Chart of the Week: Energy and Europe’s productivity problem

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Europe’s sluggish economic performance relative to the US is sometimes blamed on its relatively expensive energy. That, in turn, is sometimes blamed on its efforts to decarbonise. But despite the growing share of renewables on Europe’s grid, it is gas prices that typically set the price of its electricity thanks to a marginal pricing system; and gas prices are about four times as high in Europe as they are in the US. There are several reasons for this. It is true that Europe has higher carbon taxes than the US, which raises costs, but it also has higher taxes in general, even on clean electricity. Cutting taxes is one way to reduce costs. But the main reason that European gas prices are so much higher is Europe’s dependency on Russian gas. Unlike the US, Europe does not have the option of increasing fossil fuel production in a way that would significantly reduce gas and electricity prices — even if it wanted to — and it has struggled to find low-cost sources to replace Russian gas. German plans to ramp up investment have raised hopes that it could start to close the productivity gap with the US, as investment that lowers energy costs and improves energy security will help (by, for example, improving grid connectivity and electricity storage, which would reduce the amount of renewable electricity that goes to waste). But the bigger picture is that Europe’s productivity shortfall is not just about energy: ramping up spending on high-tech R&D, including in the defence sector, can potentially go even further.