Investment: Taking the pulse of European competitiveness

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Investment: Taking the pulse of European competitiveness

By Massimo Giordano et al., | McKinsey & Company | June 20, 2024

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A simpler way to take the pulse of competitiveness is to measure investment. Why? First, investment matters. From 1997 to 2022, 70 to 80 percent of productivity growth was the result of capital deepening—investment in infrastructure, property, plants, machinery, equipment, and so on.1 The rest came from total factor productivity that often relates to innovation, which, in turn, links with investment in R&D, human capital, and other intangible assets. Half of the slowdown in productivity growth in Europe and the United States since the mid-2000s can be traced to a persistent decline in the growth of capital per worker.   Second, investment is more forward-looking than many other economic indicators, such as productivity and GDP, and represents a commitment to a region. Third, it is strikingly simple and can therefore help stakeholders negotiate their way through complexity and trade-offs.

A region that is not investing cannot be competitive, and a region that is not competitive will fail to attract domestic or foreign investment: a vicious circle. For Europe, defined here as the 27 member states of the European Union (EU) plus Norway, Switzerland, and the United Kingdom (also referred to as Europe 30), failing to increase investment puts Europe’s prosperity, way of life, and place in the world at risk.

Europe’s net investment in the most productive assets is low both in comparison with the level before the global financial crisis and in comparison with that of the United States.

After the global financial crisis, net investment in the United States and Europe fell significantly, but the decline was especially pronounced in Europe amid the Eurozone crisis, an environment of austerity, and weak demand. In the past decade, European net investment rates as a share of GDP were on average 2.8 percentage points or about €550 billion a year (nominal) lower than in the decade before the global financial crisis.

Over the past 25 years, capital per worker has grown by 10 percent in real terms in Western Europe, by 50 percent in North America, and by 700 percent in China.  Western Europe is the only region whose total factor productivity has fallen over the past quarter-century.

While Europe’s investment share of GDP appears to be healthy on the surface, Europe is not investing on the same order of magnitude as the United States in what are typically the most productive types of investments, namely machinery and equipment, IP, and intangibles. Intangibles, including R&D and software in particular, play an increasingly important role in today’s economies. They generate economic returns of about 25 percent—that is, an increase in annual GDP of 25 cents on each dollar invested—more than other assets.   It is notable that Europe’s share of gross domestic expenditure on R&D relative to the United States and China fell from 39 percent in 2010 to 29 percent in 2021. Moreover, Europe’s spending has tended to be directed toward midtech sectors much more than high-tech ones.

Europe surpasses both the United States and China in the production of scientific and journal articles.  But its commercial innovation falls short. Europe accounts for only about 5 percent of global patent filings, compared with 15 percent for the United States and 80 percent for China.  Competitive funding and institutional autonomy could increase the output of patents by European universities.

Europe continues to face a range of barriers to investment that are well known and much discussed, but progress in bringing them down has faltered.  In one survey, European executives highlighted five main barriers to investment: high energy costs, a scarcity of people with the right skills, uncertainty about the future, regulation of businesses, and regulation of labor markets.  The most important barriers cited in comparison with the United States were energy costs and uncertainty, which executives say are higher obstacles in Europe than in the United States.

3 key takeaways from the article

1. Investment is the lifeblood of competitiveness and productivity. Investment in capital, like infrastructure and machinery, accounts for 70 to 80 percent of productivity growth across regions. Much of the rest comes from investing in R&D, human capital, and other intangible assets. Insufficient investment compromises Europe’s competitiveness, way of life, and place in the world—and without competitiveness, investment will not flow.
2. Europe’s investment pulse is low. US investment in intellectual property (IP) and equipment is double that of Europe per capita. In 2022, large US corporations devoted about €700 billion more to capital expenditure and R&D than European peers. And Europe’s venture capital assets under management are equivalent to one-quarter of the US total.
3. Europe needs to reemphasize removing well-known barriers to investment to raise its pulse. Barriers include energy costs, talent shortages, business and labor market regulation, and geo- and macroeconomic uncertainty.

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Topics:  Europe, USA, China, Productivity, Growth, Capital, Investment, Economy, Competitiveness