Why Europe Is Falling Behind — and How to Accelerate
Olivier Klein
Professor of economics at HEC
February 12, 2026
Over the span of two decades, the European Union’s relative slowdown has turned into a genuine divergence from the United States—and increasingly from China as well. This is no longer a cyclical gap: Europe’s growth trajectory has become structurally weaker, with profound implications for living standards, social cohesion, and the continent’s geopolitical weight.
Since the 2008 financial crisis, average annual growth in the U.S. economy has significantly outpaced that of the European Union. A one-percentage-point growth gap sustained over twenty years results in a GDP difference exceeding 20%, translating into reduced capacity to finance defense, infrastructure, the energy transition, or education. GDP per capita in purchasing power parity terms—once relatively close to U.S. levels in the early 2000s—has gradually drifted away, signaling a relative decline in European living standards.
This divergence comes at a time when the global economic order has shifted from a U.S./Europe bipolarity to a tripolar configuration: United States, China, and the European Union. Economic weight determines not only internal prosperity but also the capacity to fund military power, sustain diplomatic ambition, and shape technical and regulatory standards. Growth, in other words, has become a strategic variable.
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An Efficiency Problem, Not a Labor Quantity Problem
One key lesson from recent research is that Europe does not suffer from a lack of capital or from a massive education or skills deficit relative to the United States. Nor has the historical gap in annual hours worked—traditionally lower in Europe—widened since 2000.
Europe’s relative deterioration over the past two decades stems primarily from an efficiency problem in organizing production and innovation. Total factor productivity (TFP)—which measures the ability to innovate, adopt new technologies, and efficiently reallocate resources—has grown much more slowly in Europe than in the United States since the mid-1990s.
The gap is highly sectoral. Europe remains competitive in traditional manufacturing and certain regulated services, but it lags significantly in high-technology sectors: digital platforms, cloud computing, artificial intelligence, and biotechnology. These sectors now concentrate productivity gains and give rise to “superstar firms” that drive overall economic dynamism. The combined market capitalization of major U.S. technology companies far exceeds that of their European counterparts, revealing a deep imbalance in the capacity to create and capture innovation-driven value.
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A Schumpeterian Reading: Europe’s Creative Destruction Deficit
To understand this divergence, a Schumpeterian framework—particularly as formalized by Philippe Aghion—is especially relevant. Long-term growth depends on creative destruction: the entry of innovative firms, the exit of obsolete ones, and the rapid reallocation of capital and labor toward the most productive sectors.
Near the technological frontier, this process requires strong incentives for breakthrough innovation, sufficient competition to push incumbents to reinvent themselves, and institutions that accept failure and structural transformation. This is precisely where Europe underperforms.
Stylized facts are clear: since the mid-1990s, TFP growth has been roughly twice as high in the United States as in the euro area, with the gap concentrated in the most innovative sectors (ICT, digital technologies, biotech), rather than across the entire economy.
Politically and socially, Europe shows a marked preference for ex ante protection of existing jobs and firms—through regulation, labor law, and taxation—whereas the United States tends to rely more on ex post compensation for losers, via labor mobility and income-support mechanisms. The result is lower firm entry and exit rates in Europe, more limited sectoral and geographic labor mobility, and therefore slower reallocation toward the most productive activities.
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Innovation Institutions: Europe’s Structural Lag
Another key dimension concerns the organization of innovation systems. In economies close to the technological frontier, growth depends less on imitation and more on the capacity to generate and diffuse breakthrough innovations. This requires specific institutions: effective intellectual property protection, competitive markets, deep capital markets, and public agencies capable of financing long-term, high-risk projects.
The United States has, for decades, developed agencies such as Defense Advanced Research Projects Agency (DARPA), ARPA-E, IARPA, and BARDA. These bodies operate with significant autonomy, substantial funding, and high tolerance for risk. Led by program managers from scientific and industrial backgrounds appointed for limited terms, they fund applied research projects with transformative potential, often at the intersection of public needs (defense, health, energy) and private innovation.
This model has played a decisive role in the emergence of technologies that are now ubiquitous: the internet, GPS, advanced semiconductors, and key components of artificial intelligence and biotechnology.
By contrast, Europe has built a fragmented landscape of research institutions and innovation programs, often oriented toward medium-scale projects, with limited tolerance for failure and lengthy decision processes. The difficulty lies in concentrating resources on strategic priorities, taking bold technological bets, and ensuring a smooth continuum from public research to start-ups, innovative SMEs, and large firms.
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Energy, Industry, and the Low-Growth Trap
Performance gaps are also explained by real factors such as energy and industrial structure. The European Union remains structurally dependent on energy imports, particularly gas and oil, while the United States has become a net exporter. Recent energy shocks have exposed this vulnerability, durably increasing energy costs for European firms, especially in energy-intensive sectors.
Some national policy choices have compounded the problem: rapid nuclear phase-outs without immediately available decarbonized alternatives, underinvestment in dispatchable generation capacity, and slow development of interconnections. Since energy is a core production input, persistently higher costs weigh directly on competitiveness, industrial employment, trade balances, and investment capacity in other areas such as R&D and infrastructure.
Thus emerges a “low-growth trap”: weak growth, underinvestment, technological lag, and renewed weak growth.
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Europe Is Not Doomed to Decline
The diagnosis should not lead to fatalism. The European Union retains considerable structural strengths: high levels of education, world-class universities and research centers, and a dense base of engineers and scientists. Its socio-economic model—social protection, reduced inequality, strong public services—remains widely supported by citizens.
Europe also benefits from stable institutions: rule of law, judicial independence, central bank independence, and robust property rights protection. In a geopolitically fragmented world, such stability is a valuable asset that can attract talent, capital, and firms—provided Europe regains a more dynamic growth trajectory.
Recent history shows that the Union can respond decisively in times of crisis: the creation of the European Stability Mechanism and banking union progress after the euro crisis, joint debt issuance after the pandemic, and renewed emphasis on reindustrialization. Yet such advances are often incremental and slow.
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Three Reform Axes to Escape the Trap
- Deepen the Single Market.
Goods markets remain fragmented by national regulations; services markets are far from integrated; capital markets remain segmented. A genuine capital markets union, deeper integration of energy and digital markets, and reduced entry barriers in protected sectors would generate scale effects comparable to those enjoyed by U.S. or Chinese firms. - Reinforce Frontier Innovation Capacity.
R&D policy must increase overall effort and, above all, create institutions capable of financing long-term breakthrough projects with agile governance and explicit tolerance for risk. Universities, research centers, start-ups, and large firms must be more tightly connected. Venture capital and growth capital must be strengthened. Europe must enable the emergence of new “superstars” in artificial intelligence, semiconductors, health, and low-carbon technologies. More broadly, it must move away from hyper-protection and hyper-regulation—often intertwined—and toward greater acceptance of risk, failure, and the recognition and reward of success. - Redesign the Social Contract.
If creative destruction is to intensify, it must be socially acceptable. Protection should shift—as in Denmark—from protecting specific jobs to protecting individuals. Flexicurity in labor markets, large-scale lifelong learning, portability of social rights, and stronger income-insurance mechanisms are essential to reconcile economic dynamism with social cohesion.
Europe must move beyond the implicit compromise that trades short-term stability for a gradual erosion of the productive base that finances its social model. The continent’s divergence is not inevitable; it is the consequence of institutional and political choices that can be revised.
The question is not whether Europe should abandon its model, but whether it can equip itself with the institutions of a competitive frontier economy and a sufficiently strong and dynamic productive base to sustain that model in a world of far harsher power dynamics—more technological and more competitive at once.
Only then can Europe continue to shape global standards and remain a consequential actor on the world stage.