Since the early 2000s, the euro area has faced a persistent growth challenge. Output and productivity growth in the region have remained below those of global competitors such as the US and China. Over the same period, the euro area has maintained a sustained trade surplus, averaging 2.6% of GDP. This was accompanied by rising trade openness and a trendless real exchange rate (RER).
Some interpret the positive euro area trade balance as evidence of deficient domestic demand, particularly weak investment (e.g. Bernanke 2015, Kollmann et al. 2016, 2017, Demertzis 2024, Sandbu 2024, IMF 2025, OECD 2025). Others highlight structural factors such as demographics (Kollmann et al. 2015) as well as strong trade and financial linkages with the rest of the world (Chen et al. 2013). Recently, Draghi (2024) argued that weak Single Market integration and shallow capital markets suppress investment, tilting growth toward external demand and sustaining surpluses.
Most of the existing long-standing literature on euro imbalances has focused on internal adjustment within the euro area (see, for example, Zeugner and Hobza 2013, Fadinger et al. 2023, and the survey among economists conducted by Reis et al. 2016). Several studies have stressed the role of resource misallocation (Gopinath et al. 2017) and financial market imperfections (Kollmann et al. 2016, Jaccard and Smets 2020, Ozhan 2020) in explaining weak demand in the euro area particularly after the financial and sovereign debt crises.
In a new study (Ifrim et al. 2025), we revisit these dynamics using an estimated DSGE model that allows for persistent (trend) shocks to productivity and trade structure. By departing from the common assumption of transitory disturbances, this framework quantifies the long-run forces of external adjustment. Our key finding is that the euro area’s persistent productivity growth gap vis-à-vis the rest of the world (RoW) has been a central driver of the trade surplus. Trade structure shocks – particularly declining euro area home bias and falling import prices – also play a critical role by offsetting appreciation pressures on the RER.
Our findings highlight that Europe’s persistent trade surplus and weak investment are rooted not only in domestic demand conditions but also in long-standing productivity gaps and structural shifts in global trade. Our analysis thus supports recent calls for renewed reform efforts to strengthen productivity and enhance the region’s resilience to global shocks.
Global growth gaps and European adjustment
Between 1999 and 2023, real GDP in the euro area grew by only 1.26% per year on average, compared to 3.28% in the RoW. The gap in labour productivity growth – measured as GDP per person in the labour force – is similarly stark: 0.70% per year in the euro area versus 1.95% in RoW (Figure 1). These differentials are not a short-run phenomenon: The growth gap is highly persistent and is projected to continue.
Figure 1 GDP per capita growth rates
Notes: Based on World Bank Development Indicators (WDI, 2025). The dashed lines represent trend growth rates, computed as Hodrick-Prescott (HP) trends of the respective YoY growth rates.
Figure 2 Euro area–RoW trade and RER data
Notes: A fall in the euro area RER represents an appreciation of the euro. The RER is measured as relative GDP deflators and expressed as a percentage deviation from its 2010 level.
Despite this divergence, the euro area trade balance has remained consistently in surplus (Figure 2, panel b), and the euro area–RoW real exchange rate has shown no clear trend over the same period (panel c). Meanwhile, euro area trade openness – measured as the sum of extra-euro area exports and imports over GDP – has doubled from 15% to 30% since 1999 (panel a). The RoW’s relative trade openness has remained stable.
These patterns raise two important questions: (1) How much of the euro area’s trade surplus is due to weak productivity growth? And (2) why has the RER remained stable despite persistent productivity differentials?
A model with trend shocks
To address these questions, we estimate a large-scale two-region model using euro area and RoW data from 1999 to 2023. The model incorporates both stationary and non-stationary shocks, including persistent shifts in productivity growth, trade preferences (captured through home bias parameters), and sector-specific export productivity. It also features standard frictions in price and wage adjustment, investment, and consumption habits, which allow for realistic short- and medium-term dynamics.
A central innovation of our framework is the explicit modelling of trend shocks. This allows us to isolate the effects of trend shocks – such as persistent productivity differentials – from transitory disturbances. The model is estimated using Bayesian methods and matches a wide set of observed time series on output, trade, prices, and the real exchange rate.
We then use the estimated model to generate historical shock decompositions for key macroeconomic variables. In our estimated model, the persistent weakness in euro area real GDP is largely explained by a sequence of negative shocks to euro area productivity growth, compounded by strong RoW growth. The divergence in trend growth paths explains much of the sustained output and income gap between the regions.
The productivity gap as a driver of the trade balance and RER
Figure 3 breaks down the euro area trade balance and RER into contributions of key structural shocks. For the questions at hand, we highlight trend technology shocks in the euro area (blue) and the RoW (green), together with trade shocks (red). Any remaining disturbances are pooled as “Others” (grey). The full paper also analyses additional shocks not shown here (notably euro area domestic demand shocks). The decomposition yields several important insights:
- Our historical decomposition suggests that persistent productivity growth shocks account for between one quarter and one half of the observed euro area trade surplus. A positive trend productivity shock in RoW raises future income and wealth, prompting households and firms to increase consumption and investment in RoW. This generates a temporary boost in RoW demand for euro area exports and depresses RoW savings.
The trade balance effects of adverse euro area growth shocks largely mirror the RoW shock as both widen the growth gap: weaker euro area productivity lowers expected returns and investment, leading to capital outflows and compressed imports. As a result, the euro area trade balance improves in the short to medium run (Figure 3a). Figure 4a illustrates this transmission mechanism through responses following a RoW growth shock.
Figure 3 Historical decompositions of euro area trade balance/GDP and RER (downward movement = euro area appreciation)
a) Euro area trade balance/GDP
b) Euro area RER
Notes: The coloured bars show contributions of key shocks to the trade-balance-to-GDP ratio and the RER; solid lines show the data. Bars above the solid horizontal line represent positive shock contributions, while bars below show negative shock contributions. A fall in the euro area RER represents an appreciation of the euro.
- However, this is not the full story since these shocks also affect the RER (Figure 3b). Standard theory predicts that faster trend productivity growth abroad should lead to a trend appreciation of the euro area RER.
Yet, the data reveal a fairly ‘flat’ (medium-term) RER. This apparent puzzle can be explained by structural shifts in trade: a trend decline in euro area import prices, especially for non-commodity goods reflects faster productivity growth in RoW tradable sectors, notably in China and other emerging markets. This has reduced the relative price of foreign goods for European households and firms, increasing the euro area import share and mitigating appreciation pressures on the real exchange rate. At the same time, the euro area saw a secular reduction in home bias, with increased preference for foreign goods and euro area producers losing market share domestically. These developments are likely interconnected: higher productivity in RoW tradable sectors has been accompanied by improvements in product quality and variety, further deepening import penetration.
- Finally, the model offers insights into the external determinants of the domestic investment shortfall. Positive productivity shocks in the RoW not only boost foreign absorption but also raise global interest rates and relative returns abroad. In a context of financial openness, these developments reduce investment incentives within the euro area and crowd out domestic absorption. As such, the persistent weakness in euro area investment is not solely a reflection of internal demand shortfalls, but also of external structural forces operating through global capital markets.
Figure 4 Impulse response functions
Notes: A fall in the euro area RER represents an appreciation of the Euro.
Policy implications
These findings carry implications for European policymakers. First, the persistent productivity growth gap between the euro area and the RoW is not only a concern for long-term convergence; addressing this productivity shortfall would likely help reduce the surplus, by strengthening domestic demand and attracting capital inflows. Improving financial conditions for startups, reducing regulatory burdens, and investing in skills should be top priorities for advancing this objective (Adilbish et al. 2025).
Second, while short-run fiscal and monetary measures remain important tools for managing cyclical fluctuations, complementary reforms should aim at raising potential output. Our analysis shows that external imbalances reflect both cyclical and structural forces. A purely demand-based interpretation risks overlooking this.
Third, these findings are timely, considering the ongoing policy debate around competitiveness. Draghi (2024) identifies low investment and weak productivity as major impediments to growth and calls for a renewed strategy to strengthen the supply side of the economy. Our results provide empirical support for this diagnosis. The estimated model suggests that persistent structural forces – rather than cyclical weakness alone – determine macroeconomic outcomes.
Finally, our results show that external forces – such as faster growth in foreign productivity and shifts in global trade structures – exert a significant influence over European economic outcomes. This underscores the need for a coherent European strategy tackling both internal structural challenges and external developments.
Authors’ note: The views expressed in this column are those of the authors and should not be attributed to the European Commission.
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