IMF report: What can Europe learn from the US about economic growth?!
A thriving business sector, with new high-growth firms on the rise, particularly in the technology sector, are essential if Europe is to accelerate its productivity, which is lagging behind the US, according to the International Monetary Fund (IMF). . The organisation's newly published report "Europe's Declining Productivity Growth: Diagnosis and Remedies" is calling for urgent steps to close the productivity gap between the EU and the US, particularly in high-growth sectors such as information technology.
"The productivity of US-listed technology firms increased by about 40% over the past two decades, while that of European technology firms has remained stagnant."
European GDP per capita is lagging behind the US
Slowing productivity growth in Europe has become one of the main reasons behind the widening of the per capita income gap with the United States. In September, Draghi's report already noted that "a wide GDP gap has opened between the EU and the US, driven mainly by a more pronounced slowdown in productivity growth in Europe", also stated that "on a per capita basis, real disposable income has grown almost twice as much in the US as in the EU since 2000."
Now the IMF says it's up to European firms to change course, although currently their "engines of productivity growth are faltering". Compared to those in the United States, "big leading European firms are lagging behind in terms of productivity and innovation, with the change particularly pronounced in technology sectors," the report said.
"Secondly, at the other end of the spectrum, Europe suffers from a deficit of startups, with very few growing quickly and eventually making it to the top."
The challenge before European firms
According to the IMF, Europe's limited effective market size and low level of equity financing (the process of raising capital through the sale of shares) are the main drivers preventing the continent's leading large firms from growing and innovating. Although the EU and US economies both represent around 15% of the global economy when measured by purchasing power parity, the EU market is more internally segmented.
"The intensity of trade between EU countries is less than half of the level of trade between American states", the report underlines.
European firms resort to equity financing far less than their US competitors. However, it is seen as a critical tool for financing riskier and more intangible investments, which are particularly important in the technology sector that cannot be pledged as collateral. Meanwhile, the European venture capital industry (funding provided by firms or funds to early-stage startups), the ultimate source of funding for emerging technology companies, is only a quarter of its size in the US.
In the EU, debt financing is more widespread, although it exposes firms to the financial stress associated with banks. This trend contributes to the continent's lower and more volatile research and development (R&D) investment, according to the IMF. Low R&D investment is particularly detrimental to the extent to which European firms can adopt digital technologies, which need massive upfront development costs. Compared to the US, European firms have spent 3-4% of their sales on R&D in recent decades, a third of what their American counterparts have shared. US tech firms also enjoyed higher sales growth, further widening the absolute gap in R&D spending between the two regions.
What are 'gazelles' and how do they contribute to Europe's productivity?
According to the IMF, the EU has a surplus of small, mature, low-growth firms, but faces a shortage of new, high-growth firms. They are the so-called gazelles. European firms tend to remain smaller, in part because they lack the capital to fund risk-taking and realize their potential. As a result, fewer innovative new firms end up in Europe's best firm status.
The IMF cites their data, clearly showing the problem: the average year of establishment of the top 10 listed firms is 1985 in the US, while 1911 for Europe. New high-growth firms are on the rise in Europe, although they remain below levels seen before the global financial crisis. European Gazelles make up about 0.5% of the total number of firms, while their sales growth exceeds that of the leading large firms by about 10 to 15 percentage points.
What are the remedies to increase productivity in the EU?
Continued efforts towards a deeper single market are among the most recommended steps by the IMF, including the removal of administrative barriers at the domestic level in member states. Lowering remaining trade barriers within the EU could increase the effective size of the market and stimulate the productivity of European firms, the IMF says. The organization calculates that the direct impact of reducing such barriers to the level observed among American states could increase productivity by 6.7%.
It is also very necessary for the EU to progress "towards an EU capital markets union", which could also pave the way for increased risk financing, easing restrictions that limit equity capital on the continent. This is also essential to support the creation of gazelles. Another key driver for nurturing more high-growth firms is the creation of a broader pool of venture capital and other risk financing tools. According to IMF analysis, European firms greatly improve their performance by receiving VC support.
However, "in the last decade, VC investments were less than 0.2% of GDP in the EU compared to almost 0.7% in the US and they were concentrated in a few countries such as the UK or France". Europe also needs to address its demographic challenges, investing in human capital by improving skills and bringing more female workers into the labor market, according to the IMF.
A further recommendation is to implement more R&D tax incentives to support new, innovative firms, which are currently applied in less than a quarter of EU countries.
"They should also ideally be harmonized across countries so that R&D investments occur where their expected returns are highest," the report adds.
European firms should also invest in education, digitization and the adoption of frontier technologies to ensure higher productivity in the future.
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