Economy 2025: Why is Europe falling behind?

Can the continent reverse the trend and catch up with China and the US?

In recent years, a troubling trend has emerged: Europe is falling further behind the United States and China in technological innovation and economic growth. This growing gap is evident across various indicators, from GDP per capita and the market capitalization of new companies to progress in advanced technologies.

A growing gap in competitiveness and prosperity

One of the most striking indicators of Europe’s lag is the GDP per capita difference between the European Union and the United States. In 2010, the US GDP per capita was 47% higher than that of Europe. By 2021, this gap had widened to 82%. Such disparities have tangible consequences for the living standards and economic opportunities of citizens.

Recent figures paint an even bleaker picture. According to 2023 data, US GDP per capita (adjusted for purchasing power parity) stood at $73,637, while the EU’s was only $40,824. This growing disparity indicates an accelerating economic divide between the two regions (see Chart 1).

Chart 1. GDP Per Capita (Constant Prices, PPP)

Additionally, the EU’s share of global GDP is steadily decreasing, while China continues to record the most significant growth (see Chart 2).

Chart 2. Share of Global GDP (PPP): US, EU, and China

The productivity problem

A particularly worrying trend is Europe’s lagging productivity. As Nobel laureate Paul Krugman stated in 1997: “Productivity isn’t everything, but in the long run, it’s almost everything.” Long-term competitiveness is nearly impossible without strong productivity growth. While factors like currency devaluation can temporarily improve competitiveness, the long-term survival of businesses largely depends on resource efficiency and technological advancement — in short, productivity. Unfortunately, the EU is trailing in this area. Over the past two decades, European productivity per hour worked has fallen significantly behind that of the US (see Chart 3).

Chart 3. GDP Per Hour Worked (Constant Prices, PPP)

Declining export competitiveness

Europe’s economy is export-oriented. A lack of competitiveness has severely impacted the EU’s global trade position. Over the past two decades, the EU’s share of global exports fell from 19% in 2002 to less than 15% in the early 2020s. This decline is particularly evident in critical sectors such as machinery, transportation equipment, and other manufacturing industries, where Europe once dominated.

China, now the world’s largest exporter of manufactured goods, and the US, leading in digital technologies, have further pushed Europe out of its traditional strongholds. While the absolute value of EU exports has increased over this period, it has grown more slowly than global trade, leading to a relative market share decline (see Chart 4).

Chart 4. EU’s Share in Global Exports

Impact on living standards and social programs

Declining competitiveness and slower productivity growth have led to significant consequences for wage growth and living standards. Real disposable income in Europe has grown almost twice as slowly as in the US since 2000, leaving many Europeans relatively poorer than Americans.

This slowdown also directly affects Europe’s ability to fund social programs. With stagnant productivity, tax revenues shrink, limiting governments’ capacity to invest in healthcare, education, and social security. Projections indicate that without significant productivity improvements, European governments may struggle to meet rising public spending demands, particularly as populations age and the share of older citizens grows. This could force difficult choices, including cutting social benefits or increasing taxes on a shrinking workforce.

The European Central Bank has warned that without productivity improvements, Europe faces a future with fewer resources for social spending and higher public debt. Such a scenario would severely strain the social sector, long a hallmark of Europe’s identity.

The technological gap

Even more alarming is the gap in innovation and entrepreneurship, particularly in the creation of high-value companies. Over the past 50 years, the United States has far outpaced Europe in building new corporate giants. The numbers are staggering: the US has produced 68 companies worth over $10 billion, with a combined market capitalization of nearly $30 trillion. In contrast, Europe struggles to keep pace, with far fewer large-cap companies and a combined value 70 times smaller (see Chart 5).

Chart 5. Companies Worth Over $10 Billion (Founded in the Last 50 Years)

Simultaneously, China has emerged as a formidable competitor to the US. While the exact value of Chinese companies founded in the past 50 years is unknown, estimates suggest approximately $10 trillion, including names like Alibaba, Temu, BYD, Shein, TikTok, Huawei, and Xiaomi. Alarmingly, no European company founded in the last 50 years has made it to the list of the world’s top 100 most valuable companies. The last European representative in the global top 100, SAP, was founded in 1972.?

The technological lag in Europe is particularly evident in the "new digital and exponential economy," where Europe's delays go beyond economic parameters into cutting-edge, modern areas:

1. Artificial Intelligence (AI): The gap in AI investment is particularly striking. For 2024, the US is expected to invest about $100 billion in AI, which is 50 times more than the expected €2 billion in Europe.
2. Space technology: In 2022, NASA and the US Department of Defense invested over $62 billion in space technology. China’s government support amounted to $12 billion, while the European Space Agency’s 2024 budget was only €7.79 billion.
3. Deep tech: Over half of the recently established deep tech companies are located in the US. In 2022, the US invested $51 billion in this sector, more than double Europe’s approximate investment of $20 billion.

When looking at other technology parameters—such as leading technology companies, the ten largest cloud service providers, or producers of chips below 10 nanometers—Europe is practically absent on the global map.

Failure in business carries greater social stigma in Europe than in the US, discouraging bold, innovative ventures. This cultural attitude toward risk and failure slows the development of dynamic startup ecosystems, which are essential for technological breakthroughs and economic growth.

Even if we step away from high-tech fields and focus on other parts of the economy, such as digitalization in small and medium-sized enterprises (SMEs), which form the backbone of Europe’s economy, the results are also concerning. The European Union aims for 90% of SMEs to reach a basic level of digital intensity by 2030, but as of 2023, progress lagged by more than 30 percentage points. Projections show that by 2030, only 66% of European companies will use cloud services, 34% will use big data, and just 20% will adopt artificial intelligence—far below the target of 75%.

This inability to create and scale innovative businesses has profound consequences for future economic growth and technological leadership. This was recently highlighted in a report by Mario Draghi, who called for closing this gap. But what are the roots of Europe’s decline, and what path could lead to recovery?

Roots of Europe’s technological lag

Several factors contribute to Europe’s technological shortcomings:

1. Risk aversion: Europe’s business environment is often more conservative, with less appetite for high-risk but high-reward ventures that drive innovation. This is reflected in venture capital investment levels—European investments totaled €74.3 billion in 2023, while the US reached $234.9 billion. Additionally, business failure carries greater social stigma in Europe, discouraging bold, innovative projects and slowing the development of dynamic startup ecosystems critical for economic growth.
2. Fragmented market: Despite integration efforts, Europe still lacks a truly unified market, making it harder for companies to scale quickly. For example, an entrepreneur in Slovakia struggles to access a market of 500 million people as a cohesive whole. In contrast, an entrepreneur in Ohio immediately has access to the unified US market of over 300 million people. In the digital and exponential economy, scale is everything. If Europe doesn’t resolve this problem, it will lose the race not only to the US and China but also to emerging challengers like India.
3. Brain drain: Many successful European entrepreneurs and researchers move to the US in search of better funding and opportunities. This is evident from the fact that around 4.7 million highly educated Europeans live in America, and two-thirds of European science and technology graduates express a desire to emigrate. Salary differences exacerbate the problem—for instance, an Italian researcher reported earning nearly three times as much at New York University than they would in Italy.
4. Regulatory barriers: Europe’s stricter regulations, although often well-intentioned, can stifle innovation and slow the adoption of new technologies. Many major innovations (such as Apple’s AI developments and OpenAI’s new models) bypass Europe due to regulatory constraints. Recently, transitional companies like Qatar Energy have highlighted difficulties in supplying Europe with critical resources due to complex regulatory barriers.
5. Geopolitical challenges: Europe finds itself in an unenviable geopolitical position. If Europe were a company, it would be one in conflict with its largest raw materials supplier (Russia) and its biggest customer (China). A significant portion of European exports, particularly in basic industries and high technologies, depends on China. However, China’s current economic situation, political tensions, and tariffs further complicate this relationship. At the same time, the conflict with Russia raises raw material prices, and US protectionism limits market access. In this context, Europe appears “trapped,” with no clear new markets on the horizon.

A path forward

To close the widening gap, Europe must take decisive steps:

1. Increase investments in research and development: Both the public and private sectors must significantly boost innovation funding.
2. Foster entrepreneurship: Create a more favorable environment for startups, including easier access to venture capital.
3. Unify the digital market: Remove remaining barriers to create a truly unified European market for digital products and services.
4. Retain talent: Develop programs to retain top researchers and entrepreneurs in Europe and attract global talent.
5. Simplify regulations: Strike a balance between consumer protection and fostering innovation.

The stakes are enormous. If Europe fails to address its technological gap, it risks further falling behind in the global economy, with far-reaching consequences for its prosperity and influence on the world stage. The time to act is now.

***This article was originally published on Velike Pri?e on 26 December 2024, and has been translated into English. You can find the original article here.***