Europe’s economy is being outpaced by both the U.S. and China. The continent is deindustrializing and turning into a museum for tourists and migrants, with no relevant role left to play for the native middle class. What are the implications for investors?
Europe is in an existential crisis. The European Union has set sky-high ambitions for the green transition, mass immigration, and idealistic foreign policy. Unfortunately, the level of ambition is disproportionate to the continent’s economic capacity.
Unless radical and effective action is taken, Europe will be forced to scale back its ambitions and risk losing its raison d’être. This is the grim warning in the report on Europe’s future competitiveness from Mario Draghi, which exposes Europe’s productivity gap, digital divide, energy crisis, and economic decline against the US and China.
The last time Draghi took center stage, as president of the European Central Bank, he promised to do «whatever it takes» to save the euro, when government bond yields in the so-called PIIGS countries (Portugal, Italy, Ireland, Greece, and Spain) were spiraling out of control in 2012, in the aftermath of the great financial crisis. He has since served as the technocratic Prime Minister of Italy from 2021 to 2022, before being commissioned to investigate Europe’s competitiveness.
The advantage of a financial crisis is that it immediately grabs everyone’s attention. And it can be solved, as Draghi showed, by injecting unlimited liquidity into the system. An economic crisis, on the other hand, comes quietly and stealthily. It can go unnoticed until it’s too late. And it rarely has a quick fix.
Reality Check
If you read European newspapers or listen to speeches from European politicians, you might easily be misled into thinking that there is no crisis at all. Europe will soon succeed in freeing Ukraine from Putin’s iron grip. Europe will secure a free Palestine. Europe will succeed in integrating millions of migrants from the Third World—and Ukraine. And Europe will lead the green transition, from a fossil-based to a decarbonized and digital economy.
The bureaucrats in Brussels seem more concerned with the situation in the U.S., where Donald Trump once again threatens to tear down the republic. With thinly veiled schadenfreude, the liberal commentariat gloats about how foolish Americans must be, voting for the Orange Man and still drinking from plastic bottles without attached caps. Meanwhile, we happy Europeans have the EU to guide us into a safely regulated and enlightened future. If only it were that simple.
The fact is, a large and growing wealth gap has opened between the U.S. and Europe. The fact is, Europe’s economy is dying, although both parliaments and editorial boards across the continent have yet to grasp the seriousness of the situation.
The Productivity and Growth Gap
Since the early 2000s, Europe has experienced sluggish growth compared to its transatlantic counterpart. Real disposable income per capita in the U.S. has grown almost twice as fast as in Europe since the turn of the millennium. Draghi’s report reveals that this is not a temporary challenge but a deeply rooted problem.
The gap between the EU’s and the U.S.’s gross domestic product (GDP) has gradually widened from just over 15 percent in 2002 to 30 percent in 2023, while in purchasing power parity (PPP) terms, the gap is now 12 percent. The gap in GDP per capita has grown less due to faster population growth in the U.S., but it remains significant, with PPP figures showing an increase from 31 percent in 2002 to 34 percent today.
Europe’s productivity level almost closed the gap with the U.S. in the late 1990s. From only 22 percent of U.S. levels after World War II, it rose to 95 percent in 1995. However, today, labour productivity in Europe has fallen back to 80 percent of U.S. levels. Around 70 percent of the gap in GDP per capita between the U.S. and Europe is explained by lower productivity in the EU.
If current trends persist, growth in Europe is expected to stall completely. If the EU maintains its average productivity growth since 2015 of 0.7 percent, it will only be enough to keep GDP constant until 2050. After that, the economy will shrink. By 2040, the EU’s workforce is expected to shrink by nearly two million workers annually, while the ratio of working-age people to retirees is expected to fall from around 3:1 to 2:1. This is incompatible with maintaining the EU’s generous welfare states.
Without action, Draghi warns, Europe will face tough trade-offs, including scaling back its welfare systems, environmental ambitions, and/or foreign policy objectives.
The Digital Gap
One of the most concerning aspects of Europe’s economic crisis is its inability to keep pace in the digital economy. This is the explanation for most of the productivity gap across the Atlantic. While the U.S. has created giants like Apple, Amazon, Microsoft, and Google, Europe has failed to foster a competitive digital technology sector. The report points out that only four of the world’s top 50 tech companies are European.
In fact, not a single EU company with a market value of over €100 billion has been founded in the last 50 years, while all six U.S. companies with a valuation over €1 trillion were founded in that period.
Venture capital (VC) also paints a bleak picture. In all stages of development (seed, early-stage, and later-stage), European startups receive only 20 percent of the funding that U.S. startups do. As a result, many European entrepreneurs seek funding from American venture capitalists and scale up in the U.S. market. Between 2008 and 2021, nearly 30 percent of unicorns founded in Europe—startups valued at over $1 billion—relocated their headquarters abroad, with the vast majority moving to the U.S. Europe is therefore suffering from a significant brain drain of entrepreneurial talent, further widening the technological gap with the U.S.
Energy Crisis and Industrial Decline
Energy costs are another major challenge for European industries. European companies pay between 2-3 times more for electricity and 4-5 times more for natural gas compared to their American counterparts. Much of this is due to the EU’s decision to wean itself off dependency on Russian gas. The decision to stand up for a free Ukraine in the face of Putin’s aggression was made with noble intentions. However, it stands as a symptomatic example of how the EU’s political will exceeds its economic capacity. With no affordable alternatives to Russian gas, Europe’s plunge into the Ukraine conflict without an energy plan B has accelerated the region’s economic decline, without achieving the goal of strangling Russia’s petroleum revenues. Meanwhile, Europe’s industrial production is crumbling under the pressure of soaring energy costs.
The automotive industry was once Europe’s pride. But in this sector, too, the continent’s comparative advantage is eroding. Vehicle production in the EU has fallen by 25 percent since 2000, while China is rapidly overtaking Europe in the race for electric vehicles. Similarly, in the pharmaceutical sector, there are exceptions like Novo Nordisk, but overall Europe is being outpaced by the U.S., where investment in research and development is twice as high.
Lost Opportunities in Space and Defense
In sectors like space and defence, Europe’s inability to compete is obvious. The EU is expected to account for only 10 percent of the 6,500 satellites to be launched globally between 2023 and 2032. Moreover, the EU has had to rely on rockets from bogeyman Elon Musk’s SpaceX to launch satellites for its strategic Galileo space program.
In defence, Europe lags far behind the U.S. As history professor Adam Tooze points out, the EU’s defence industry suffers from a capacity gap on two fronts. The EU spends only one-third of what the U.S. does on defence, and much of this funding is misallocated, focusing on outdated technologies rather than innovation. Without significant investment in new technologies, Europe’s defence industry risks becoming obsolete.
It is also undeniable that much of the success of the U.S. technological sector was built on the foundation of public investments in the defence industry after World War II and during the Cold War, through programs such as DARPA. At the same time, we see that other countries with large-scale investments in defence, such as Israel, have succeeded in developing globally competitive tech sectors. So, it is tempting to asj whether Europe’s underinvestment in defence has not only made the continent militarily impotent but also technologically and industrially impotent?
Political Obstacles to Reform
Although Draghi’s report proposes bold reforms—including increased investments in research and development (R&D) and the integration of Europe’s fragmented capital markets—there is a lack of political will across the EU. Draghi calls for €800 billion in investments for digitalization, green energy, and industrial modernization, equivalent to 4.5 percent of the EU’s GDP in 2023, per year. In comparison, the post-war Marshall Plan amounted to 1-2 percent of GDP per year. Yet, it is as unlikely that the capital will be raised as it is that member states will agree on how to invest it.
Economics professor Howard Davies argues that the absence of a pan-European capital market is a hindrance to European businesses. But efforts to unify capital markets are hampered by national interests, and the creation of a stronger European securities regulator, similar to the SEC, remains a distant goal.
European politicians often become their own worst enemies. Andrew McAfee, who leads MIT’s digital economy initiative, disagrees with Draghi’s recommendation to increase public R&D funding. Instead, McAfee argues that overregulation, not underfunding, is the primary bottleneck for European innovation. He claims that Europe’s technological regulations stifle growth and that a more laissez-faire approach, similar to the U.S., is essential to foster tech startups and attract venture capital. He points to the alphabet soup of new laws and regulations introduced by the EU in the last decade: GDPR in 2018, the DSA in 2022, the DMA in 2023, and the AI Act in 2024. McAfee is echoed by tech entrepreneur Pieter Levels, who believes the EU should scrap all the newly enacted laws associated with the recently departed European Commissioner for the Internal Market and Elon Musk’s nemesis, Thierry Breton.
Europe’s Path Forward: Innovation or Decline
Draghi’s report is a wake-up call for Europe’s leaders. Without decisive action, Europe risks further economic and technological decline. But will the politicians wake up? This writer has little faith that they will rise to the occasion. The only leader who seems to have glimpsed into the palantír and foreseen Europe’s downfall is Emmanuel Macron. During a panel discussion at the Berlin Global Dialogue last Wednesday, the French president gave a dire warning: “Our previous model is over. We overregulate and underinvest. In the next two to three years, if we follow our classic agenda, we will be out of the market.”
As Black Swan author Nassim Taleb wittily points out: «France went from being an engineering powerhouse to making handbags. Why? Technology is too competitive, with low margins; leave it to the Chinese and sell them luxury handbags, champagne, and perfume.» He has a point. In fact, LVMH is Europe’s second most valuable company, worth three times as much as the high-tech Airbus.
Europe is becoming a museum. A place where wealthy Americans and Chinese come to admire the cultural treasures of a late Civilisation. And a place where poor migrants from the Third World come to scrape and scavenge what remains of the wealth of yesteryear.
As Draghi warns, without significant increases in productivity, Europe will not be able to maintain its welfare model, meet its climate goals, or remain an independent global player.
Sadly, there is little to suggest a European productivity miracle that could offset the two demographic time bombs the continent is facing: the ageing of its native citizens on the one hand and mass immigration of low-productivity migrants from underdeveloped countries on the other hand.
The lights won’t go out overnight. It will be a slow and agonous process. For Bernard Arnault and other vendors of luxury goods, there will long be a market for profiting from Europe’s heritage. But there will be less room for the European middle class in tomorrow’s world. More demanding than Asians, less productive than Americans, the average European must prepare for a brutal reality check. It has already begun and will only intensify in the years to come.
Mario Draghi can hope for a new renaissance. But he knows that today’s situation is more reminiscent of the fifth century, when the Roman Empire fell and the Dark Ages followed.
What Should Investors Do?
If you already live, own property, and work in Europe, there are few good reasons to invest your savings in Europe—unless there are specific opportunities where you have a particular information advantage. You are already overexposed to Europe’s economic fate. As the Draghi report points out, Europeans save more but get lower returns on their financial investments than Americans. Consequently, if you don’t choose to pack your bags and move across the Atlantic, there are many reasons for Europeans to at least move their financial investments to the U.S. The American stock market has outperformed European stocks over the past decade. While this is no guarantee of future returns, who would bet on a Europe in decline?
