By David Born

A perfect storm is brewing over Europe. Increasing trade barriers are taking a toll on its export-reliant economy. Security threats have escalated dramatically since the war in Ukraine, driving defense and security spending to new heights. Meanwhile, Europe’s domestic industries face mounting pressure from intensifying competition, particularly from China and other emerging players.

By now, it is clear to all: a radical course correction is needed. Europe must reignite growth to safeguard its prosperity in the years ahead. Against this backdrop, the Roland Berger Institute explores what a bold reinvention could look like. What reforms are essential? And what obstacles must be removed to ensure Europe remains competitive on the global stage?

To grasp how far Europe has fallen behind the U.S. in recent decades, three scenarios help illustrate the challenge. All assume that the American economy will continue growing at 2% annually until 2040. The key question: How fast must Europe expand to narrow, or even close, the gap?

Currently, Europe's economy is growing at just over 1% - a figure that already includes Germany’s massive investment program to upgrade infrastructure and military capabilities.

In the first scenario, where the gap with the U.S. remains unchanged, Europe would need to grow at 2% annually. Restoring the EU economy to its relative strength in 2000 - when it stood at 83% of US GDP - would require a bullish 3.1% growth rate. Closing the gap entirely? That would demand an extraordinary 4.4% annual expansion - an unrealistic prospect in today’s environment.

It is crucial to see these three scenarios as a thought experiment, an illustration of the scale of the challenge facing European policymakers and businesses. The message is clear: Europe’s economy must return to stronger growth. With the era of the "peace dividend" over, the continent faces soaring defense costs. At the same time, economic expansion is essential to prevent welfare cuts - cuts that could undermine Europe’s social model and, ultimately, the stability of its liberal democracies.

It is no secret that Europe has fallen behind in key competitive factors. A look back at Adam Smith and classical economic theory helps put this into perspective. According to Smith, an economy can only thrive if it holds a competitive edge in one of three key areas: land, labor or capital. With limited natural resources, Europe must rely on the other two.

Unfortunately, the opposite has been true in recent years. Europe’s labor productivity growth - which also reflects shifts in capital productivity - has lagged behind its main competitors, making it significantly harder for European firms to compete on the global stage.

The root causes of this slowdown are not external shocks such as the US-China trade war since 2018, the COVID-19 pandemic or the energy price surge following Russia’s invasion of Ukraine. While these factors have certainly weighed on European economies, the real problem lies in long-standing structural weaknesses. In our report, we have identified six areas that structurally burden Europe the most:

A demographic headwind

Europe’s population is aging. Birth rates remain low, while life expectancy continues to rise. If current trends persist, the working age population will shrink by nearly 8 million until 2030, with severe consequences for businesses and the broader economy. A shrinking workforce means fewer skilled professionals and mounting fiscal pressure.

The lost tech revolution

The world’s most critical digital industries are firmly dominated by American and Chinese firms. With few exceptions, Europe has failed to produce globally leading tech giants. Worse still, the continent risks falling even further behind in cross-cutting digital technologies, jeopardizing its competitive edge in key industries like automotive or mechanical engeneering.

Costly overregulation

Regulation is essential to ensure businesses operate within a stable legal framework. But nowhere is the regulatory maze as dense as in Europe. According to a Eurochambres survey from autumn 2023, administrative costs resulting from excessive regulation are a significant burden for most companies - and in a quarter of cases, they are deemed extremely severe.

High energy prices

Access to affordable energy is a key factor in the competitiveness of each and every business. The problem is that firms in Europe pay far more for electricity than their counterparts in the US or China. While Russia’s invasion of Ukraine sent energy prices soaring, the gap to the US existed long before the war. Unsurprisingly, more than three-quarters of European companies cite energy costs as a major barrier to new investment.

A difficult path to defense autonomy

It is clear that Europe must spend more on its own defense. With the US stepping back as the guarantor of European security, the buzzword of the moment is “defense autonomy.” But achieving it will be costly - far exceeding the previous target of 2% of GDP for military spending.

The widening investment gap


Without overdue investments to boost productivity, drive innovation and modernize infrastructure, any real economic breakthrough will remain out of reach. The bigger question is: where will the money come from? Many EU countries are already heavily indebted, and a unified European capital market - which could facilitate private investment - is lacking.

Despite all the justified criticism and the scale of the challenges ahead, Europe must avoid one crucial mistake: underestimating itself. The continent has plenty of strengths to build on. Take Spain, for instance, which has staged an impressive turnaround, emerging last year as the fastest-growing industrial nation. Bold labor market reforms, a resurgent services sector and competitive local energy prices have all played a role in its success.

Europe should not underestimate its own strength

The rest of Europe has little reason to hide either. A healthy trade surplus with the US proves that many European firms remain globally competitive. And when it comes to exports of goods and services, Europe still outpaces both China and the US. But to ensure this remains the case, long-overdue structural reforms must finally be tackled with determination.

For policymakers, the playbook is clear: Address labor shortages swiftly, ideally through the uniform implementation of the Blue Card initiative across all member states. A unified EU capital market is just as essential as rolling back excessive reporting requirements - whether on supply chains or labor standards. Energy policy also demands urgent action. A more interconnected grid, coupled with advanced storage solutions, could provide businesses with what they need most: access to more affordable energy.

Yet while structural reforms are critical, they alone will not secure Europe’s prosperity in the decades ahead. Businesses must step up as well. In an era of rising trade barriers, they need to future-proof production and develop smart localization strategies, particularly to strengthen their presence in fast-growing markets across the Global South. At the same time, companies must embark on parallel restructuring and transformation, underpinned by active cash management. This will unlock resources for investment in R&D, key technologies, and future growth areas. Done right, these efforts could lay the foundation for a decade of renewed expansion - one in which Europe’s businesses regain lost ground.