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  1. The Staggers
6 February 2023

Why size does matter for Europe and Brexit Britain

The US’s advantage over us is scale. Small is no longer so beautiful.

By Jeremy Cliffe

Attend a policy discussion or think-tank seminar in a European capital these days and, sooner rather than later, you will hear the concern expressed that the continent is falling farther and farther behind the US. That is true of measures of prosperity: in 2008, the year the Great Recession struck, GDP per capita in the EU was 76 per cent that of the US; in 2021 it was just 54 per cent. It is true of hard power: over the past year the Americans, not the Europeans, have provided by far the most military support to Ukraine and led the overall Western response.

And it is true industrially: of the world’s 100 biggest companies by market capitalisation, 15 are European and 62 are American; for every European billion-dollar start up the US has eight; a report from the consultants McKinsey finds that the US is also ahead of Europe on eight of ten future-defining “transversal” technologies. Now that Joe Biden’s administration is pumping hundreds of billions of dollars into US industries to accelerate the country’s green transition, Europe is scrambling to catch up.

There are various explanations for this but the core European problem is one of scale. The US may be divided into 50 states but it is a coherent and complete federation, with an entirely integrated single market in goods, services, people, capital and data. Bigger markets mean bigger companies, cities and clusters, which in turn mean higher productivity and levels of innovation. America’s federal budget, the pooling of resources to spend on common priorities, also enjoys huge advantages of scale.

Compare that with Europe. The EU’s single market is less closely integrated than the American one, particularly when it comes to services, people and data (it is much more arduous, for example, to move as an engineer or coder from Spain to Germany than it is from California to Texas). In many fields it remains fragmented, a linked group of shallow ponds rather than one deep lake. 

That makes it harder for European firms to grow to the scale of their American counterparts. Big companies tend to be responsible for a disproportionate share of cutting-edge research and development investment, so this helps to explain why Europe generates a fraction of the revolutionary tech breakthroughs. A less integrated big market also means shallower pools of capital, which further compounds Europe’s relative lack of scale. A 2021 report by the think tank New Financial said: “On average, capital markets across the EU27 are half as large relative to GDP as in the UK, which in turn is roughly half as developed as the US.”

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The fragmentation of the European economy also means that Europe’s cities are undersized compared with American ones: the US with 330m people has nine metropolitan regions of over five million people, while the EU with 447 million has just three (four before Brexit, with London). The bigger cities get, the more they can benefit from agglomeration and cluster effects, so the greater their productive and innovative capacity. US tech firms have benefited from the concentration of ideas, expertise and venture capital in Silicon Valley, for example, whereas their European counterparts are split between at least half a dozen major centres (London, Berlin, Stockholm, Helsinki, Amsterdam and so forth). So this difference is a significant explanation for the prosperity gap.

Europe’s private-sector scale deficit is matched by its public-sector one. The US federal budget is equivalent to about 24 per cent of GDP; the EU’s pooled budget represents about 1 per cent, with the vast majority of state spending done at national level. Of course, that fragmentation allows member states to pursue their different priorities, but the cost is much less co-ordination and optimisation of that spending for collective goals and interests. 

These benefits of scale were starkly visible in America’s bigger and more dynamic fiscal responses to the Great Recession and then to the Covid-19 pandemic, helping the American economy to bounce back from both crises with greater speed and vigour than the European one. Even during the pandemic, when the EU defied previous taboos to agree a €750bn recovery fund, the US response far overshadowed it. A 2021 report for the European Parliament credited America’s “massive” stimulus for the country’s faster recovery from the shock and noted: “The smaller fiscal response in the euro area also likely reflects the inability to trigger a joint common fiscal package that can be put in place quickly.”

Further benefits of scale are evident in certain areas of common interest, like defence spending. Added together, Europe’s military budgets amount to about half of the American one, but together its militaries are much less than half as formidable and effective (as the former European Commission president Jean-Claude Juncker once put it, the EU gets about 15 per cent of America’s firepower for about 50 per cent of its spending). The fragmentation creates immense inefficiencies. As a recent paper for the Center for Strategic and International Studies, a think tank in Washington, notes, “European armed forces suffer major redundancies, with 29 different types of destroyers, 17 types of main battle tanks and 20 types of fighter planes, as compared to four, one and six, respectively, for the United States”.

To be sure, there are fields where the EU can still hold its own. But tellingly, these are generally ones where it does fully pool its resources and uses the full benefits of its size. It has a major voice in global tech regulation because it speaks with one voice on that topic. The same is true of climate policy (though that lead is at risk now that the US has mobilised its superior investment capacity for green industry) and trade (where the EU remains a major force by virtue of negotiating as a bloc). The single market is more fully developed in goods than in other areas, which helps to explain why European firms that do achieve global scale are often conventional manufacturing giants (Volkswagen, Nestlé, Unilever) rather than services or high-tech ones.

There are of course good reasons why Europe remains more fragmented. The US has been an integrated political and economic entity since its inception as a state. Europe by contrast is a patchwork of states and nations with different languages, histories and cultures, and naturally any legitimate order on the continent has to respect that reality. Yet at the same time it is clear that we are in an era where scale matters and brings distinct advantages, and where Europe’s fragmentation is thus increasingly costly in terms of prosperity, technological sophistication and hard power. The question, then, for the continent is how willing it is to overcome that fragmentation by pooling resources and decision-making in crucial areas to achieve the scale enabling it to keep up with the US (and, in many fields, China). To choose not to, for historical and cultural reasons, is an entirely valid choice. But it should be taken with eyes open to the trade-offs it involves.

Naturally that is a particularly difficult reality for Britain. The project of Brexit rested on a “small is beautiful” view of the world: the idea, fashionable about a decade ago, that the future would be one of decentralised industries, smaller government, more bottom-up and less top-down. By leaving the EU, went the thinking, Britain could free itself from a big, lumbering, monolithic bloc constantly moving at the pace of the slowest and gain the advantages of being more nimble and niche. Since 2016, however, the limits of “small is beautiful” have been brutally exposed. In many important fields fundamental to a state’s prosperity, power and resilience, scale still matters, and arguably matters even more than it did before.

Hence Britain’s unenviable situation today. On military and defence matters the country has been forced to refocus on Europe, shorn of “post-geographic” fantasies about a role primarily as an Indo-Pacific power. Visions of abundant beneficial trade deals have run aground on the reality that market size dictates the terms of trade. And economically Britain looks increasingly at risk of being squeezed by the giant industrial strategies of the US on one side and the EU on the other, a prospect causing growing concern on Whitehall. In an age of supertankers, the buccaneering British schooner looks alarmingly vulnerable. Sometimes, it turns out, small is not so beautiful.

[See also: What the US midterm results mean for Joe Biden]

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