Accelerating Europe: Competitiveness for a new era

At a glance

Europe is one of the world’s leading regions in terms of sustainability and inclusion. But its per capita income remains 27 percent lower than in the United States. Closing that prosperity gap depends on accelerating growth by becoming more globally competitive.
We have entered a new geo-economic era that makes competitiveness more urgent and more challenging for Europe in seven arenas that matter for the future, from energy to technology and supply chains.
Shoring up competitiveness in these areas is critical. We estimate that about €500 billion to €1 trillion of value added could be at stake annually by 2030. For perspective, this is three to six times the incremental annual investment needed to achieve net zero. Addressing these issues will determine the region’s ability to unlock future growth while preserving its unrivaled sustainability and inclusion model.
To thrive in this new era, Europe needs an integrated agenda for competitiveness, with business leaders and policy makers working hand in hand toward ambitious new goals. Critical choices and potentially uneasy trade-offs lie ahead.
Sharply higher goals could include: doubling innovation-related private and public spending in areas such as artificial intelligence, with a differentiated approach for adoption vs. development; doubling the average scale of Europe’s leading firms, perhaps by introducing a “28th regime” of common business rules; cutting power and gas prices in half by developing and accessing new sources of energy; accelerating reskilling, labor redeployment, and talent attraction to enable technology adoption; adding $400 billion of annual corporate investment and doubling the inflow of greenfield FDI; securing access to critical materials; and rethinking regulation and industrial policy.

Europe is a global leader on sustainability and inclusion but needs to revive its competitiveness

Sustainability, inclusion, and growth reinforce—or undermine—one another. Together these three elements can deliver a prosperous and green future. Thus far, Europe has a strong record on the first two (Exhibit 1). It leads the world in reducing carbon emissions. It also leads on most dimensions of economic inclusion and social progress, including income inequality and life expectancy.

But Europe has not fared so well on the growth part of this equation. Europe’s per capita GDP (at purchasing power parity, or PPP) was 27 percent below that of the United States in 2022. About half of this gap reflects productivity differences, while the other half is due to societal choices to work fewer hours per capita across a lifetime.

Unless Europe can reenergize growth, its leading position on sustainability and inclusion could be compromised, eroding Europeans’ standard of living. Accelerating growth requires becoming more globally competitive, even in the face of mounting pressures.

This article, part of an ongoing research series by MGI, presents a fresh perspective on these issues. It delves into the factors that will define competitiveness and economic performance in the years ahead across 30 European economies (the 27 member states of the European Union (EU) plus Norway, Switzerland, and the United Kingdom. We deliberately steer away from examining the governance structures of the EU, choosing instead to focus on the economic dynamics. In the months ahead, we will publish a comprehensive report exploring these themes in greater depth.

A new geo-economic era disrupts Europe’s economic model

Europe’s competitive strength has long been based on industrial excellence: its continuous innovation of industrial products and processes; the world’s most sophisticated and connected supply chains; exceptional stability and broad-based skills in the workforce; affordable energy; and widely available low- and medium-risk capital.

Europe is home to iconic high-growth, high-profitability champions in almost all sectors. But even before new challenges came into the frame, signs were beginning to flash that its competitiveness was eroding. In aggregate, Europe’s largest companies already trailed their US counterparts in multiple measures. From 2015 to 2022, they spent roughly half as much on R&D as a share of revenue and invested less (even adjusting for their smaller size). In turn, they grew at two-thirds the pace and their return on capital was four percentage points lower. In 2022, total market capitalization was 2.5 times higher in the United States than in Europe, and the scale of US firms was almost double (Exhibit 2). The issues appear to be systemic rather than cyclical.

Now, new fragilities are coming to light, and Europe faces even more pressure on seven fronts that will define future competitiveness:

Innovation: Accelerating tech disruption challenges Europe’s historical industrial model. Disruption is challenging established sectors that are highly exposed to global competition; these include areas such as automotive, aerospace, and pharmaceuticals in which Europe has had a strong record as an industrial innovator. The competitive edge now increasingly comes from the application of ten frontier technologies. But our past research has found that Europe leads on only two of them (next-gen materials and clean technologies), while lagging in areas such as artificial intelligence (AI) and quantum computing. Take generative AI (gen AI) as just one example. ChatGPT reached 100 million new users in just two months—the fastest any technology has ever reached this milestone. Yet in 2023, Europe invested $1.7 billion in gen AI, compared with $23 billion of US venture capital and private equity that went into these technologies. As of November 2023, 35 gen AI companies had scaled up in the United States, but only three in Europe.
Energy: Europe’s import dependencies have been exposed, particularly hitting energy-intensive industries. For decades, European industry benefited from access to affordable energy, but Russia’s invasion of Ukraine, which cut off access to Russian gas, starkly highlighted the dangers of Europe’s dependency on overly concentrated energy imports. In 2021, Europe imported 55 percent of the energy it needed. By contrast, China imported 25 percent, while the United States was a net exporter of energy. Moreover, Europe obtained its energy from a limited number of suppliers; one-quarter of its imports came from fewer than three countries in 2021. Industrial power and gas prices doubled between the first half of 2020 and the second half of 2022 as Europe sought to replace Russian gas imports with a combination of efficiency measures and liquefied natural gas imports.

Capital: The rising cost of capital exposes Europe’s lower returns and investment gaps. For many years, interest rates have been low, and capital has been abundant. Under these conditions, there was less downside to European firms delivering about 20 percent less return on capital than US companies. But rates have increased at a time when significant capital is needed for the net-zero transition and to support innovation. European corporations may need to reevaluate their investment portfolios.

Europe has had a persistent gap with the United States in net investment. It attracted $90 billion of greenfield foreign direct investment (FDI) in the first three quarters of 2023, while the United States drew $300 billion; this widened a longstanding historical gap to one percentage point of GDP. Capital expenditures by large European companies declined slightly between 2015 and 2022 after adjusting for inflation, while investment by their US counterparts grew by 30 percent due to rapid investment in the tech sector. By the end of that period, investments by large US corporations were 60 percent higher than those of their European peers. Last, European capital markets are not as deep as those in the United States. In 2022, their private equity assets under management were 50 percent lower and venture capital financing was 75 percent lower.

Supply chains: Rising geopolitical tensions are affecting Europe’s historical trade patterns. Europe has long been outward looking on trade. According to International Monetary Fund data, Europe is 30 percent and 70 percent more open than the United States and China, respectively, and has 30 percent and 20 percent fewer trade restrictions. Yet geopolitical turbulence is bleeding over into trade relations, giving rise to more disputes and prompting companies to reconfigure supply chains. The number of new trade and foreign direct investment (FDI) restrictions affecting EU countries almost tripled between 2012 and 2022. For instance, China, which accounts for 80 percent of the global supply of graphite (a key component in electric vehicle batteries), restricted exports of the material in December 2023. Disruptions to supply chains, particularly for critical goods such as semiconductors and minerals, could bite hard. In 2021, the United States held 35 percent of the semiconductor value chain, while Europe had only 10 percent. Europe is home to 2 percent of global mining and processing of ten critical materials, while China conducts 14 percent.

Talent: Making smoother and faster worker transitions is challenging with Europe’s labor market rules. A new labor market challenge is emerging. Where the region once had an abundance of workers to fill positions, labor markets have become tight in many European economies. The job vacancy rate in the eurozone stood at an all-time high of 3 percent in September 2023.

Looking ahead, automation and the net-zero transition are likely to set off some of the largest labor market shifts in history. The latter alone could create 11 million jobs but eliminate six million others through 2050 in Europe. Europe’s current labor market structure will make these shifts more difficult to manage. For instance, job switching is twice as common in the United States as in the EU. Europe has also lost some focus on the skills of the future: In 2021, the EU had about 20 percent fewer STEM graduates per thousand inhabitants than the United States and 45 percent fewer than South Korea. Demographic headwinds will pose another structural challenge: due to aging and low birth rates, the EU’s working-age population is expected to decrease from 64 to 58 percent of the total population by 2040.

Size: Scale matters more than ever, but Europe remains fragmented. Europe’s integrated economy is comparable with the size of the US and Chinese economies (about $21 trillion versus $25 trillion and $18 trillion, respectively, as of 2022). Smaller countries have appeared to benefit from being part of a powerful bloc. But it has been more difficult for European corporations to scale, which matters at a time when many markets have winner-take-most dynamics. In 2022, the combined revenue of all listed companies with more than $1 billion in revenue was $12 trillion in Europe, compared with $18 trillion in the United States. For companies in telecommunications, airlines, and defense that operate on a national rather than European scale, this translates into 30 percent less revenue per company than US peers. In 2022, the market-to-book ratio of top European companies was 60 percent that of their US counterparts—meaning fewer available financial resources and a higher chance of being M&A prey. Finally, economies need to have the ability to generate the large firms of the future. While European companies such as Northvolt, Doctolib, and Bolt have scaled up rapidly in recent years, Europe is currently home to 13 percent of the world’s unicorns (on par with China), while the United States has produced 50 percent.
Competition and markets: Regulation and industrial policy are becoming stronger tools of competitiveness again worldwide. Europe has benefited from its adherence to open trade and its limits on state aid support to drive competition. But the world is changing. Many governments have reintroduced or increased tariffs as well as engaging in more active industrial policy. The US Inflation Reduction Act, for instance, provides nearly $400 billion of energy and climate funding, most in the form of tax credits; to claim many of those credits, manufacturing must occur on US soil. China funds industrial policy to the tune of 2 to 5 percent of GDP, while the EU averages about 1 percent. Europe has taken some policy steps, such as the 2021 Recovery and Resilience Facility, which devotes about €250 billion out of €723 billion to support the green transition with funds and loans. It was followed by the Green Deal Industrial Plan and the EU Chips Act in 2023. State aid rules have also been overhauled to help fund decarbonization. But the global playing field remains fluid.

These seven priority areas will likely define European competitiveness in the new era. Looking across them, we estimate that about €500 billion to €1 trillion of value added could be at stake annually by 2030. To put that in perspective, this is in the range of 5 to 10 percent of Europe’s 2022 GDP in private industries excluding real estate, three to six times the incremental annual investment needed to achieve net zero, or 12 to 24 percent of Europe’s social protection expenditure in 2022.

To safeguard its future growth and prosperity—as well as the unrivaled sustainability and inclusion delivered thus far—Europe cannot afford to risk losing ground.

Making Europe more competitive for the future involves critical choices and higher goals

Europe remains ambitious, but what will it take to meet the mounting challenges? Some of the groundwork has been laid, with multiple recent initiatives meant to sharpen its competitive edge. But capturing the full potential value at stake requires focusing on all seven dimensions outlined above. The analyses and benchmarks throughout this article suggest that goals can and should be set far higher (Exhibit 3). But strategic choices have to be made, many involving uneasy tradeoffs.

Within an effective policy framework, corporations can play vital roles: investing strategically in pivotal areas, creating and supporting growth-oriented ecosystems, nurturing a skilled talent pool, and forming partnerships or joint ventures with industry peers or across industries. Business leaders will need to look beyond their immediate interests and the boundaries of their industries, collaborating with each other and with policy makers to tackle any systemic barriers and gear up for long-term competitiveness.

1. Innovation: Can disruptive technologies such as AI be scaled up by doubling corporate R&D budgets?

Europe could aim to double its corporate R&D budgets to lay the foundations for future growth, pulling ahead of US levels. This would involve going from 3.7 percent of revenue today to 7.4 percent (vs. 6.8 percent for the United…

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