🇪🇺Is there a way to reverse the European decline?
I wanted to bring together a few considerations.
A) Is there a problem?
Relative decline compared to the US exists, but the catch-up of the rest of the world to Europe resembles Russia’s advances in Ukraine [Pic 1-2].
The main case can be made for developed Western European countries: structurally lower growth than the US, and lower growth than much of the rest of the world. European history in the new millennium is Italian stagnation, but also 150 million people quadrupling their GDP per capita.
B) Let’s set the bar:
2% long-term real GDP per capita growth is more or less the upper limit a developed country can aspire to. The US has been hitting this benchmark with stunning consistency for roughly 200 years [Pic 3], and it is a good proxy for the pace of advancement of the technological frontier.
Looking nostalgically at France's or Italy’s 5% annual growth rates in the 1970s is foolish: Poland and Bulgaria are going through that development phase right now. Growth rates must always be compared to the level of development, otherwise comparisons are meaningless. From the perspective of long-term structural prospects, a Brazil growing at 1.9% is far more worrying than a Germany growing at 1% from a base 5 times larger.
So, our growth targets are:
1) 2% GDP per capita growth for the countries at the tech frontier.
2) 2% GDP per capita growth for the less developed countries.
The latter is broadly in line, especially net of the sovereign debt crisis, which is unlikely to repeat, but Western Europe will likely act as a ceiling on others’ development, so missing (1) could mean reducing the room for (2).
C) Let’s identify the problems:
Why do developed European countries struggle to grow at the US pace of 2%, and instead grow closer to 1%? I would say the main differences are two:
1) Demography. Not just demographic growth: the effect is mainly driven by demographic composition, though the two are obviously linked.
GDP per capita is commonly understood as a proxy for production. That is not wrong if properly interpreted, but in my opinion it is misleading, especially when looking at long-term trends.
GDP per capita is essentially a proxy for the level of technological adoption. Historical growth in GDP per capita is not people consuming more wheat; it is people consuming, or investing in, increasingly diversified and complex products. Of course, in order to afford them, people must exchange things perceived as having comparable value, meaning they must also produce increasingly diversified and complex goods.
Demand determines supply as much as the opposite.
Ageing slows per capita growth long before population decline becomes visible, which then later hits aggregate GDP growth. Older populations have less dynamic consumption patterns and push the working population toward less dynamic forms of production.
The history of GDP per capita and wage growth in Japan and Italy has been remarkably similar, and the main things the two countries have in common are the timing of their catch-up phase and the fact that they are the two countries furthest ahead along the demographic curve.
Demography appears to be a dominant factor behind growth dynamics of developed countries in recent decades, and Germany, France, and the UK are entering a demographic environment similar to that of Italy and Japan 20 years ago.
The positive side is that many middle- and low-income countries have worryingly low TFRs relative to their level of development (another metric that must always be compared to development level in cross-country analysis). China is a disaster in this regard, but one of a moltitude.
Once again, the US seems to be the only major competitor with both a competitive TFR and a growing population stock.
2) Scale. The US dominates almost all scale-based frontier technology sectors, while China is becoming disruptively competitive in several scale-based mid-value sectors.
In many low-scale-dependent sectors, Europe retains extraordinary leadership.
The semiconductor industry is emblematic: Europe leads in the most complex and highly specialized segment, EUV lithography machines, which does not require scale and instead relies on a myriad of highly specialized SMEs spread across the European territory, mainly along the Blue Banana. But Europe remains weak in almost every scale-based segment of the industry. One should realize that this pattern repeats across multiple sectors.
The problem is that scale-based sectors are a major source of growth when competing against rivals capable of exploiting scale advantages, eventually also in military competition. Losing scale-intensive sectors can create significant employment stress, particularly in high-volume industries.
Most other problems ultimately derive from these two structural issues.
I honestly do not believe that regulation or taxation levels explain the growth differential, except insofar as they are linked to demographics and fragmented scale coordination.
To be clear, reforms in these areas matter and can play a big role in year over year competition, but I'd rule out the differences between the US and Europe are large enough to justify the structural growth gap, the US is neither a tax nor a regulation heaven, and many successfull States have effective tax rates very similar to those of Western Europe.
By contrast, even ignoring the Imperial muscles of the US (and one shouldn't), the broader effects of advanced ageing, weaker presence in scale-based sectors, and underinvestment caused by fragmented national systems are clearly large enough to explain the divergence in growth rates, both absolute and per capita.
D) Solutions?
This analysis leaves little room for hidden or quick solutions, and I do not believe such solutions exist. I know this is unpopular, but I think this is the reality.
Both demography and full European integration require decades.
The latter is 'slowly' ongoing, while for the former one can only speculate, and reversing ageing dynamics within the next 30y is practically impossible.
Again, paying less for a notary in order to launch a startup is good, but it is not enough to reverse long term growth macro-trends.
One may find hopium in tech developments, certain technological waves may indeed be better suited to ageing societies, automation being the obvious example; or in questions such as: “Could societies ageing earlier gain some kind of first mover advantage over societies ageing later?” as I was recently asked (so far the former are losing).
These and many others remain speculative or marginal considerations, and it is unclear how they could compensate for the broader structural disadvantages described above.
To solve Europe’s scale problem we need:
-Integration of regulations across as many sectors as possible;
-Fiscal convergence, either through convergence of national legislation or through a larger share of EU-level spending in total expenditure, or both, especially regarding subsidies and intra-EU tariff equivalents;
-Integration of infrastructure and capital markets;
-Regional security and a common European strategy.
Each of these processes is already ongoing to some extent, but they are long and complex processes that depend on one another and involve significant transition costs.
As things stand, people and businesses plan within fragmented regulatory, infrastructural, financial, and strategic systems. Every additional step toward integration brings only marginal immediate gains. Positively there's high switching costs, and what is obtained is quite resilient.
E) Conclusions:
We're slow. Are we in a hurry?
There's a long pipeline of things to do and the sooner the better, but Europe has leverage and time to manage both enemies and allies.
I do not think it is an unambitious goal that, over the next 50 years, Europe should aim to remain as wealthy relative to the rest of the world as it is today, which requires a minimum level of sound political decision-making, while gradually bringing the main pillars of integration to functional completion.
Europe’s share of global GDP will continue to decline for some time simply because of demographics, but being rich matters far more than being numerous.
I cannot ignore the idea that a Eurasian order is inherently more stable for plenty of reasons, and such an order cannot ultimately be centered anywhere other than Europe. That moment may eventually come.
But today, everything still suggests that this will be another American century, and recognizing this is a strength, not an admission of weakness.
Europe’s main domestic objective is managing the difficult process of integration, a monumental task deserving of every available resource.
Its main foreign policy objective should increasingly be to speak as a Union, keeping Russia close and the US closer.
As for the rest, perhaps Europeans should complain less. I fully support self-criticism and the constant struggle to improve, but this should not become defeatism. Our problems concern how many euros to print to finance pensions and whether we can overtake the US in more frontier technologies. In Vietnam there are 100 million people producing goods for us for $500 a month, with a TFR below replacement level, no widespread pension or healthcare systems, and entirely dependent on the goodwill of the US and China. If French budget puzzle seem complicated, most fiscal situations around the world are generally worse.
Europe is not the land of decline; it is the land of hope. The current European leadership was born in a Europe still divided in two, and in just 30 years it has achieved an extraordinary number of successes in integration, while also lifting roughly 150 million people out of Soviet poverty.
People can debate convergence criteria all they want, but has there ever been a period in European history in which Europe was this uniformly developed and almost every country enjoyed such comparable prospects of long-term stability?
The founders of the modern European Union are pioneers of a new era that visionaries already foresaw as inevitable for Europe 150 years ago. They are not late administrators of decline.
The European Union therefore cannot be nostalgic. The past no longer exists; nostalgia can only be directed toward realities that are gone forever. Europe must not return to something, it must move toward something else.
The future is undefined and must be built. That makes things difficult, but it also makes Europe the only civilization with a truly open and elastic horizon of hope.
China’s “common prosperity” is a joke, and the whole world knows it; the Chinese themselves may soon realize it too.
The American Dream has become a crumpled cigar, that is the project genuinely at risk of turning into nostalgia.
The European Union has no existing social pact to preserve; it is building one out of many different social pacts, and that is why it moves slowly.
The final result may well be worthy of the ambition behind the project, but it will require an extraordinary civilizational effort, and such a process inevitably appears chaotic.
Is there a way to reverse the decline? With or without the euro?