Europe is being left behind by the US because of slow productivity growth, which has helped to create a widening gap in GDP between the US and Europe and a sluggish increase in living standards, according to a report by the European Commission.

While Europe benefited from a stable geopolitical world, it was able to free up defence budgets to spend on other priorities. But the war in Ukraine has drawn a line under that era. “Europe has abruptly lost its most important supplier of energy, Russia,” the report said. “All the while, geopolitical stability is waning, and our dependencies have turned out to be vulnerabilities.”

No tech boom

Most strikingly, Europe has mostly missed out on the benefits of the digital revolution’s productivity gains and has weak performance in emerging technologies, the report said. With a shrinking workforce, the region must boost its productivity to achieve better growth by an unprecedented amount.

“To digitalise and decarbonise the economy and increase our defence capacity, the investment share in Europe will have to rise by around 5 percentage points of GDP to levels last seen in the 1960s and 70s,” the report said. “This is unprecedented.”

Without such growth, the report predicts that the region will not be able to sustain its current social models and faces and “existential challenge” to its ambitions.

Three-pronged approach

To tackle such issues, Europe must first refocus its efforts on closing the innovation gap with the US and China – particularly in advanced technologies such as AI. The region greatly underspends compared with its competitors in innovation and European companies are trapped by inconsistent and restrictive regulations, it said. 

Second, the region needs a plan to couple decarbonisation and competitiveness, so that decarbonisation efforts do not derail growth and profitability.

“Decarbonisation must happen for the sake of our planet,” the report said. “But for it also to become a source of growth for Europe, we will need a joint plan spanning industries that produce energy and those that enable decarbonisation such as clean tech and automotives.”

Finally, Europe must reduce its dependencies and increase its security, the report said.