THE BLOG
01/17/2013 08:24 am ET Updated Mar 19, 2013

The Re-emergence of Europe: Restoring Europe's Competitiveness

The European Union, which comprises 27 member states, currently suffers from "competitiveness deficit" compared to other advanced economies. It has lagged behind the U.S. for the last two decades and, if we look at gross domestic product per capita, the gap has actually widened over that period.

Why is this and what can be done to improve the region's competitiveness?

The EU clearly struggles to match the U.S.'s efficient labor markets and its capacity to innovate. One reason for this is the severe disparity between northern countries and those of the south, central and eastern parts of Europe. In this sense, "union" is a misnomer.

According to the World Economic Forum's Global Competitiveness Report 2012-2013, which ranks 144 countries according to their productivity and competitiveness, countries like Finland, Sweden, the Netherlands and Germany occupy positions three to six on the report's Global Competitiveness Index, whereas Romania and Greece occupy positions 78 and 96, respectively.

One exception to this broad north/south divide is France, currently lagging other northern economies by some way at 21 in the table. While it has an excellent human capital base and a good propensity for technological adoption, France's businesses are saddled with an extremely rigid labour market and an often difficult regulatory environment. The country stands at a fork in the road. Will the economy become more "northern" or more "Mediterranean"?

We define competitiveness broadly as "the set of institutions, policies and factors that determine the level of productivity of a country". As well as macroeconomic stability, northern Europe receives a much stronger assessment for the quality of its institutional environment, the efficiency of markets, its propensity for technological adoption and innovation, among other factors.

Productivity drives prosperity, growth, return on investment and rising living standards. So it is clear that we need to narrow the productivity gaps between member states if the euro is to survive and Europe as a whole is to become more competitive.

But how? Previous attempts have been less than successful. The Lisbon Strategy, launched in 2000, sought to make Europe "the most competitive and dynamic knowledge-based economy" by 2010. It failed because the remit was too broad and there was no compliance regime to make it stick.

Its replacement, the Europe 2020 Strategy, has the similar aim of creating jobs through sustainable, inclusive and innovation-driven growth. Seven major initiatives are underway, covering research and innovation, youth education and employment, high-speed Internet and the digital single market, the shift towards a low-carbon economy, creating a better business environment, up-skilling labour markets, and fostering social cohesion through poverty reduction.

But by the European Commission's own admission, the strategy has achieved disappointing results so far. A protracted debt and banking crisis has not helped.

In the World Economic Forum's view, these aims can be achieved by: reforming labor markets; encouraging competition and entrepreneurship; reducing government spending; restoring macroeconomic stability by reforming the banking system; and investing in the growth-enhancing areas of education, technology and innovation.

There are reasons for optimism. Greece's debt-reduction and labour reform programme, while manifestly unpopular with the electorate, has convinced the EU authorities to release the next tranche of bail-out money. Other southern countries are engaged in a broad range of structural reforms, as well as the widely-publicized fiscal austerity measures.

Many polls and surveys show that a majority of European citizens -- particularly in southern Europe -- appreciate the need for reform, despite the pain. These changes should eventually narrow the competitiveness gap within Europe and therefore the gap between Europe and other more advanced economies.

Fiscal discipline and economic growth do not have to be mutually exclusive, so long as spending cuts are not so sudden and drastic that they put the economy into cardiac arrest. Getting the balance right is undoubtedly difficult -- we do not have space here to revisit the arguments between Keynesian and liberal economists -- but the Baltic states in particular have demonstrated that austerity and growth are possible.

This post is part of a series by Professor Klaus Schwab, Founder and Executive Chairman of the World Economic Forum, based on his book The Re-emergence of Europe.