The former England midfielder is in charge of the Manchester United side competing in the inaugural UEFA Youth League.
The 38-year-old, part of the famous Class of 92, said the structure of youth football in England must change and insisted the experience of playing foreign opposition is vital for young players.
"We are well behind," he said. "People keep saying things are not right but no-one does anything about it. We just go round in circles.
"We (Class of 92) were lucky because of the foreigners rule in place at the time. The manager was forced to play us in Europe.
"Now UEFA have started this competition, yet we don't even have Under-19s football. It goes straight from 18 to 21, which is a massive leap.
"There is so much education you still need during those years. Even when we played it took us four or five years to get used to it.
"We were getting beaten, getting knocked out, giving stupid fouls away, daft penalties, getting used to how players from other countries play, understanding the referees are different.
"Even the way players approach referees or speak to them is different. You can play as many top English teams as you like but it is still blood and thunder. To develop properly, exposure in Europe is essential."
Butt coaches Manchester United's Under-19s with former team-mate Paul Scholes, in addition to working with the club's reserves alongside Warren Joyce.
He believes he is better for the experience of working under some of most respected coaches in the country during his time at United and hopes the club's current crop of young talent view him and Paul Scholes in the same light.
"I am getting better," Butt said. "I have worked with some great managers, and obviously the best one in Sir Alex.
"I am learning from the coaches who are at United now, some of whom have been coaching and managing for 20 or 30 years.
"You have to be your own man but I would be foolish if I didn't pick up little bits from other people.
"Eric Harrison was obviously an important figure in my football life. There were times when I hated him. But the things he got me - and the other lads - to do were right.
"Before that we had Brian Kidd and Nobby Stiles. It is brilliant to work with those people. You knew they had been there and done it.
"Hopefully the present generation think that about myself and Paul Scholes."
And United executive vice-chairman Ed Woodward reckons the use of a 'B' team in a lower league could be the answer to a lack of competitive football for younger players.
"If we could have a 'B' team playing it would solve a lot of the issues," Woodward said. "The reserves do deliver some of the objectives. The system just isn't as good as it could be."