Evans on Eurosclerosis and Why Europe Risks Falling Behind

On January 30, 2024, Paul Krugman, in this New York Times column, concluded that “Europe is in astonishingly good shape, economically and socially compared with almost any other part of the world.”

Sure, GDP per capita was persistently lower than that of the U.S., and growth was far slower than that of China, but that was just because Europeans decided to work less and enjoy life more.  “[A] choice, not a problem.”

A year later, there was a consensus that Europe, as an economy, was near collapse and needed critical care.  There was deep pessimism over Europe at Davos at the end of January 2025, and not just because of an antagonistic America. European politicians, officials, commentators and business leaders use the phrases “existential crisis,” “five minutes to midnight”, and, in reference to Germany’s economy, “Kaput” to describe the state of affairs.

In the 12 months or so after Professor Krugman’s op ed, Professor Mario Draghi issued his devastating report on “competitiveness” undertaken for the European Commission.  “Existential crisis” was his preferred phrase for the state of affairs.  The automobile industry was in freefall. The dearth of digital business had really sunk in. The AI revolution had passed over a continent filled with AI scientists. In late February 2025, the Bundesbank chief,  Joachim Nagel, said that it was “five minutes to midnight” for Germany as a leading economy.  “Kaput,” a book published in 2024, explained how it happened. Economic growth has slowed to a crawl.

If it weren’t for the tariff wars, this would be the biggest economic story of the decade. It still should be.

To be sure, Europe is not literally facing collapse.  But it is on a path to doomsday when the European lifestyle and Europe’s place as an economic power will be a distant memory.

European leaders aren’t questioning this dystopian vision. They are trying to figure out how Europe can get its mojo back.

We should hope they do. Many of us care about Europe because we’re from there, have lived in Europe, have friends or travel there. We want Europe to be successful because it is the largest democratic region in the world next to India, the biggest U.S. ally for national security, and a huge export market with nearly 500 million people.

Alas, Europe isn’t facing the root causes of its disease, and time is running out for a cure.

Eurosclerosis

The malady isn’t new or the understanding that, left untreated, it would be fatal.

The European economies were a mess in the 1970s and 1980s.

Unemployment was high, job creation was low, and growth was slower than in many places.  A prominent German economist, Herbert Giersch, coined “Eurosclerosis” to describe the disease. Social welfare programs, heavy regulation, and, in particular, rigid labor markets were often-cited causes.

Commentators credit the Single Europe Act of 1986, which promoted European integration and other reforms, for curing the disease.  Unemployment, while still high, fell; labor productivity improved, and market liberalization gave consumers better choices.

Remission is a better term. By the mid-1990s, the European Commission, increasingly concerned about Europe’s economic trajectory, began commissioning periodic studies to diagnose the problem and recommend solutions.

It turns out that Eurosclerosis is not a single disease, but rather the outcome of at least four related ones that economists and others have identified over the years.       

Workitis is the best known. People need to work for an economy to thrive. They are key inputs into the production of most goods and services, which people consume or are traded for other goods and services they want. People are the source of ideas, and innovation, as well as knowledge-transfer to each other. That is key to driving growth. Taxes on their earnings and the companies they work for fill government coffers. They are central to the process that enables European countries to collect their value-added taxes. And those taxes are what pay for social programs, including for older people who aren’t working anymore or people who can’t for whatever reason.

European labor force participation is pretty good, but people work relatively few hours. Work weeks are short with many days off and long vacations. The problem is worse in the large economies that are the source of most absolute growth. Germans who worked put in an average of 1,331 hours in 2024 compared with 1,796 for the U.S., a quarter less.

Riskphobia is pervasive. Market economies thrive when people and companies bet on new ideas that could lead to incremental or drastic improvements, including new products and services.  They depend on entrepreneurs who start new firms and companies that gamble on new products and processes.  These bets are risky. Most entrepreneurs, including those who were early movers in new technologies, fail.  We see the winners, like Steve Jobs, and forget about the losers, like David Potter, the founder of Psion, which created the once-dominant Symbian operating system for mobile phones. And the many more who don’t even make it to market or profits.

Europeans, by and large, don’t like to take risks. They prefer to play it safe. Surveys that compare the willingness to take risks find that people in the major European countries are more risk averse. Their behavior confirms this. They put their money in safe assets while Americans and Chinese bet on the market more. They put about 70 percent of their savings in low-yield bank accounts. Professor Draghi found their wealth grew for Europeans a third as much as for Americans since 2009. And they favor social policies that reduce their risks in most parts of their lives.  European companies invest less in risky R&D, and executives are more cautious.

Everyone doesn’t need to be a risk taker to drive innovation and growth.  Enough do, though, because many need to try for a few bets to pay off. And it isn’t just startups. Corporate executives and government officials need to be risk takers, too.

Then there is marketphobia. Europe embraced markets more as part of its therapy for ending the Eurosclerosis of the 1970s and 1980s. However, large European countries do not place as much faith in markets as the U.S. and China, particularly before Xi Jinping’s pivot back to state-owned firms. In his book, “Kaput: The End of the German Miracle,” economic journalist Wolfgang Münchau shows how the German industrial policy backfired, as the government and corporations teamed to place bets on heavy manufacturing, while missing the digital revolution.  European antitrust is predicated on the ordo-liberal conception of “fair competition,” which fits poorly with modern dynamic markets.

Regulatitis is the flip side of marketphobia. Both are plausible consequences of riskphobia. Regulation is to European economies what fried food and milkshakes are to your arteries. The European Commission and the member states just love to regulate. “Thou-shalt not” regulations, accompanied by lots of paperwork, clog up the system from starting companies, to hiring and firing workers, to day-to-day operations.

Professor Draghi zeroed in on this problem in his diagnosis of why Europe isn’t a competitive global economy anymore.  Some of the statistics are staggering. There are around 100 tech-focused laws and over 270 regulators active in the digital sector across the EU. The pervasive regulation of labor markets and the paperwork for starting businesses are well-documented.  He proposed, seriously, a Commissioner for Simplicity.

Europe’s main role in the digital economy, including AI, is to create regulations and pat itself on the back when other jurisdictions adopt them. This pretty much sums up the failure of economic policy at the European Commission over the last decade.

The Doomsday They Knew Was Coming

Low productivity growth. Widening gaps in income with other developed countries. Flaccid information technology adoption. Few digital startup successes. Industry dominated by old, very old, companies.

The European Commission has recognized these problems going back to the mid-1990s. Every few years, it assembles a group of experts, mainly economists, and tasks them with diagnosing the problem and coming up with the solution.

In 2002, the European Commission president asked a high-level group of experts to consider how to become, by 2010, “the most competitive and dynamic knowledge-based economy with sustainable economic growth.” Their 2003 report noted that the “current combination of low growth and higher public expenditure is not sustainable, and will become less so in the future” in part because of the aging of the population.

Seven years later, the European Commission announced its plan to turn Europe into an “Innovation Union” based on a “comprehensive innovation strategy from research to retail.” It noted that, “[b]oosting our research and innovation performance is the only way for Europe to support sustainable growth and create good and well-paid jobs that will withstand the pressures of globalization.” It observed that Europe lagged behind the U.S. in public and private sector research and development.

The Commission assembled a group of experts to consider possible pathways, which they summarized in the Global Europe 2050 report, issued in 2012. They considered three scenarios: a pessimistic one (EU under threat) based on substantial decline, an optimistic one (European Renaissance) in which “investment in technological and services innovation will have a direct impact on economic and social development.” In the middling one (Nobody cares), “economic growth will remain stubbornly lower than in the U.S. and China, and [Europe] will fail to exploit our potential for innovation and will, in consequence, lose our position in terms of global competitiveness to other regions in the world.”

By early 2024, it was clear there was no European Renaissance. It seemed like “nobody cares” was where Europe had ended up. Many economists and commentators thought that was OK. A choice, not a problem. The next 12 months revealed that Europe was “under threat.” There would be no Global Europe in 2050, just a collection of largely backward countries, perhaps still appealing tourist destinations, with relatively low living standards, facing serious challenges.

It wasn’t just Eurosclerosis.

There’s an old joke that economists have predicted 11 of the last five recessions. The discipline isn’t called dismal for a reason, and macroeconomists do not have a great track record at predictions.

Demographers have a far better track record because they have an easier job. The one thing you can say about the number of 25-year-old native-born workers a quarter century from now is that it depends mainly on the number of women having babies this year.

Putting migration aside, a country needs to have an average fertility rate—the number of babies per woman over her lifespan—of 2.1 to keep the population stable. Europe fell below that threshold in the mid-1970s. It reached 1.5 by 2020 and has declined more since. In 2024, only Monaco had a fertility rate of 2.1 or more (it hit it on the nose). Italy was one of the lowest at 1.21.  That means the total native-born population will decline. Unlike the U.S., Europe does not come anywhere close to making up the difference with immigration.

Along the way, as Europe depopulates, the number of working-age people will decline while the older share of the population rises. Based on World Bank forecasts, the working-age population in Europe will decline from 64 percent to 57 percent between 2024 and 2050. The fall in tax revenues will make it impossible to sustain social welfare programs and liberal labor policies. Living standards fall too. This is an accelerant for the brush fire of low productivity, low work hours, and low economic growth.

Eurosclerosis plus depopulation is fatal to the European vision, as the Commission and its experts have long known.

Is This Time Different?

The European Commission and the EU member states are in crisis mode and have swung into action. That didn’t happen in 1998, 2002, or 2012. Reports gathered dust.

Professor Draghi deserves considerable credit for putting forward a deeply documented case on the problems Europe faces and proposing specific steps that the EU needs to take to move to a viable growth trajectory.

His report, however, came during a year when the cracks in the European economy were too hard to ignore. The automobile industry, the pride and joy of Europe, was in dire straits. Growth had come to almost a standstill in the major European economies, especially Germany as well as  the United Kingdom.

Meanwhile, the United States and China were powering ahead and taking a lead in technologies and industries that will define the future of the world.

When Professor Draghi yelled fire, the house was burning down.

Four months after the release of the Draghi report, the Commission had created a roadmap, the Competitiveness Compass, “to reignite Europe’s economy.”

To close the innovation gap, the Commission had a dedicated “EU startup and scale-up strategy” for young companies, an AI initiative to help big companies adopt new technologies, the simplification of rules and laws with the aim of having one set of rules across the EU, and a plan to support the development of new technologies.

Moreover, to increase Europe’s “competitiveness”, it further planned to cut red tape, remove barriers in the single market, provide incentives for risk capital to flow seamlessly across the EU, promote skills and quality jobs, and ensure better coordination between the EU and countries.

There is considerable energy in Brussels and across Europe by governments to take the existential threat quite seriously and to implement solutions. Pressures from the U.S., on one side, and Russia, on the other, have increased the urgency. All this proceeds in parallel in the United Kingdom. Europe has gone, at least figuratively, from nobody cares, to everyone cares, and everyone is worried.

Not surprisingly, the Commission has not acted as aggressively as Professor Draghi wanted, and getting the EU member states to give up sovereignty, make investments and generally go along is a challenge.  It is too early to know how much of what has been sought will take effect. There are already green shoots as entrepreneurs and investors bet on European growth.

Root Causes

Nevertheless, there are significant risks that Europe won’t reignite its economy, will fall further behind more dynamic countries and living standards will stagnate.

To a carpenter, every problem is a nail, and to a technocrat, every problem has a government solution. Industrial policy or state capitalism is back in vogue. The government is driving many of the solutions in Europe, betting on technologies and industries, and advocating European champions. Legitimate worries about being dependent on other countries are encouraging the pursuit of these objectives.

The risk is that Europe will wrap itself around the axle with industrial policies rather than rely on markets to place the right bets. Like startups that turn into trillion-dollar companies, successful industrial policies look great in retrospect. Economists have found evidence that industrial policies have solved some market failures and created considerable benefits. There is no support, however, that industrial policies, taking successes and failures into account, drive economic growth or that countries that choose a greater proportion of government-driven versus market-driven solutions are more successful. Germany’s industrial policies worked well until they didn’t, and China’s pivot back from entrepreneurial-driven markets under Xi has stunted growth severely.

Since the European Commission sounded early warnings about innovation and growth in the mid-1990s, successful digital firms have launched around the world. They were started by entrepreneurs who somehow got funding. Many of these firms began in countries and regions where they faced serious obstacles. The 30-year digital winter in Europe, during which few significant players have emerged, is a puzzle. The excuses, such as fragmentation, regulation and lack of investment, aren’t persuasive, as I argued early last year. Sure, a fully integrated common market would help, but why hasn’t Germany, the third-largest economy in the world, minted some world-class digital champions on its own?

The root causes of Europe’s competitiveness problem are likely deeper.  Reducing red tape makes sense, but the malady is thinking that regulation is the solution to every perceived problem with company decisions.  Fostering an innovation-friendly environment for startups and driving better financing is welcome news, but many Europeans will need to be willing to risk failure—because most will fail—to increase the supply of entrepreneurs, a tiny fraction of whom could create decacorns, much less trillion-dollar companies.  Making Europe less fragmented will grease the skids for firms, but those may be American or Chinese companies who will mainly benefit if the other policies don’t ignite domestic innovation, entrepreneurship, and growth.

European policymakers should be asking, how do we get people to work harder, how do we get people to take risks, and how can we rely on markets more? At least based on public pronouncements and chatter, that doesn’t seem to be the focus of efforts to reignite the European economy. Without devising remedies for the underlying causes, it is doubtful Europe, writ large, will move to a higher trajectory with sustained growth.

In the Long Run We’re Not Dead

John Maynard Keynes famously said, “In the long run we are all dead,” to caution against basing current policy on future results. Fortunately, in the long run most of us are older, but kicking. Someone age 60 today can expect to be around 20 years from now, most every twenty-something will, and almost all babies.

In the long run, we are living in an economy shaped by decisions made years, or decades, before. Our future selves will regret that policymakers didn’t make better decisions back then, and that we allowed this to happen.

The European quagmire of today derives from the failure to address fundamental problems that, with veritable certainty, would have devastating consequences decades hence if not solved.  Well-warned policymakers kept kicking the can down the road.  Choices to work less, play it safe, and rest more on the comfort of regulations than the turbulence of markets were problematic. The shrinking working-age population will eventually pay the tab.

The United States is hardly immune to facing a similar fate. Economists and others have warned for many years that the growth in the national debt is unsustainable. Generous benefits and low taxes look good today.  In the long run, looking back, our future selves may look back and wonder why our younger selves and our politicians didn’t do more.

Time to End the Love Affair

In his January 2024 op ed, Professor Krugman said, “It’s true that real GDP per capita is generally lower in Europe, but that mainly because Europeans take more vacation time than Americans—which is a choice, not a problem.” In my experience, that was a common reaction by my fellow economists to evidence that GDP per capita was lower in Europe than in the U.S. and that the gap was widening. It turns out that the choice not to work was a profound problem.

For those who saw European economic policy as enlightened, it is worth reflecting on what went wrong and taking lessons from that.

 

David S. Evans is an economist who has  more than 10 books and 200 articles, many related to entrepreneurship, platforms, the digital economy, and competition policy. He is chairman and co-founder of  . He has taught at the University College London and the University of Chicago Law School. For more details, see . This article is part of Evans’ Catalyst Series and extends insights developed in his book Catalyst Code: The Strategies of the World’s Most Dynamic Companies, co-authored with Richard Schmalensee.