Over the past forty years, the growth differential between the United States and Europe has continued to widen, with a stall worsening after each crisis. While the GDP gap (in constant 2015 dollars) was only 8% in 1985, it stands at 38% in 2022. How can such an evolution be explained?
Several factors are at work. Part of the recent stall is due to the increase in Europe’s energy bill – and, consequently, production costs – linked to the shutdown of cheap Russian gas supplies. As the world’s largest producer of oil and gas, the United States has not suffered from the energy shock resulting from the Russia-Ukraine conflict, which has even boosted American exports of liquefied natural gas to Europe.
Double standards
A second cyclical factor is the fiscal policies put in place in response to crises. While the United States and Europe have supported households during the Covid-19 pandemic, the US government’s support has been disproportionate, with a budget deficit as a percentage of GDP twice as high as that of the euro area. Households have been able to accumulate savings that they are now spending, driving up US growth. Added to this is the vast plan – Inflation Reduction Act – of nearly $370 billion in subsidies in the green technology sector launched by Joe Biden in 2022 aimed at supporting American companies in return for an obligation to produce locally and/or locally content goods used in their production.
Monetary policy has also played an important role this year. Both the U.S. and European central banks have raised interest rates in response to inflation, even though the nature of inflation is different. On the American side, the rise in prices is the result of the dynamism of consumption, while on the European side it comes from the energy crisis. In the latter case, an increase in interest rates depresses consumption, dragging down European growth even further.
However, these cyclical factors should not obscure the structural reasons for Europe’s lag in terms of growth. A first major factor is demographic, with, in particular, a working-age population that is growing in the United States and stagnating in Europe, a factor accentuated by a greater ageing of the European working population.
Less union, less innovation
The second structural element is that Europe is fragmented in the sense that it is not a fiscal union and must therefore limit the widening of its deficit in order to avoid falling prey to the financial markets. This is not the case for the United States, where the dollar remains the international reserve currency, which allows it to pursue large-scale fiscal support policies. The size of the domestic market is a third structural factor. While the US market for goods and services is integrated, the euro area market is more fragmented, which limits the effects of scale of production.
Fourthly, spending on research and development is much higher in the United States than in Europe, where there is a glaring underinvestment in research and development, boosting technological innovation – an element reinforced by highly developed research partnerships between universities and US companies. All tech sectors are showing very strong dynamism in the United States, leaving Europe lagging behind in terms of productivity. A fifth, crucial factor relates to the level of higher education, which is much higher in the United States than in Europe.
All in all, there are many reasons for Europe’s lagging behind in terms of growth, and policies need to be put in place to boost research, innovation, demography and education – the latter being a key determinant of long-term competitiveness.