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Economic growth and productivity growth across the nations of the European Union has been lagging the US economy. What are the reasons and what might be done? A group of essays in the June 2025 issue of Finance & Development offers some insights. A common theme is that EU economic integration has not proceeded as planned. As a result, EU firms are selling into smaller national markets, rather than a continent-wide market, and their incentives to attract finance and to invest in economies of scale and new technologies are accordingly reduced.

For example, here is Alfred Kammer in “Europe’s Integration Imperative.“

The EU has made significant progress freeing up trade between its member states, but plenty of obstacles remain. High trade barriers within Europe are equivalent to an ad valorem cost of 44 percent for manufactured goods and 110 percent for services, IMF research shows (2024). These costs are borne by EU consumers and companies in the form of less competition, higher prices, and lower productivity.

The EU is also a long way from capital market integration, with cross-border flows frustrated by persistent fragmentation along national lines. The total market capitalization of the bloc’s stock exchanges was about $12 trillion in 2024, or 60 percent of the GDP of the participating countries. By comparison, the two largest stock exchanges in the US had a combined market capitalization of $60 trillion, or over 200 percent of domestic GDP. Limited EU-level harmonization in important areas, such as securities law, hampers growth by preventing capital from flowing to where it’s most productive.

This is one reason Europe has fallen behind in the adoption of productivity-enhancing technologies and its productivity levels are low. Today, the EU’s total factor productivity is about 20 percent below the US level. Lower productivity means lower incomes. Even in the EU’s largest advanced economies, per capita income is about 30 percent lower than the US average (see Chart 1). 

Kammer points out:
 

Not only do Europe’s leading companies lag their US competitors, but they are falling further behind over time. This is true across all sectors, but especially for tech. While the productivity of US-listed tech firms has increased by about 40 percent over the past two decades, European tech firms have seen almost no improvement. One reason could be that US firms are simply trying harder: They have tripled their research and development spending to 12 percent of sales revenue, three times European companies’ ratio, which has languished at an average of 4 percent in recent decades.

The future would look brighter if Europe could hope for young high-growth firms to reduce the innovation and productivity deficit. Alas, the EU has few such companies. And they have a substantially smaller economic footprint than those in the US, where younger firms account for a far larger share of employment. In other words, the EU has too many small, old, and low-growth companies. About a fifth of European employees work in microfirms with 10 people or fewer, about double the US figure. And while the average European firm that has been in business 25 years or more employs about 10 workers, comparable US companies employ 70 (Chart 2).

Issues for the EU may be especially acute for young tech companies. As Kammer points out, banks are typically the primary source of capital for EU companies, and banks typically want to lend to companies with collateral–not a company based on a few patents and an idea: “[T]here is a troubling trend of innovative European firms taking their talents to more dynamic markets elsewhere, with future “unicorn” companies valued at more than $1 billion leaving the EU for the US at a rate that is 120 times faster than the other way around, according to research by Ricardo Reis, of the London School of Economics.”

Other essays in the issue focus on what would be needed for an EU savings and investment union that could support innovative new companies, as well as essays with more details on Germany, Poland, Greece, and Spain. But for now, in an essay that offers qualified optimism about the future for innovative EU firms, Alessandro Merli begins:

“The US innovates, China replicates, Europe regulates” is how critics summarize the continent’s approach to innovation. Exhibit A of the European Union’s regulatory overreach is the now infamous Artificial Intelligence Act, which governs AI—even though the region has not yet produced a single major player. Productivity in US technology firms has surged nearly 40 percent since 2005 while stagnating among European companies, according to IMF research. US research and development spending as a share of sales is more than double what it is in Europe. No European company ranks among the 10 largest tech companies by market share. 

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