Europe’s Productivity Gap Is Also a Problem of Scale

The European Union could close around one-third of its productivity gap with the United States if its economy had a similar distribution of large and small companies, according to new analysis by the European Central Bank. The finding strengthens the case for reforms aimed at helping European businesses expand across borders and reach the scale of their US competitors.

EU workers currently produce around 20% less output per hour than their US counterparts, while the two economies were much closer in productivity terms in the mid-1990s. The ECB analysis suggests that the gap is not explained only by how efficiently individual companies operate. The structure of the European corporate sector itself also matters, because large companies tend to be significantly more productive than smaller ones.

Companies employing at least 250 people generate an average of about €86,800 in value added per worker each year, according to the ECB analysis. Firms with fewer than 10 employees produce less than half that amount. Increasing the share of companies able to move from small and medium-sized operations into larger, more productive businesses could therefore have a substantial effect on aggregate European productivity.

Fragmentation limits European scale

The problem is closely connected to the way the EU's Single Market operates. Europe has a market of roughly 450 million people, but businesses expanding across the bloc still face different national rules, tax systems, legal structures and administrative requirements.

For companies, this can mean that expanding from one EU country into another does not function as simply as expanding within a single large national market. Smaller firms can face particularly high costs when attempting to build operations across several jurisdictions, while investors also encounter fragmented capital markets.

The ECB has identified weaker innovation, fragmented regulation and less developed capital markets among the factors holding back European productivity. These constraints can prevent companies from raising sufficient capital, investing in technology and expanding internationally at the pace required to become global competitors.

The issue is not limited to manufacturing. Services, technology, finance and other sectors increasingly depend on the ability to operate across borders and attract investment at scale. A fragmented market makes it more difficult for successful European companies to turn domestic growth into continental expansion.

The EU is trying to make it easier to scale

The ECB has backed the proposed EU Inc framework, which would create a common EU-wide corporate legal structure for companies operating across the bloc. The idea is intended to reduce the need for businesses to navigate 27 separate national company-law systems and multiple corporate forms as they expand.

The proposal is part of a wider discussion about how to turn the Single Market into a more integrated economic space. Rather than requiring every national system to become identical, the approach would provide companies with an additional common framework through which they could establish and operate across EU countries.

The ECB said such a regime could strengthen competition, innovation and productivity by making it easier for businesses to expand. The underlying objective is to ensure that a successful company in one member state can access the full European market without facing a new set of structural barriers every time it crosses a national border.

This is also becoming an issue for Europe's ability to finance technological investment. The International Monetary Fund has separately identified the difficulty European firms face in scaling up as a central explanation for the productivity gap with the United States. IMF analysis published in March found that young US firms have a combined stock-market valuation many times larger than their EU counterparts, while European firms remain considerably smaller on average.

Capital and technology are part of the same problem

The scale issue is increasingly important as Europe seeks to close gaps in artificial intelligence, digital infrastructure and other technology-intensive sectors. Larger companies generally have greater capacity to invest in research and development, acquire technologies, build data infrastructure and absorb the costs associated with entering foreign markets.

The ECB has also highlighted the importance of investment in AI for future productivity. While Europe is not leading the development of the largest frontier AI models, its industrial base gives it a potentially important position in applying AI to manufacturing and other complex physical processes. In a speech earlier this year, ECB Executive Board member Philip Lane argued that productivity gains would depend not only on developing new technologies but on their diffusion throughout the wider economy.

The same structural constraints appear in European finance. Senior EU officials have recently called for larger banks and deeper capital markets, arguing that fragmented national financial systems leave European lenders at a disadvantage compared with large US institutions. European Central Bank Vice-President Boris Vujcic has pointed to differences in trading activities, technology investment and cross-border consolidation as areas where scale has become increasingly important.

The comparison is particularly relevant for technology investment. The largest US banks spend substantially more on information technology relative to their assets than European lenders, according to EU officials, affecting areas such as artificial intelligence, digital payments and cybersecurity.

A broader competitiveness challenge

The ECB's latest analysis therefore places company size alongside a much wider set of European competitiveness problems. Europe has a large consumer base and substantial industrial capacity, but its economic potential is still divided among national markets.

The consequences are visible in the EU's position in global competition. European companies face growing pressure not only from US technology and financial firms but also from Chinese manufacturers, which have moved into higher-value segments traditionally dominated by European exporters. The ECB has warned that China's industrial expansion is increasingly squeezing European companies in sectors such as machinery and transport equipment.

For European policymakers, the challenge is consequently not simply to create more start-ups or increase spending on innovation. It is to build an environment in which companies that succeed can grow rapidly enough to become major European and global players.

That requires functioning capital markets, fewer barriers to cross-border expansion and corporate rules that allow companies to operate across the Single Market without reproducing the complexity of 27 separate systems.

The ECB's estimate gives a measure of the potential economic impact. If Europe had a corporate structure closer to that of the United States, it could eliminate roughly one-third of the existing productivity gap without assuming that individual European firms suddenly become more efficient. The implication is that part of Europe's productivity problem may lie not only inside companies, but in the economic system around them.