Introduction

The growing gap in GDP growth per capita between the United States and Europe is starting to worry policy makers. Data from the European Centre for International Political Economy (ECIPE) highlights a concerning trend. The economic gap between the European Union and the United States has been widening at an alarming pace.

From 2010 onwards US GDP per capita grew at an average of 3.4% while EU GDP per capita grew by 1.6% on average. As a result, the difference in GDP per capita grew from 47 percent in 2010 to 82 percent in 2021. If the trend continues, the prosperity gap between the average American and European in 2035 will be as big as between the average European and Indian today. The average American GDP per capita will equal $96,000 while the average European GDP per capita will equal $60,000.

Source: Data from the European Centre for International Political Economy (ECIPE), World Bank

Contributing Factors to the Gap

1. Productivity

One of the central drivers of the gap in GDP growth per capita is productivity. The United States has consistently exhibited higher levels of labor productivity, driven by technological innovation, a more flexible labor market, and a business-friendly regulatory environment.

The Euro Area’s slowdown in productivity growth is demonstrated by its Total Factor Productivity (TFP) growth rate. This benchmark, which measures the rate of technology and innovation growth in the economy, was stronger in the 1990s than today.

2. Secular trends

Europe has been facing an energy crisis since the Russian invasion of Ukraine in 2021. Even before that, Europe’s energy dependence has impacted the cost structure of European firms. Compare this to the US, which has become a net oil & gas exporter. In addition, Europe’s demographics are hurting its economy. Europe has an ageing population with low child birth rates, resulting in a decreasing workforce. In addition, the growing share of retirees results in higher social benefits and taxation.

3. Rigid economy

Higher regulation in Europe has resulted in a more rigid economy, where multiple sectors are more akin to an oligopoly than an outright free market. The entry and exit of firms in European markets is much lower than in the US, leading to lower dynamism and resource misallocation according to an ECB study. Incumbents face less competition, reducing the need for innovation.

4. Lack of R&D

Between 2014 and 2019, European firms grew on average 40 percent slower than their US peers and spent 40 percent less on R&D according to McKinsey. The US generates more patents than Europe in computing and AI. More worryingly, the US has also generated more patents in materials technology and cleantech, sectors in which Europe has outperformed the US in the past.

Conclusion

The growing gap in GDP growth per capita between the US and Europe carries several implications. It underscores the importance of productivity, innovation, and a flexible economy in driving economic growth.

Structural reforms are needed to avoid that Europe becomes the old continent, left behind by the economic growth of both the developed and developing world. There are too many barriers to entrepreneurship in Europe, such as far-reaching regulation incomparable to any other region in the world, and relatively high taxation rates.

Europe faces the challenge of finding ways to close this gap without falling apart politically. Tough choices are needed to improve our competitiveness, before it is too late. Hopefully European policymakers take note of the divergence and take action.

Sources

1.       ECIPE (2023). If the EU was a State in the United States: Comparing Economic Growth between EU and US States

2.      Lopez-Garcia, Paloma. (2021). Key factors behind productivity trends in EU countries. ECB Strategy Review.

3.      McKinsey Global Institute (2022). Securing Europe’s Competitiveness: Addressing its Technology Gap.