The European Union is on a 20-year economic losing streak. A new research study shows that the EU’s economic slowdown relative to other areas of the developed world is due to bad government policies that can be cured. Reversal of these policies requires political will, as it would involve the shrinking of the size of government, combined with regulatory and tax reforms. The study’s reform proposals are particularly timely, given that the White House is currently pursuing economic reforms of its own and is engaged in trade talks with the EU.
The EU’s Economic Slowdown
A newly released paper by the Growth Commission, an independent economic-research organization that produces new analysis of national policies that affect economic growth, documents a 20-year history of relative EU economic decline. Specifically:
- Over the last 20 years, annual growth of gross domestic product in the EU has averaged barely 1%, less than half the average growth rate in the 38 OECD member nations(which include the United States, Canada, Australia, and other developed countries).
- In a generation, the EU’s share of global GDP (on a purchasing-power-parity basis) has decreased from almost one quarter to one seventh.
- If EU member state economies had grown at the same rate as the United States since 2005, the overall EU economy would be $3 trillion greater today—equivalent to $8,500 per person in lost opportunity.
Causes of the Slowdown, Bright Spots, and Solutions
Key Causes
The Growth Commission paper identifies the average size of government in European nations as the principal reason for lethargic growth, as evidenced by the expanse of the public sector, the size of the tax burden, and onerous regulatory frameworks.
In Europe, governments generally account for between 44% and 55% of GDP, a figure 10% higher than in North America and 20% higher than in Asia. The paper examines individual nations and finds that the larger the share of government in the economy, the slower the economic growth rate.
The paper identifies further causes of the continent’s growth problem as the EU’s relatively high energy prices, rigid employment regulations, and a general lack of corporate dynamism and entrepreneurship.
EU Bright Spots
There are eight Eastern European nations—the Visegrad Group countries (Poland, the Czech Republic, Slovakia, and Hungary), Slovenia, and the Baltic States (Estonia, Latvia, and Lithuania)—that have enjoyed higher GDP growth rates than elsewhere in the EU.
These nations have lowered taxes, reduced the size of the state, and generally been fiscally prudent with sustainable debt/GDP levels. Their growth rates reflect these prudent decisions.
The “bright spot” nations’ policy successes serve as “natural experiments” that demonstrate the real economic benefits of reforms based on scaling back government involvement in the economy.
Specific Solutions
The paper delineates specific solutions that could swiftly and collectively enhance EU economic growth and international competitiveness. These include:
- Freeing up energy markets through market-based solutions, accepting that the rest of the world has little de-facto interest in “net zero” environmental policies. (The paper stresses that the EU’s industrial base cannot compete where its base energy costs are between two and four times those of the United States, let alone the even lower costs of India and China.)
- Deregulating labor markets, limiting growth in minimum wages, and reducing impediments on labor flexibility. (The goal is increased employment formation and opportunity.)
- Reaching comprehensive trade deals on goods and services with the United States in other services, creating a win-win trade scenario for all parties. (This would require the EU to accept mutual recognition of technical standards, rather than harmonization toward EU standards.)
- Focusing on empowering the population through greater labor flexibility, rather than importing cheap foreign labor.
- Greatly increasing new company formation by encouraging greater startup-capital pools and appropriate tax incentives.
- Becoming tax competitive globally, both in terms of absolute rates and tax design, by adopting tax provisions that reduce tax barriers to investment and capital formation.
- Reexamining every new regulation introduced over the last 10 years with a presumption to repeal, unless there is an overwhelming justification for maintaining the regulation.
- Decentralizing by delegating power back to national capitals and community levels, creating a competition among ideas and regulatory systems in order to drive growth.
- Examining much more closely the cost of maintaining large social-welfare models that discourage private initiative.
- Adopting a 10-year EU plan to, by 2035, reduce the size of member states’ public sectors by 5% relative to GDP, as well as a further 5% by 2045. This would still leave the typical EU state size at around 35% of GDP—a high figure by global standards, but much closer to the OECD average.
Alignment with US Reforms
The EU’s economic woes do not exist in a vacuum. The EU nations remain major trading partners and allies of the United States, and it is in the mutual interest of the United States and the EU to see Europe succeed. This is especially the case during a period of rising geopolitical challenges due to Russian and Chinese policies.
Fortunately, potential European reforms highlighted in the Growth Commission report align well with certain key U.S. reform efforts, and with U.S.-EU trade talks.
The Trump administration is currently pursing major reductions in federal regulatory burdens that distort competition, and promoting state regulatory reforms as well. These deregulatory initiatives could, for example, lower (and in some cases eliminate) regulatory barriers that stymie energy production (such as permitting and environmental restrictions) and spur job opportunities by paring back costly and burdensome labor-related rules.
More generally, recently proposed U.S. deregulatory reforms and government-workforce policies seek to reduce the size of government, echoing the Growth Commission report’s concern with the scope of government in the EU. Deregulatory efforts could also spur mutually beneficial reforms in future rounds of U.S.-EU trade talks.
Anticompetitive market distortions (ACMDs) are a hindrance both in international transactions and in the home market of each country doing the distorting. While each country that lowers its own ACMDs will benefit, ACMDs often are the fruit of special-interest lobbying and are thus hard to dislodge.
The elimination of certain U.S. ACMDs, cited by American negotiators, could improve the outlook for EU negotiators’ agreement to reduce some harmful European ACMDs. A fall in regulatory burdens on both sides of the Atlantic might, in turn, pave the way for mutually agreed-upon tariff reductions by the United States and the EU. This would be a substantial “win-win” for both the U.S. and EU economies.
By spotlighting the dire need for dramatic EU action at a time of significant U.S. government initiatives, the Growth Commission report adds valuable fuel to the fire of EU reform efforts.