Until around 1995, postwar labour productivity grew much faster in Europe than in the United States. But since 1995, Europe’s productivity catch-up ground to a halt and then reversed. The ratio of EU-15 relative to US average labour productivity, using 1995 PPP exchange rates, was 77% in 1979, reached 94% in 1995, and by 2004 had slipped back to 85%. About half of this reversal was from the US surge in productivity growth, which has been much analysed. But the other half of the story, Europe's productivity slowdown, hasn't.
Ian Dew-Becker and Robert J. Gordon from Northwestern University examine what caused this retardation in a new paper to be presented today at the Macroeconomics and Productivity Workshop in Boston, part of week two of the NBER Summer Institute 2006. The paper, The Slowdown in European Productivity Growth: A Tale of Tigers, Tortoises, and Textbook Labor Economics (PDF), argues that increasing taxes on European labour in the period up to 1995 encouraged more capital-intensive production - raising growth but reducing employment rates. Labour market reforms over the past decade have cut labour taxes, but at some cost to productivity growth:
One of the exogenous driving forces in this was an increase in labor taxes before 1995 and a reduction after 1995. We show that a substantial portion of the post‐1995 turnaround in the growth of European hours per capita can be explained by a reversal in the previous regime of ever‐increasing tax rates. We conclude that Europe must accept slow productivity growth as a consequence of labor market reforms that have achieved a desirable turnaround in growth of hours per capita.
The paper contains an extensive analysis of the industry decomposition of European productivity growth, based on a decomposition of Europe’s fastest‐growing “Tigers,” its slowest‐growing “Tortoises”, and a Middle group. The decline in tax rates and turnaround in the growth of hours per capita is distinctly more important in the Tortoises than in the Middle group, adding to the case that changes in the cost of labor are driving both the positive turnaround in hours and negative turnaround in productivity in the EU compared with the US.
Note: Also worth reading is the authors' December 2005 NBER working paper on US productivity growth, Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income, which found that "only the top 10 percent of the income distribution enjoyed a growth rate of real wage and salary income equal to or above the average rate of economy-wide productivity growth." (See The Economist's coverage). You can find a free version of the paper here; a revised version is forthcoming in Brooking Papers on Economic Activity, 2005, no. 2.
Update: Dave Altig at Macroblog links to this post (thanks), and presents Bernanke's views on productivity: The Chairman Speaks: Why Don't Rising Productivity Tides Raise All Boats (Equally)?
Bernanke's explanation is that "the United States has done a lot better at using those [ICT] technologies than a lot of other industrialized countries." He also cites competitive pressures as an important driver of firm productivity - something i absolutely agree with.
On the Dew-Becker and Gordon paper itself, Dave muses:
My instinct is to side with some version of the Bernanke explanation. But there is rarely a single factor that provides a fully satisfactory explanation of any particular set of facts, and I haven't read the paper cited by TNE. So I'll leave it as an open question.