Europe is in steep structural economic decline. The decline is now so embedded that Europe is at a crossroads. Either she rediscovers her dynamism, or the continent faces increasing global marginalisation and a relative fall in living standards.
Just a generation ago, the European Union accounted for almost a quarter of global GDP on a purchasing power parity basis. It was the world’s largest bloc. Today that has fallen to one seventh of world GDP, having been overtaken by both the US and China.
Perhaps more strikingly, if current rates of growth are maintained, within a dozen years or so, Indian GDP will be larger than all Europe’s. While European wealth remains far higher per head, the gap is rapidly closing. Wealth and influence are linked. Failure to address the fundamental reasons for the EU’s underperformance would simply ensure marginalisation.
The critical point is that Europe has ceased to grow. Over the last 20 years, EU growth has barely averaged 1% per annum. Some argue that this is an inevitable consequence of being a rich region with inevitable ‘catch-up’ from developing markets; but this line of argument does not explain why growth in other advanced economies has been far superior.
Average growth in Australia, Canada, the US and the OECD has been more than double the European level. To put this in simple context, if the EU had grown at the same rate as the US since 2005, the European economy would be $3 trillion greater today, equivalent to $8,500 per head in lost opportunity. Growth rates thus matter greatly.
Why has this happened? A paper released by us at the Growth Commission highlights several primary causes.
Firstly, no other region has a public sector, tax or regulatory framework remotely as complex and onerous as the EU’s.
Second, EU public sector balance sheets have generally weakened materially over the last 20 years, reducing flexibility and potentially risking monetary stability.
Third, European cost bases are uncompetitive globally, primarily caused by relatively very high energy costs, rigid employment regulation and an overall regulatory environment designed for protection at the expense of innovation.
Fourth, European economies generally have a bias to legacy industry over newer higher-growth markets.
The EU is the global statist continent. Public spending in the EU averages just under half of GDP, some ten percentage points higher than the US and twenty percentage points higher than Asian competitors.
Similarly, EU tax rates average 42% of GDP, leaving the continent at a significant tax disadvantage. Our paper models average achieved growth and state size and finds a strong inverse correlation. States with lower public spending grow faster. One might politically choose a high-level welfare net – but in doing so there is a prosperity price and Europe is suffering that price.
Add into the mix very high levels of social provision, generally high minimum wages and energy prices that are almost double US averages, it is little wonder European growth has been elusive.
Perhaps most striking, however, is the near total dominance of the US and, to an extent, China, in new technology. Simply looking at the 100 largest global technology companies by market capitalisation shows that only four are European.
To the EU’s credit, it commissioned former European Central Bank President Mario Draghi to examine why European competitiveness was lagging. However, while we agree with much of his analysis relating to the scale of the challenge, the same cannot be said of his conclusions and recommendations, which can largely be summed up as more centralisation and more Europe.
However, while Europe in general may be failing, within that wider decline there are some green shoots. The real divide on the continent is between the failure of ‘Old Europe’ and the growing success of the Visegrad nations, Slovenia and the Baltic states. If they maintain current growth rates, most of these eastern European countries will have overtaken ‘Old Europe’ in terms of GDP per capita within a decade. This, from their starting place 30 years ago, is an extraordinary achievement.
How have they done it? There are of course many factors at play, but in each we find public debt levels, taxation and social spending which are all materially lower than those of ‘Old Europe’. A further observation is the differential approach to migration policy. While as a generalisation ‘Old Europe’ has encouraged inward migration – often from outside Europe – Visegrad countries have adopted the opposite strategy. Indeed, in many cases migration flows have been negative, thus making the per capita GDP growth even more impressive.
Visegrad countries tend to be more cohesive and are less reliant on state-based welfare budgets. They have developed networks which increase the incentive to work, a lesson ‘Old Europe’ would do well to understand.
The EU is clearly aware theirs in aggregate is a high-cost, high-tax, high-regulation model. While Europe had been cognisant of its consistent underperformance, there was an unspoken strategy which had the tacit support of previous US Presidents and other developed Anglosphere countries: this was to attempt to export a high-cost model globally via net zero legislation and other regulatory standards, while encouraging inward migration to dull labour costs in an attempt to insulate Europe from global pressures.
This strategy may well have been the management of decline, but had some credence when other major advanced countries tacitly supported it. But the election of President Trump has made this untenable. We now live in a world where competitive advantage is key.
As an example, regardless of one’s perspective on climate change, adopting a strategy which is roundly ignored by the largest global carbon emitters – the US, China, India and Russia – makes little economic or environmental sense. European industry requires competitive energy input costs; current low carbon solutions simply do not offer that. Ultimately the EU needs to re-build global competitiveness if it wishes to arrest decline.
Our paper makes nine key recommendations designed to rebuild competitiveness and entrepreneurial advantage. However, our overarching recommendation is to outline a ten-year plan to reduce the size of the public sector’s share of the economy by 5% by 2035 and a further 5% by 2045, which would take the public sector to around 35% of European GDP, roughly where the US is today.
The private sector is a far more efficient allocator of capital than the state. By recycling spending control into tax cuts, we can create a virtuous circle rather than the current doom loop of despair and decline. Coupled with a focus on reducing energy prices, liberalising labour markets and focusing on encouraging gainful employment over welfarist strategies, Europe could regain its mojo – and quite quickly.
Wrapping oneself in the current comfort blanket is a delusion. It underwrites decline and entrenches the current doom loop. Given the scale of underperformance, breaking that cycle is urgent – but the good news is that many of the lessons can already be found from within the continent: go east to Visegrad, young man.
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