The Slowdown in European
Productivity Growth: A Tale of
Tigers, Tortoises, and Textbook
Labor Economics
Ian Dew-Becker, NBER
and Robert J. Gordon, Northwestern University and NBER
NBER Summer Institute
Macroeconomics and Productivity Workshop
July 20, 2006
The US Accelerates,
Europe Decelerates


From 1950 to 1995 EU productivity growth was faster
than in the US
But in the past decade since 1995 we have witnessed




An explosion in US productivity growth
A slowdown in EU productivity growth equal in size
An explosion in research on the US takeoff and but much less
research on Europe’s slowdown
The magnitude of the shift


EU/US level of labor productivity (ALP)
1979
1995
2004
77%
94%
85%
Bringing Together the
Two Disparate Literatures

Literature #1, why did Europe’s hours per capita
decline (hereafter H/N)




High taxes, regulations, high minimum wages
Europe made labor expensive
Movement up Labor Demand curve => low employment +
high ALP
Literature #1 misses the turnaround


Since 1995 decline in tax rates and employment protection
measures
Big increase in hours per capita, turnaround in both absolute
terms and relative to the US Move back down LD curve
Literature #2 on EU-US
Productivity Growth Gap



Central Focus of Lit #2 on post-1995
turnaround
Since 1995 EU H/N has grown faster than US
Fully 85% of EU productivity slowdown has its
counterpart in a speed-up of EU H/N

Europe paid for lower ALP mainly with higher
hours rather than less consumption
Primary Attention in Lit #2:
The US Revival

TFP accounts for most of the ALP gap, capitaldeepening relatively little



ICT production TFP explains a relatively small share of EUUS difference
Most of the difference is TFP in ICT-using industries
Of these, the most important are:




Wholesale trade
Retail trade
Financial/securities
Caveat – Groningen definition of ICT-Use is obsolete,
retail is not ICT-intensive (See Stiroh 2006)
Textbook Labor
Economics
7
6
High-Cost Labor
Supply Curve
Labor Demand
Curve
5
Real Wage
4
(W/P)0
A
3
Low-Cost
Labor
Supply Curve
(W/P)1
B
2
1
0
Downward shift in labor
supply curve reduces real
wage and productivity
-1
-2
1
2
3
4
5
N0
6
Labor Input
7
N1
8
9
10
11
The Labor Demand Curve

1970-95 EU climbs to the left


Hours per capita decline, average labor productivity increases
In this sense much of Europe’s 1970-95 productivity catchup
was “artificial,” propelled by policies making labor expensive


No busboys, grocery baggers, stores open less, no valets…
1995-2004 EU slides right


Hours per capita start increasing while they decline in the US
Effects are magnified by slow reaction of capital
This Paper: There is
Another Half to the Puzzle



The EU-US “turnaround” is the 1995-2004 US
acceleration minus the EU deceleration
About 1/3 of the turnaround represents
Europe’s deceleration, the rest the US
acceleration
Almost none of the literature on the EU
productivity slowdown relates it to the slide
down the labor demand curve.

Exception: recent paper by Saltari-Travaglini
ALP Growth, 1981-2004
3.5
3.0
U.S. Output per Hour
E.U. Output Per Hour
Percent
2.5
2.0
1.5
1.0
0.5
0.0
1981
1986
1991
1996
2001
Output vs. Hours
4
We use a parameter of 1600 rather
than 6400, so we’re picking up business
cycle level movements
US Output per Capita
3
EU-15 Output per Capita
2
1
US Hours per Capita
0
-1
EU-15 Hours per Capita
-2
EU-US population growth is fairly constant (~.7%)
-3
1981
1986
1991
1996
2001
Turnaround in TFP Growth
but not Capital
6
5
U.S Capital Input per Capita
Percent
4
3
E.U. Capital Input per Capita
2
E.U. Total Factor Productivity
1
0
U.S. Total Factor Productivity
-1
1981
1986
1991
1996
2001
6
As in JHS, we know this is mainly due
to movements in hours, not capital
5
U.S. Capitital Deepening
E.U. Capital Deepening
Percent
4
3
2
Since 2000, productivity is not driven by investment
Rather, by TFP growth and hours decline
1
0
1981
1986
1991
1996
2001
Defining Tigers and Tortoises,
Pop Shares and Private ALP Growth

Tigers: Ireland, Finland, Greece


ALP 4.79%
Middle: Sweden, Austria, UK, Germany,
Portugal, France


Pop Share: 5%
Pop Share: 61%
ALP: 2.45%
Tortoises: Belgium, Netherlands, Denmark,
Luxembourg, Spain, Italy

Pop Share: 34%
ALP: 0.72%
Within EU, big change from
homogeneity to heterogeneity


Standard deviation of ALP growth rates across 15
countries, 0.80 1979-95 to 1.23 1995-2004.
Mainly accounted for by non-ICT TFP

Tortoises actually have negative non-ICT TFP growth



Spain and Italy are negative overall
Where is this coming from? Is it concentrated in one
industry like retail or across many industries?
No spillover effect from capital deepening to non-ICT
TFP growth
Comparison of Heterogeneity within
Europe and within the United States




Use gross state product per employee in the US vs
GDP per employee in the EU – thanks, Susanto
The three American Tigers are Arizona, Massachusetts,
and Oregon
Acceleration ‘80-’95 vs ‘95-’04 was exactly 1.91 in both
the EU and US Tigers
Comparing eight BEA regions to five large EU nations,



US eight regions, 1.77 to 2.77
Big EU countries, 0.0 to 2.10
Initial obvious explanations: automatic fiscal stabilizers
in the US, labor mobility
Productivity vs. Share Effects
in EU-US, 1995-2003
Real estate
Manufacturing is nearly as important
as retail
Prod
Share
Comm.
Serv.
Finance
Trans.
Retail/wholesale
Non-durables prod
Non-durables share
Manufacturing
ICT prod
Const./utilities
Farms/mining
-0.7
Non-ICT share
Non-ICT prod
ICT share
But ICT is tiny
Only ~2% hours share
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
ALP growth multiplied by nominal shares
Real Estate
U.S.
Communications
Services
Finance
E.U.
Transportation
Retail/Wholesale
Manufacturing
US acceleration is widespread, not just in retail
and manufacturing.
Construction Utilities
Farms/Mining
EU weakness is also widespread
-0.2
-0.1
0
0.1
0.2
0.3
0.4
0.5
Tigers vs. Middle, It’s All
Manufacturing
Real estate
Of the 1.95 percentage point gap, ~3/4
is due to manufacturing
Prod
Comm.
Serv.
share
Finance
Trans.
Retail/wholesale
Manufacturing
Const./utilities
Farms/mining
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
Tortoises vs. Middle
Real estate
Prod
Comm.
Serv.
Share
Finance
Trans.
Failure is more widespread.
Totally unrelated industries account for the decline
Note that this is largely driven by productivity,
not share effects
Retail/wholesale
Manufacturing
Const./utilities
Farms/mining
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
Interpreting the Tortoise
Problem after 1995



Failure is across the board
Consistent with basic theme of paper, that there is a
macro cause, a reduction in taxes and in regulations
Understanding Share Effects



ICT Share higher in US vs EU and also middle vs tortoises
Big EU share deficit in retail/wholesale and services,
consistent with high tax story
Part of Tiger success is moving resources, out of
agriculture for Greece and Ireland, into ICT mfg for
Ireland and Finland
ALP and Simple Labor Economics


Y/H is only half the welfare story – H/N tells
us the other half
Decline in H/N in Europe vs US -- 88% to 74%



In 1960, US was lowest; by 2004 it’s highest
Big turnaround after 1995
Growth rate of H/N
1979-95 -0.6%
 1995-2004 +0.5%


Our current empirical investigation of H/N vs.
taxes and regulations is still in its early stages
The Tortoises are on a Hours
Growth Tear,
How Much Due to Taxes?


Tortoise growth in H/N was 1.74 percent post 1995,
vastly outstripping the US and EU Middle countries
But Ireland also grew at 1.8%

Reflects massive investment and associated TFP growth
Average Tax wedge
45
40
Tortoises
35
Tigers
30
25
EU-15
Middle
US
20
15
Note that the Tortoises are always highest, followed by Middle countries,
followed by the Tigers and then the US
10
All countries markedly reduce taxes around 1997
5
0
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
Reactions of Hours to Taxes

Regressions of H/N on tax wedge





Using H/N is a first approximation, need to study separate
effects on E/N and H/E
Double-log specification, estimated elasticity of H/N
to tax wedge is -0.4
Changes after 1995 don’t match the tax changes very
well, but they go in the right direction
Middle countries are the exception
While everybody else was increasing H/N, middle
countries were working less – counter to tax story
Add in reaction of capital to
hours




In the short run, unit elasticity – i.e. capital moves
slowly
Long run, zero reaction – capital adjusts
We can multiply the labor elasticity (.4) by the reaction
of capital to hours (1) by capital’s share (.33) to get the
short run reaction of ALP to a 1% tax shock:
.4*1*.33=.132.
In other words, a 5% tax increase could be expected to
lower short run ALP growth by ~.66%.
Conclusion




EU productivity growth decline is across-the-board and
not concentrated in retail. Durable manufacturing and
ICT are culprits
Similarly, failing in Tortoises compared to EU average is
across the board, with a significant contribution of
manufacturing
Our bottom line is a mix of exogenous tax effects and
exogenous decline in TFP growth
Analogies with US 1972-95 slowdown, Europe ran out
of ideas
What to Remember from
this Paper




Recent Reports by the OECD and others join together
high unemployment and slow productivity growth as
part of a general malaise.
Our focus is different
Labor market and tax reforms have raised hours per
capita after three decades of decline.
Rising hours per capita and declining growth of output
per hour are signs of victory for European labor
market reforms, not signs of defeat.