Growth at stake: bridging the gap in productivity, investment and innovation

In the context of a widening growth gap between the European Union (EU) and other major economies, closing the productivity gap is key. Boosting investment in research and innovation, and fostering technological development and diffusion, in what we could call the ‘good industrial policy’, is essential to strengthening productivity and sustaining living standards.

A challenging economic context

By 2025, the EU’s economy was 7% bigger than in 2019, the year preceding the series of shocks started with the pandemic. Over the same period, the US economy expanded by 15%, effectively growing at twice the rate of the EU. Meanwhile, China’s economy had grown by one third since 2019, roughly double the pace of the US.  Population growth during this period was stagnant in both the EU and China, and only modest in the US, meaning that average per capita income in Europe increased significantly less than in the US or China.

A simple growth decomposition exercise tells us that labour growth and capital deepening accounted for less than half of the growth rates in China and in the US, as the bulk of growth in these economies has come from strong productivity growth, substantially stronger than in Europe. This is arguably the most important source of worries. It also explains the renewed focus on competitiveness, which may be a ‘dangerous obsession’ if applied at the country level, as some have explained[1], though in reality it refers to relative productivity growth[2].

How to boost productivity with “good industrial policy”

Historical trends in productivity growth[3] show that the gap between European countries and the US has typically grown in periods of relative underinvestment: in other words, when investment levels in Europe lagged behind those in the US, subsequent productivity growth also tended to be lower.

This empirical observation is consistent with what various strands of economic theory have often suggested: from neoclassical[4], endogenous[5] or Schumpeterian[6] growth theories, investment is either the proximate cause of productivity growth or the fundamental mechanism through which innovation and knowledge accumulate. Relative productivity growth in advanced economies increasingly depends on research, technological development, and innovation.

Beyond investment, other measures have the potential to boost productivity. Most countries today, and in particular China and the US, are actively sustaining their economies. Economic literature suggests to carefully calibrate public intervention, to avoid misallocation, rent-seeking, capture and inefficiency. Yet actions to encourage entry of new firms in key markets, simplification for SMEs and startups to scale up, provision of technical support for technology transfer and for the early detection of emerging technologies, human capital development, education, targeted and temporary protection for key industries, place-based innovation policies, are all types of interventions that support the economy without protecting the interests of the incumbents or raising barriers to innovation.

Together, these form what we would define the ‘good industrial policy’.

A massive investment gap

With respect to the US, the EU has accumulated a massive investment gap. While, looking at gross figures may (mis)lead some to think that total investment in the EU is similar to the US – at roughly 21% of GDP – taking a closer look at the data shows a very different picture, in particular if we look at net investment trends. Net investment means the net capital formation, which takes into account the depreciation of the existing capital stock. In other words, it provides a measure of the actual investment done in the economy, which goes beyond the simple maintenance of the existing stock of capital.

In the first decade of the century, net private investment in the EU averaged 5.2% of GDP, but it fell considerably in the second decade to around 2.9%, and remained at roughly 3% after the pandemic. In absolute terms, this represents almost €3tn short of private investment with respect to the trend of the first decade of this century. However, it is worth highlighting that private investment in the US also declined after the first decade, though not to the same level. The cumulated investment gap of the private sector in the EU vis-à-vis the US, between 2012 and 2024, amounted to approximately 1.3tn euro.

The main investment gap from the public sector, however, is even larger. Average net public investment in the EU was 0.8% of GDP in the first decade of the century, falling to just 0.2% in the following decade, right before the pandemic shock. It recovered to an average of 0.5% after the pandemic. That gap meant that the EU economy was already falling short of €683bn in public investment during the second decade compared with the first, even before the pandemic.

The gap is even more pronounced when compared with the recovery of public investment in the US. Reaching the same level of public investment on GDP as the US would have required EU governments to invest an additional €1tn in the 10 years preceding the COVID-19 shock, and about half a trillion more between 2021 and 2024 only. In total, the cumulative public investment gap for the EU between 2010 and 2024 amounts to roughly €1.5 trillion.

How to address it

Private investment remains the dominant component of our economies due to its larger scale. However, there is growing evidence of the leading and steering role of public investment. The more uncertainty weighs on economic activity, the more private investment contracts, and the stronger the need for public investment to provide directionality, guarantee, and an anchor of stability, for the private sector to follow.

Given the current environment of uncertainty, the role of public investment becomes crucial to crowd in private investment in most productive areas. Within the multilevel EU’s governance system, this role is particularly delicate. On one hand, public investment may signal a stable commitment to focus on strategic areas, such as research and innovation. On the other hand, EU-level instruments can enhance efficiency and effectiveness by financing European public goods, internalising cross-border spillovers, and preventing fragmentation along national lines, thereby reaping the benefits of the Single Market.

Securing Europe’s growth future

To uphold living standards and maintain them at the level of the best performing economies, Europe needs more robust economic growth. In a context of stagnant or declining demographic trends, that should come from stronger productivity growth. Achieving sustained productivity growth, in turns, depends on our capacity to provide the right incentives to reshape the structure of the economy and to boost investment in research, technological development and innovation.

[1] Krugman, Paul (1994). Competitiveness: A Dangerous Obsession. Foreign Affairs, 73(2), 28–44.

[2] Draghi, Mario (2024). The Future of European Competitiveness: A Competitiveness Strategy for Europe. Report prepared for the European Commission. Published 9 September 2024.

[3]Long Term Productivity Database, updated in 2026, based on: Bergeaud, A., Cette, G. and Lecat, R. (2016): “Productivity Trends in Advanced Countries between 1890 and 2012,” Review of Income and Wealth, vol. 62(3), pages 420–444.

[4] Solow, R. M. (1957). Technical Change and the Aggregate Production Function. Review of Economics and Statistics, 39(3), 312–320.

[5] Romer, P. M. (1990). Endogenous Technological Change. Journal of Political Economy, 98(5), S71–S102.

[6] Aghion, P., & Howitt, P. (1998). Endogenous Growth Theory. MIT Press.

The opinions expressed in this #CriticalThinking article are the author’s alone and cannot be attributed to the European Commission, the VUB or Friends of Europe.