How to Awaken Europe's Private Sector and Boost Economic Growth

IMF Blog, September 11, 2024

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Income per person in the European Union is on average one-third less than in the United States, mostly because of lower productivity.
The aggregate productivity problem can be traced back to performance differences at the firm level.
Market valuations of US-listed firms have more than tripled since 2005, while Europe’s have grown by only 60 percent.
Productivity for US technology firms has surged by nearly 40 percent since 2005, yet it’s little changed for European companies.
Research and development spending as a share of sales in the United States is more than double that of Europe.

Europe has a lower number of startups, and too few grow fast to become large firms.
In the United States, the fastest growing young companies employ six times more people (as share of total employment) than their European counterparts.
With fewer successful young firms, Europe generates fewer large and highly productive companies later on and has an overabundance of small and low-growth firms.

Market size
- While the EU and US markets are comparable in terms of purchasing-power parity gross domestic product, the EU’s market is highly fragmented.
- Trade intensity between EU countries is less than half the level between US states, limiting economies of scale and network effects—especially harmful in tech sectors where rapid scaling matters.
Access to finance
- In the last two decades, US-listed firms have issued about twice as much equity relative to their size as their European counterparts.
- Venture capital as a share of the economy in the EU is only around a quarter what it is in the US.
- Equity is crucial to finance intangible investments (patents, trademarks) that can’t be pledged as collateral and to protect investments against short-term fluctuations.
- Debt financing bears higher interest rates, especially for younger businesses.

Deepen the European single market to lift constraints to growth for Europe’s most productive firms.
Remove remaining barriers to trade within the EU and advance the capital markets union to incentivize R&D and investments that require a large customer base.
Invest more in physical infrastructure to connect EU countries and pursue deeper services trade liberalization to expand firms’ market access within Europe.
Ease constraints that inhibit venture capital to increase equity financing availability for startups and young firms, including:
- Harmonizing regulations that hinder investments in larger venture funds.
- Having the European Investment Fund play a catalytic role by providing a quality seal and due diligence as a public good.

Ease remaining administrative barriers to entry to help more people start businesses, especially in services sectors.
Design labor market regulations that protect workers, not jobs, by:
- Combining more flexible layoff procedures with adequate unemployment benefits.
- Strengthening active labor market policies that support job search and skill development.
Make tax and regulatory incentives for small firms temporary to incentivize firm growth.
Support tertiary education and address skill mismatches to foster idea creation through new firms and technology adoption by existing businesses.

The EU must find common ground for removing barriers to goods, services, capital, and labor flows within the single market.
Efforts should span opening protected sectors, lowering regulatory costs of operating across borders, expanding capital markets for innovative ventures, and investing in education.
A thriving business sector is key to reducing Europe’s large productivity and income per capita gap.

Source: IMF blog post by Diego Cerdeiro, Gee Hee Hong, Alfred Kammer, September 11, 2024.