A deeper and more integrated capital market in Europe could benefit Estonian startups and provide funding for the expansion of existing businesses. Deregulation and cutting red tape could also help Estonian companies, writes Karsten Staehr.
One side effect of getting older is that I’ve experienced the same things many times. I’ve seen countless Christmases and New Year’s celebrations and while there are occasional differences, they’re also quite similar. The same applies to discussions about Europe’s competitiveness and economic growth.
Why is Europe falling behind and what can be done?
The debate over Europe lagging behind the United States and China picked up new momentum at the end of last year, spurred by two European policy proposals. The European Central Bank put forward ideas for simplifying the European Union’s banking regulations to create more integrated financial markets within the EU. The European Commission adopted an action plan aimed at reducing red tape and easing regulation, with the goal of cutting administrative costs for businesses and making it easier for new companies to succeed.
Europe falling behind
From the end of World War II until the 1970s, economic growth in European economies was generally higher than in the United States. Europe had to rebuild after the war, whereas the U.S. economy had suffered far less damage. By the 1970s, most European countries had been rebuilt and some had even reached U.S. income levels.
However, the oil price shocks of the 1970s hit the European economy much harder than that of the U.S. Beginning in the early 1980s, the U.S. economy started to grow faster than Europe’s and that trend has more or less continued ever since.
There are many factors behind Europe falling behind the U.S. One simple reason is that U.S. economic growth has outpaced Europe’s because the U.S. population has grown faster, thanks to higher birth rates and greater immigration.
Another factor is that the number of hours worked by the average American has remained broadly stable over time, while Europeans — Estonians included, over the past decade — have been working less. Americans have opted to work long hours, while Europeans have traded higher incomes for more time with their children, families and leisure activities.
It’s also worth noting that Americans spend a disproportionately large share of their income on healthcare, yet die much earlier on average than people in Western Europe. In fact, Americans live about as long as Estonians, but healthcare spending in the U.S. is several times higher.
Despite all of this, there’s no denying that output or income per hour worked is higher in the U.S. than in Europe and hourly productivity in the U.S. has grown faster than in Europe over several decades. Broadly speaking, U.S. productivity is on par with that of the richest Nordic countries but significantly exceeds hourly productivity in Germany, France and Italy. That gap has only widened in recent decades, as U.S. productivity has grown faster than in most European countries.
The so-called U.S. economic miracle since the 1980s has largely been driven by the rapid expansion of the IT sector. Virtually all major IT innovations have originated in the U.S. and have often made both the owners and employees in the sector very wealthy. Microsoft, Google, Facebook and Apple all have their headquarters in the U.S. If a European IT company is successful, it’s often bought by an American firm, as we saw with Skype here in Estonia. The new artificial intelligence revolution is being born in the U.S., China is playing second fiddle and no one is looking to Europe for AI innovation.
The U.S. IT sector is undeniably successful, but it’s also worth pointing out that Europe is highly competitive in many other industries, often matching or exceeding the U.S. in performance.
Europe is very competitive in producing pharmaceuticals, machinery, cars, aircraft, food, maritime transport and more. The productivity problem in Europe is largely concentrated in the IT sector, but it’s fair to say that this is, in fact, a major issue, given how important the sector is and how much more important it is likely to become in the future.
New methods
As I hinted earlier, concerns about Europe falling behind are nothing new and the same goes for the ideas aimed at improving the region’s competitiveness and economic growth. The 2000 Lisbon Process aimed to make Europe the world’s most competitive and dynamic knowledge-based economy. A 2024 report by Mario Draghi concluded that little has changed since the Lisbon Process and recommended a greater focus on investment, industrial policy and energy.
The recent proposals from the European Central Bank and the European Commission are valuable and may contribute to a more dynamic European economy and stronger growth. However, the impact is unlikely to be significant, as the experience of previous measures leaves little room for optimism. Europe still struggles with the economic gap.
What about Estonia? Since regaining independence in 1991, Estonia has done well and the income gap with Western Europe has narrowed. But economic growth has been relatively slow since the global financial crisis of 2008 and especially in recent years. In that sense, Estonia has much in common with the rest of Europe.
A deeper and more integrated capital market in Europe could benefit Estonian startups and provide financing for the expansion of existing businesses. Deregulation and reducing bureaucracy could also help Estonian companies, though certain regulations and standards remain useful because they help ensure a level playing field for competition.
Estonia has a relatively large IT sector, which offers good jobs and high salaries. The economic success of the U.S. has been largely driven by its IT sector, so could the same be possible in Estonia? U.S. tech companies are often founded by people educated at top universities like Harvard, Stanford and the Massachusetts Institute of Technology.
What’s notable is the synergy between top U.S. universities and private IT companies: universities train engineers at the highest level and companies generously support these institutions. University and doctoral-level education often receive too little attention in Estonia, but this may be one area where Estonia doesn’t need to wait for progress at the European level.
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