How Did Europe Get Left Behind?

If the United Kingdom or France joined the United States, they would become the poorest states in the country, with a GDP per capita lower than even Mississippi. Germany would be the second poorest. For most of the second half of the 20th century, Europe and the U.S. rivaled each other in GDP. In 2008, the EU and U.S. had GDPs of $14.2 trillion and $14.8 trillion, respectively. Closing 2023, the EU has seen little growth, with a GDP of around $15 trillion, while the U.S. has marched ahead to a GDP of $27 trillion.

The EU GDP growth clocked in at 0.1 percent for 2023’s last quarter, a small fraction of the U.S.’s 3.4 percent during the same period. The UK fell into recession in the back half of last year, but the French economy looks to an optimistic forecast of 0.9 percent growth for 2024 to put six months of stagflation in the rearview mirror. While inflation has come down to just above 3 percent, similar to the U.S., the European Central Bank’s rate hikes have taken a larger toll on the nation-states.

One reason Europe has fallen behind? A spending handicap.

After the 2008 Global Financial Crisis (GFC), which originated in the U.S. real estate debt and loaning markets in 2007 and triggered a recession in Europe in the second quarter of 2008, the U.S. and Europe increased stimulus spending and access to liquidity. This increased the debt-to-GDP percent in the U.S. from 61.8 percent in 2007 to 82.0 percent in 2009 and from around 60 percent to 73 percent for the average EU government in the same time period. Because the U.S. benefits from the dollar’s reserve currency status, it can comfortably borrow large amounts at relatively low rates due to the high demand and liquidity of the U.S. treasury market. Europeans cannot take advantage of the same privilege, and thus saw a growing debt crisis in the years following the GFC in countries like Ireland, Greece, Portugal and Spain, which were having trouble paying back the debt their governments had borrowed. The crisis peaked in 2010 when Greece’s sovereign debt was downgraded to junk by rating agencies. Numerous European countries required bailouts from the IMF and EU and instituted new austerity policies that limited public spending.

Such austerity policies became handicaps in dealing with future crises: during the COVID pandemic, the U.S. distributed $5 trillion in stimulus, while the U.K. and Germany spent $500 billion, France spent $235 billion, and Italy $216 billion, as per Moody’s. Though controversial then and a contributor to the steep inflation that followed, the cash cascade likely helped the U.S. spend itself out of a recession. Household savings were at dramatic highs following the pandemic, allowing consumer spending—contributing to 70 percent of the U.S. GDP—to be strong through the Federal Reserve rate hikes. Post-pandemic, the U.S. has continued its public investment streak with the Infrastructure Investment and Jobs Act, CHIPS Act and Inflation Reduction Act, contributing another $2 trillion to its manufacturing and construction sectors and far exceeding EU contributions.

The privileged ability to spend through the dollar’s global reserve status, though amounting to a national debt of unprecedented size, has allowed the U.S. to run circles around Europe in public spending and crisis-time stimulus while subverting debt crises.

A variety of other factors

The explanation of why the U.S. economy has outpaced Europe cannot be reduced to just one reason. Broad structural differences are at play: the U.S. enjoys a large single free trade zone, where capital and labor can unquestionably cross state boundaries without additional tax, tariff or currency conversion costs. Brexit and many other hurdles have tested the EU’s free trade zone. The U.S. is also unusually entrepreneurial: more start-ups are founded in the U.S. than in the European Union, and the U.S. leads the world in VC funding. Eight of the ten largest companies globally by market cap are American; none are European. The U.S. is also the globe’s most attractive place for investment, making the New York Stock Exchange larger than every European stock exchange combined (and that is just one of the U.S.’s equity exchanges). Recent events also serve as obstacles: energy embargos on Russia have been far more taxing on Europe, with the cost of electricity far higher than in the U.S. and not yet returning to pre-sanction levels.

Recent events also serve as obstacles: energy embargos on Russia have been far more taxing on Europe, with the cost of electricity far higher than in the U.S. and not yet returning to pre-sanction levels.

What’s next?

European leaders are eager to act. “We’re in danger of falling out of touch. There is no time to waste. The gap between the European Union and the U.S. in terms of economic performances is becoming bigger and bigger,” former Italian Prime Minister Enrico Letta admitted in a recent report.

Last week, European leaders gathered to discuss the “European Competitiveness Deal,” aimed at helping the continent catch up to the U.S. and China. The policy would upskill workers, make Europe more attractive for capital, reduce the cost of energy and strengthen trade, as per the European Commission. Among Europe’s long-term challenges is that its leaders ultimately need to make their markets an attractive place for Europeans to invest their savings; French President Emmanuel Macron noted that “Europe has more savings than the United States of America … and every year, around 300 billion euros of these savings go to finance the American economy.”

The U.S. greatly benefits from a stronger Europe, giving it an ally to help curtail Chinese and Russian influence. However, the U.S. has recently levied tariffs against Europe while implementing trade and subsidy policies. European leaders have criticized it as protectionist, reducing Europe’s global competitiveness and growth potential.