Why is Europe’s Productivity Slowing Even Further?

Labour productivity in the EU has been flat lining for some time. Between 2004 and 2024, the growth in labour productivity in the US has been twice that of the Eurozone. In other parts of the world, maintaining strong employer-employee relationships is used as a tool to drive productivity. However, in several parts of the EU, working hours have been reduced to provide a better work-life balance. This has significantly impacted productivity in the region. Here are some other major factors weighing on productivity and the region’s growth in the short and long term.

Restrictions in Innovation

Most start-ups grow in the domestic markets before charting international waters. The EU, however, has an extremely restrictive business environment. In fact, the Eurozone sets benchmarks for the world regarding the expanse of guardrails. Consider GDPR compliance, for instance. A company must enable data audits, consent management and agreement transparency. Failure to do so can lead to penalties of up to 4% of the company’s annual global turnover or €2 million. In an increasingly personalised services landscape, the lack of access and power to leverage user data is bound to stifle business growth.

GDPR compliance also requires adhering to the “Data Protection by Design” principle, risk assessment, incident response guidelines, etc., which add to operational overheads. In 2021, just 2 years after the implementation of GDPR, business profits in the EU declined by 8.1% and sales by 2.2%. This is enough to deter home-grown start-ups and foreign companies. Moreover, the EU has a heterogeneous consumption landscape with language barriers, which means businesses need higher initial investment even for smaller potential markets.

The EU has also been the first to introduce AI use restrictions, creating friction in what most businesses consider a growth engine in the current times. Penalties for breaching the AI Act could be between €7.5 million and €35 million, depending on the severity of the infringement. With clear guidelines for providers, deployers, importers, distributors, and manufacturers the stakes for businesses have risen disproportionately to their profit potential in the near term.

Yet, the positivity around AI is reflected in European stocks, with Acuity’s AssetIQ widget showing bullish sentiment for AI stocks like SAP.

Domestic Troubles

The greatest challenge the EU faces is that the debt crisis that used to plague smaller economies has now clutched the largest ones. France and Germany, two of the most important economies in the bloc, are struggling. To add to the turmoil, the political picture in the two nations is also of uncertainty. Fiscal imbalances, accompanied by the lack of a plan to navigate them, point to continued periods of low growth.

This can be seen in the bearish sentiment towards the CAC 40, France’s benchmark stock index, according to Acuity’s AssetIQ widget.

Energy Crisis

Since the Russia-Ukraine war began, the EU has been in an energy crisis. Its over-dependence on Russia cost the region significant productive capacity. Energy costs for the EU rose up to three times that of the US and China. The rise in energy prices affected energy-intensive industries deeply, especially manufacturing and AI data centres.

Gas prices surged 45% between January and November 2024. The EU had used up its reserves by August, way ahead of the November 1, 2024, deadline, deepening the energy crisis in the region. German factories lowered and even stopped production, citing energy availability issues while consumer demand in the region remains subdued due to high costs.

This has impacted an array of small businesses dependent on heating equipment. Even energy-dependent manufacturer Volkswagen is facing a plant closure in Germany. No surprise then that Acuity’s AssetIQ widget reflects a bearish sentiment towards the stock.

The region has now taken energy supply into its own hands. The EU now spends 10 times more on clean energy capacity building than on fossil fuels. However, this may take some time to ignite business growth. Electricity grid congestion and supply gaps in low-emission hydrogen add to the energy disadvantage for European industries.

Rising Friction in International Trade

China is strategically building self-reliance and lowering import requirements. Imports from the Euro Area in 2023 were only two-thirds (in terms of share of GDP) of the imports in 2013. Germany has taken the biggest blow, which increased imports from China, while the latter lowered its import dependence.

These headwinds have been strengthened by concerns around America’s restrictive trade policies. Tariffs imposed under Trump’s presidency paint a depressing picture. Poor demand may further deter production and weigh on the bloc’s economy, struggling to accelerate growth.

Forging Ahead

Amid slow economic growth, the STOXX 600 is anticipated to generate 9% total returns in 2025. Goldman Sachs downgraded its 2025 forecast for STOXX 600 due to a “moderate rise in risks.” ECB President Christine Lagarde has also been concerned about growth being “tilted to the downside.”

The EU needs to build de-risking strategies to build resilience through market diversification. Low interest rates (relative to the US) may create opportunities for business expansion. However, the bloc must ditch protectionism to open its economy to innovation. Industry competitiveness is critical to expanding exports and attracting businesses.