In the past few decades, the European economy has fallen behind. Whilst the US economy booms, Europe struggles to avoid recession.
In dollar terms, in 2008, the EU was 90% the size of the US, today it is 65%. As a share of world GDP, Europe is declining, overtaken by China and in the future perhaps India. The Euro has already fallen 33% in the past decade, as investors become more pessimistic.
During the 1980s and 90s, the EU made great progress with the single market helping to reduce barriers to trade. The EU was a model of stability and growth, helped in no small part by the German economic miracle of the post-war period, but in recent years, this has come unstuck, Covid and surging gas prices saw the single market fraying at the edges.
But, the Nobel prize winning economist Paul Krugman argues one of the biggest barriers to economic growth in Europe has been an obsession with reducing debt, especially in Germany. Since the Euro debt crisis of 2010, the EU has prioritised trying to reduce fiscal deficits, leading to weak economic growth. But, an unfortunate consequence of austerity has been a failure to reduce debt to GDP anyway. Italy’s debt has soared despite efforts to reduce borrowing. This is because slower economic growth leads to lower tax revenue, which leads to rising budget deficits, which leads to more pressure for austerity. Europe has been stuck in a cycle of low growth, low confidence and austerity. Italy is symbolic of Europe’s economic stagnation – with one of the worst wage growth rates in the developed world. Austerity is not the only cause of Italy’s woes, but it has hardly helped, and the recent rise in interest rates is particularly bad timing for all of Europe.
The effects of austerity and weak growth have been magnified by demographic factors. The European population is ageing fast and this is slowing down investment and productivity growth. In previous decades the ageing population could be offset by increasing female labour market participation and high migration levels, but with a populist backlash to migration, this can no longer be relied on. Europe has a chronically low birth rate, and with housing costs going through the roof, there will be no easy solution.
One impact of an ageing population is that firms have begun hoarding labour – paying workers, even if not particularly productive. It is a similar situation to Japan in recent decades. Another problem of an ageing population is that it puts further pressure on government spending on health and pensions. European economies already pay a higher share of GDP on pensions but demographic changes only put more pressure to raise tax or cut public sector investment.
Varied impact of decline
When talking about a European economic decline it is important to bear in mind, the impact is quite varied across the continent. The biggest losers in Europe have been Germany, Italy and Greece. By comparison, eastern countries like Poland and northern economies like Ireland have been doing well. The biggest driver of the European economy in post-war period was Germany, and it is Germany’s economic slowdown which is most worrying. German industry in particular complains of a regulatory burden. The economist reports, it takes 120 days for a German firm to receive an operating license. Italy and Greece, hardly bastions of free enterprise take 40 days. Construction permits take 50% longer than the OECD average, and Germany’s adoption of digital services lags behind the rest of the world.
5G adoption is much lower in Europe than elsewhere. The once mighty German car industry has struggled from Brexit and is facing competition from the fast growing Chinese electric vehicle industry. Europe has so far missed the boat on big tech and AI. This global growth sector is being dominated by the US and Asia, and European firms have lacked the flexibility and nimbleness to jump into these new areas of growth. The EU have sought to take on big tech with policies like GDPR, but this is another example of a regulatory burden which undermined business – especially small and medium-sized – and not the big tech giants which was the goal of the regulation. The old German growth model of regional banks and federal regulation are falling behind in the new age of AI startups and digital revolution.
Impact of Soaring Gas Prices
It doesn’t help that in the past decades, Germany made the fateful decision to give up nuclear power and put all its faith in cheap Russian gas. The shock rise in gas prices in 2022 was very damaging for both German industry and the wider European economy. Given the inflation shock of higher gas prices, the European economy has actually done less badly than many feared. A key factor has ironically been imported liquid natural gas from the US. But, the transition to a green economy and energy that doesn’t rely on foreign dictatorships will be difficult and expensive for Europe and Germany in particular. In the US, the recent inflation was primarily because of strong demand and a strong economy. In Europe, it was rising energy prices, which is why Europe ended up worst of both worlds – inflation and low growth. On a more optimistic side, it is possible the recent geopolitical shock will give some benefits to Europe as firms try to diversify away from China.
However, Europe is struggling to compete with the US when it comes to industrial subsidies for green technology. In the US, President Biden’s ambitious programme of subsidies for renewables led to a surge in American growth and manufacturing and has given American firms (perhaps unfairly) a competitive advantage. The EU by comparison, find it harder to create such an ambitious spending programme.
What about the Euro? Is the European Union’s experiment with a single currency actually causing lower growth? Initially, the Euro led to a wave of euphoria as consumers and firms enjoyed frictionless trade. In the Euro, countries in the south borrowed to fund consumption from the north. However, this initial euphoria masked a growing divergence with southern economies becoming uncompetitive and running large deficits. When the global credit crisis hit, the Eurozone was plunged into crisis, with bond yields surging as markets worried about debt levels. Some European countries like Spain and Ireland have been able to bounce back, but Greece and Italy have been hit hard by a decade of austerity. The crisis highlighted the difficulty of having a single currency and single monetary policy over such a widely divergent area. Since 2008, the Euro has fallen 50%, highlighting the decline in prospects of the European economy. It reflects the fall in economic growth and stagnation of economic prospects.
Now, it is important to bear in mind that the problems faced by Europe are not unique. Japan, the US and even China are seeing slower growth than in previous decades. The post-war period was a unique opportunity with transforming technological developments, rise in labour market participation and the baby boomer generation. Many of these advantages are no more, and so growth becomes harder. But, it does seem Europe has struggled more than the US.
Now whilst it is true, the European economy definitely has struggled, it is important to bear in mind, a bigger picture. Firstly, the US has a higher GDP per capita, but it also works 15% longer hours. In the case of Germany, it is 35% more hours. Some of this reflects longer paid holidays. The EU mandates a minimum of 20, the US mandates a minimum of 0. American workers may be better paid, but many long for some of the benefits of European workers. Also, the decline in the Euro means that comparison in US dollar terms needs careful evaluation. In $ terms, EU productivity has fallen behind the US, but in purchasing power parity, EU productivity has exceeded the US. Going back to the first comparison of economic growth, if we use PPP rather than $, the relative difference in performance is not quite as bad.