Jolt Growth or Invite Geopolitical Irrelevance

"It is as if Europe has become stuck in a rut" was the conclusion of a review led by Andre

Sapir in 2003. A little over two decades later, it’s hard to
imagine former European Central Bank President Mario Draghi’s
report on the future of European competitiveness concluding much
different when it lands in June.

We estimate the gap that has emerged between the European
and US economies since the year 2000, reached about 18% of
potential GDP in 2023 - more than €3 trillion (around $3.2
trillion). Our long-term forecasts show that the shortfall is on
track to reach almost 40% by 2050. Without a major jolt, the
European Union will become a much-diminished global power,
leaving the US battling it out with China for economic
supremacy.

In 2012, with Europe’s sovereign debt crisis in full swing, it
fell to Draghi to save the euro. Now, he's being asked to rescue
Europe itself. European Commission President Ursula von der
Leyen has asked him to prepare a report on the future of the
region's competitiveness – it's due to be published next month.
Without a word having yet been printed, one takeaway from the
report is already known — radical change is needed.

Europe has long been on a path of relative economic decline.
We estimate that potential output – the level of GDP that could
be sustained if all resources were put to work, while keeping
inflation stable – has grown by about 1.2% on average since
2000, shortly after the inception of the euro. For the US, the
Congressional Budget Office estimates it has grown by a little
more than 2% a year since then, creating a wider divide in
economic clout.

Rather than the number of people available to work, the main
reason for the emergence of that gap is a shortfall in
productivity - the efficiency with which people do their jobs.
In part that reflects a failure of European businesses to adopt
new technologies, relative to their peers in the US.

Digging into the country detail shows that all four of the
euro area’s largest economies have a serious problem, but
southern Europe has driven an outsize share of the shortfall
relative to the US.

Whatever solutions are cooked up to solve Europe’s economic
malaise, a big focus needs to be placed on raising productive
potential in Italy and Spain. The EU’s recovery and resilience
facility (RRF), a scheme aimed at boosting the economy’s supply
potential, has disproportionately benefited these countries and
there’s plenty more yet to be spent. But we do not consider that
this initiative will have transformational impacts on their
growth trajectories.

To understand what’s at stake, it’s worth asking what would
have happened if the euro-area economy had kept pace with that
of the US since the inception of the single currency. With the
economy as much as €3 trillion bigger, we estimate income per
worker could have been about €13,000 higher.

And, assuming defense spending of 2% of GDP as a baseline (in
line with NATO guidance), a bigger economy would also have
created space for an extra €64 billion of military outlays in
2023.
* Looking ahead, Europe’s productivity problem will be
compounded by an aging population. Unless something is done to
turn things around, that will mean the gap only gets bigger
between 2023 and 2050.


Putting it all together, the euro area’s first five decades
could be marked by an almost 40% gap emerging relative to the US
economy, implying a roughly $11 trillion annual shortfall in GDP
by 2050, in today’s prices. Put plainly, that would be a
disaster in economic management and threaten the EU’s position
at the top table in geopolitics.

The scale of the problem shows that von der Leyen was right
to have commissioned the review. Draghi will no doubt have
constructive things to say about how the bloc should position
itself as it competes globally and some of the big reforms
needed to do so. But we should recognize that Europe’s growth
issues long-predate the rise of geopolitics and the recent
embrace of strategic industrial policy.

The widening gap between the European and US economies
since Sapir’s review was published in 2003 is a damning
indictment of policy making at the EU and national level in the
years that followed. Reviews aren’t just for reading, they need
to be acted upon.

Source: Bloomberg