From laggard to leader? Closing the euro area’s technology gap

Inaugural lecture of the EMU Lab by Isabel Schnabel, Member of the Executive Board of the ECB, at the European University Institute

Florence, 16 February 2024

More than 30 years after its inception, Economic and Monetary Union is widely seen as a success. It has steadily gained support among Europeans. Nearly 80% of euro area citizens support the single currency.^[1]

This is a strong vote of confidence, which shows that the euro is more than a currency. Our monetary union has become a global leader in social protection, a pioneer in fighting climate change and a guardian of free trade and democracy.

But these values and achievements are being increasingly questioned and challenged in a world that is becoming less open, less stable and less reliable.^[2] To assert its role, the euro area needs to remain competitive; it must be capable of creating the sustainable growth that our social and economic fabric depends on.

However, this capability is increasingly under threat. At the turn of the millennium, Europe was operating at the global technological frontier, but today many euro area firms are laggards. Compared with many of their global peers, they invest less in both physical capital and research and development, and they are less productive.

Today I will explain the factors behind the euro area’s competitiveness crisis and propose remedies to address its deeper root causes.

I will argue that our most potent weapon for enabling European firms to catch up to the technological frontier is to eliminate the remaining barriers to the free movement of goods, services and capital in the European Union. European firms would then be able to compete and thrive in an environment of disruptive technological change where the “winner takes most”.

Europe’s lost IT revolution

Europe looks back on a long history of innovation and fundamental transformation.

In the 16th and 17th centuries, the discoveries of Nicolaus Copernicus and Isaac Newton marked watershed moments for social and scientific progress. In the 18th and 19th centuries, the rise of industrial Europe laid the foundations for modern society and the ensuing significant improvements in the standard of living.

After World War II, Europe once again became the world’s engine of productivity growth. In the four largest economies in the euro area, the ratio of labour productivity compared with that of the United States increased rapidly, soaring from 25% in 1945 to 100% in 1995 and thereby closing the productivity gap with the United States (Slide 2, left-hand side).^[3]

These gains were widely shared across euro area economies, reflecting the fast integration in trade and finance in the run-up to the establishment of the EU’s Single Market, with new technologies spreading rapidly across borders (Slide 2, right-hand side).^[4]

So, going into the 21st century, Europe was operating at the global productivity frontier.^[5] Productivity growth was slowing over time, but that was to be expected as the distance to the frontier narrowed. But in the following years, the euro area took a different course and fell behind other economies like the United States.

Between 1995 and 2007, annual growth in GDP per hour surged measurably in the United States, whereas it slowed and diverged in the euro area. By the time of the global financial crisis in 2008, euro area economies had accumulated productivity losses of some 20% relative to the United States, with the productivity ratio falling back to 0.8.

The euro area has not been able to recover from this loss of competitiveness. Productivity growth has remained subdued, a development reinforced more recently by the repercussions of the pandemic and the Russian war in Ukraine.

The dismal trajectory of Europe’s productivity has been subject to much analysis. Most economists agree that European firms’ failure to reap the efficiency gains brought about by information and communication technologies – or ICT for short – is one of the root causes.^[6] This shows up in both the capital stock and total factor productivity.

Over the past three decades, a striking gap in the real IT-related capital stock has emerged between the euro area and the United States (Slide 3).^[7] Broad-based investments in ICT fundamentally transformed the US economy, especially the services sector, as ICT became a general purpose technology which radically changed the way many firms operated and served their customers.^[8]

As a result, annual productivity growth in the services sector in the United States increased by 3.2% on average between 1995 and 2005, compared with just 0.9% in Europe.^[9]

But even in the United States, the productivity boost driven by the ICT boom proved temporary. Since the global financial crisis, productivity growth has been subdued across advanced economies, despite continued rapid technological change, including the rise of generative artificial intelligence (Slide 4).

The potential causes of this slowdown have been discussed intensively and controversially. Some argue that the most recent technological innovations are simply less revolutionary than earlier inventions, such as the railway, electricity or the telephone.^[10]

Others claim that we have yet to see the full benefits of AI and other cutting-edge technologies, as history shows that technology adoption rates can be slow.^[11] In 1987 Robert Solow famously remarked that computers were everywhere except in productivity statistics.^[12]

Empirical evidence supports this second hypothesis. It finds that although technologies developed at the global frontier are spreading across…