Saturday, December 14, 2024

The economic gap between the EU and the US is widening

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By Andreas Charalambous and Omiros Pissarides

The US and the EU face common challenges, including escalating geopolitical turmoil, climate change, digital transition and taming inflation, while, at the same time, creating favourable conditions for sustainable growth, during a period of limited fiscal space.

In this context, over the last decade, the EU has lost ground compared to the US. Indicatively, compared to pre-pandemic levels, the US economy grew by 8.7 per cent during the first quarter of 2024, while the EU grew by 3.4 per cent. Analysing the phenomenon, we highlight the following.

Firstly, the EU suffers from underinvestment, as a result of inherent weaknesses in governance and decision-making processes, excessive bureaucracy, high energy costs, the absence of an efficient capital market and the consequent over-reliance on bank lending, as well as insufficient incentives to support cutting-edge technologies.

The US, by contrast, enjoys significant advantages in the form of stronger governance and more efficient decision-making, supports sectors with high growth and innovation potential, while it maintains dynamic university-business ties that enable top level research as well as the employment of highly skilled graduates, backed by an infrastructure that supports stronger labour mobility.

The American capital markets are also more developed, offering corporations access to both the bond and the stock markets. Biden’s policy, involving $360 billion worth of subsidies and tax breaks for green investments within the US, is an example that is attracting companies and executives from around the world, including from the EU. As a result, US unemployment currently stands at 3.8 per cent, its lowest level in the last 50 years.

Secondly, the EU is faced with eroding competitiveness and is lagging behind in terms of productivity. In practical terms, Europe’s population is ageing and government policies to reverse the trend of lower productivity have not been successful. The assimilation of migrants, which could provide a solution, is not achieved. On the contrary, increased migration flows are causing intractable problems and contribute to political polarisation.

At the same time, some aspects of social policy are problematic For example, the ECB estimates that in 2023, compared to the period before the pandemic, the annual loss of working hours was equal to two million full-time workers. Furthermore, the EU faces weaknesses in terms of attracting quality workforce, as well as in providing suitable training.

Thirdly, some factors create additional challenges. Indicatively: (a) the Russia-Ukraine war has affected the EU disproportionately, due to the external orientation of its economies and the insecurity it has created, which leads a part of the population to increase savings and reduce consumption, (b) housing loans within the EU are characterised, primarily, by a floating interest rate while in the US a fixed one. In the context of the rising interest rates we have experienced in recent years, European households’ spending on housing has increased, but not that of American households, and (c) US wage growth creates more purchasing power compared to the EU.

The above is not to suggest that US policies are entirely correct. Economic growth in the US is achieved in a manner that adds to the already massive government debt and contributes to rising inflation and de-globalisation. EU leadership, however, must recognise that the policies it follows require urgent re-orientation, in the context of a concerted effort to highlight the leadership role it must play.

Andreas Charalambous and Omiros Pissarides are economists

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