, the world's largest, told the Financial Times. “The Americans just work harder.”

“European companies need to regain their self-confidence,” said the European Association of Chambers of Commerce.

The list of reasons for the so-called “competitiveness crisis” is endless: the European Union has too many regulations and its leadership in Brussels has too little power. Financial markets are too fragmented; public and private investment is too low; companies are too small to be competitive on a global scale.

“Our organisation, decision-making and financing are designed for the 'world of yesterday' – before Covid, before Ukraine, before the conflagration in the Middle East, before the return of great power rivalry,” said Mario Draghi, a former president of the European Central Bank who is leading a study on European competitiveness.

Cheap energy from Russia, cheap exports from China and fundamental dependence on US military protection are no longer a given.

At the same time, Beijing and Washington are investing hundreds of billions of dollars in expanding their own semiconductor, alternative energy and electric car industries, thereby disrupting the global free trade regime.

Private investment is also lagging behind. Large companies, for example, invested 60 percent less than their American counterparts in 2022 and grew only two-thirds as fast, according to a report by the McKinsey Global Institute. Per capita income is, on average, 27 percent lower than in the United States. And productivity growth is slower than in other major economies, while energy prices are much higher.

Draghi's report will not be published until after voters in the 27 EU countries go to the polls this week to elect their parliamentary representatives.

But he has already declared that “radical change” is needed. In his view, this means a huge increase in community spending, an overhaul of Europe's chaotic financing and regulatory structures, and a consolidation of smaller companies.

The challenges of getting more than two dozen countries to act as one have become even greater given rapid technological advances, growing international conflicts, and the increasing use of national policies to control the economy. Imagine if every state in America had national sovereignty, and federal agencies had limited power to raise money for things like the military.

Europe has already taken some steps to keep up. Last year, the European Union adopted a Green Deal, an industrial plan to accelerate the energy transition, and this spring it proposed a defense policy for industry for the first time. But these efforts are dwarfed by the resources deployed by the United States and China.

The bloc “will fall far short of its ambitious energy transition targets for renewable energy, clean technology capacity and domestic supply chain investment,” research firm Rystad Energy said in an analysis this week.

To keep pace with developments, Mr Draghi believes that public and private investment in the European Union for the digital and green transition alone must increase by an additional half a trillion euros per year (542 billion dollars).

Both his report and Mr Letta's were commissioned by the European Commission, the European Union's executive body, to guide policymakers when they meet in the autumn to draft the bloc's next five-year strategic plan.

There is still a sizeable group in Europe – and elsewhere – that favours open markets and is wary of government intervention. But many European leaders, politicians and business leaders are increasingly talking about the need for more aggressive collective action.

Without pooling public resources and creating a single capital market, they argue, Europe will not be able to make the investments needed to compete effectively in defense, energy, high-performance computing and more.

And without the consolidation of smaller companies, the country cannot compete with the economies of scale available to large foreign corporations that are better able to capture market share and profits.

For example, there are at least 34 large mobile phone networks in Europe, said Draghi, four in China and three in the USA.

Letta said he had experienced Europe's particular competitive deficits first hand when he spent six months visiting 65 European cities for his report. It was impossible to “travel by high-speed train between European capitals,” he said. “This is a profound contradiction that symbolizes the problems of the internal market.”

However, the proposed solutions go against the political agenda. Many politicians and voters across the continent are deeply concerned about jobs, living standards and purchasing power.

But they are wary of giving Brussels even more control and financial power. And they often look on reluctantly when national brands merge with competitors or familiar business practices and administrative rules disappear. Another concern is the creation of a new bureaucratic morass.

This year, angry farmers in France and Belgium blocked roads and dumped truckloads of manure to protest against increasing EU environmental regulations governing their use of pesticides and fertilizers, planting schedules, zoning and more.

Blaming Brussels is also a handy tactic for far-right parties seeking to exploit economic fears. The anti-immigration Rassemblement National in France has called the European Union an “enemy of the people.”

Current polls suggest that right-wing parties are likely to win more seats in the European Parliament, which would lead to an even greater fragmentation of the Parliament.

At the national level, heads of government can protect their prerogatives. Over the last decade, the European Union has tried to create a single capital market to facilitate cross-border investment.

But many smaller countries, including Ireland, Romania and Sweden, are opposed to handing over power to Brussels or changing their laws because they fear this would disadvantage their national financial industries.

Civil society organisations are also concerned about the concentration of power. Last month, 13 European groups warned in an open letter that greater market consolidation would harm consumers, workers and small businesses and give too much power to large corporations, leading to rising prices. They also fear that other economic, social and environmental priorities could be pushed into the background.

For more than a decade, Europe has lagged on several competitiveness indicators, including investment, research and development, and productivity growth. But according to McKinsey, the country is a world leader in reducing emissions, limiting income inequality, and expanding social mobility.

And some of the economic differences with the US are the result of conscious choices. Half of the gap in GDP per capita between Europe and the US is due to Europeans choosing, on average, to work fewer hours over their lifetime.

Such choices could be a luxury that Europeans can no longer afford if they want to maintain their standard of living, others warn. Energy, market and banking policies are too different, says Simone Tagliapietra, senior fellow at Bruegel, a research institute in Brussels.

“If we continue to have 27 markets that are not well integrated,” he said, “we cannot compete with the Chinese or the Americans.”