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

n  From 1950 to 1995 EU productivity growth was faster than in the US

n  But in the past decade since 1995 we have witnessed n  An explosion in US productivity growth n  A slowdown in EU productivity growth equal in size n  An explosion in research on the US takeoff and but much less

research on Europe’s slowdown

n  The magnitude of the shift n  EU/US level of labor productivity (ALP) n  1979 1995 2004 77% 94% 85%

Bringing Together the Two Disparate Literatures

n  Literature #1, why did Europe’s hours per capita decline (hereafter H/N) n  High taxes, regulations, high minimum wages n  Europe made labor expensive n  Movement up Labor Demand curve => low employment +

high ALP

n  Literature #1 misses the turnaround n  Since 1995 decline in tax rates and employment protection

measures n  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

n  Central Focus of Lit #2 on post-1995 turnaround

n  Since 1995 EU H/N has grown faster than US n  Fully 85% of EU productivity slowdown has its

counterpart in a speed-up of EU H/N n  Europe paid for lower ALP mainly with higher

hours rather than less consumption

Primary Attention in Lit #2: The US Revival

n  TFP accounts for most of the ALP gap, capital-deepening relatively little n  ICT production TFP explains a relatively small share of EU-

US difference n  Most of the difference is TFP in ICT-using industries n  Of these, the most important are:

n  Wholesale trade n  Retail trade n  Financial/securities

n  Caveat – Groningen definition of ICT-Use is obsolete, retail is not ICT-intensive (See Stiroh 2006)

Textbook Labor Economics

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Labor Input

Real

Wag

e

Labor Demand Curve

High-Cost LaborSupply Curve

Low-Cost LaborSupply Curve

(W/P)0

(W/P)1

N0 N1

Downward shift in labor supply curve reduces real wage and productivity

A

B

The Labor Demand Curve

n  1970-95 EU climbs to the left n  Hours per capita decline, average labor productivity increases n  In this sense much of Europe’s 1970-95 productivity catchup

was “artificial,” propelled by policies making labor expensive n  No busboys, grocery baggers, stores open less, no valets…

n  1995-2004 EU slides right n  Hours per capita start increasing while they decline in the US n  Effects are magnified by slow reaction of capital

This Paper: There is Another Half to the Puzzle

n  The EU-US “turnaround” is the 1995-2004 US acceleration minus the EU deceleration

n  About 1/3 of the turnaround represents Europe’s deceleration, the rest the US acceleration

n  Almost none of the literature on the EU productivity slowdown relates it to the slide down the labor demand curve. n  Exception: recent paper by Saltari-Travaglini

ALP Growth, 1981-2004

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1981 1986 1991 1996 2001

E.U. Output Per HourU.S. Output per Hour

Percent

Output vs. Hours

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1981 1986 1991 1996 2001

US Output per Capita

EU-15 Output per Capita

EU-15 Hours per Capita

US Hours per Capita

We use a parameter of 1600 rather than 6400, so we’re picking up business cycle level movements

EU-US population growth is fairly constant (~.7%)

Turnaround in TFP Growth but not Capital

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1981 1986 1991 1996 2001

U.S Capital Input per Capita

E.U. Capital Input per Capita

E.U. Total Factor Productivity

U.S. Total Factor Productivity

Percent

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1981 1986 1991 1996 2001

U.S. Capitital DeepeningE.U. Capital Deepening

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As in JHS, we know this is mainly due to movements in hours, not capital

Since 2000, productivity is not driven by investment Rather, by TFP growth and hours decline

Defining Tigers and Tortoises, Pop Shares and Private ALP Growth

n  Tigers: Ireland, Finland, Greece n  Pop Share: 5% ALP 4.79%

n  Middle: Sweden, Austria, UK, Germany, Portugal, France n  Pop Share: 61% ALP: 2.45%

n  Tortoises: Belgium, Netherlands, Denmark, Luxembourg, Spain, Italy n  Pop Share: 34% ALP: 0.72%

Within EU, big change from homogeneity to heterogeneity

n  Standard deviation of ALP growth rates across 15 countries, 0.80 1979-95 to 1.23 1995-2004.

n  Mainly accounted for by non-ICT TFP n  Tortoises actually have negative non-ICT TFP growth

n  Spain and Italy are negative overall

n  Where is this coming from? Is it concentrated in one industry like retail or across many industries?

n  No spillover effect from capital deepening to non-ICT TFP growth

Comparison of Heterogeneity within Europe and within the United States n  Use gross state product per employee in the US vs

GDP per employee in the EU – thanks, Susanto n  The three American Tigers are Arizona, Massachusetts,

and Oregon n  Acceleration ‘80-’95 vs ‘95-’04 was exactly 1.91 in

both the EU and US Tigers n  Comparing eight BEA regions to five large EU nations,

n  US eight regions, 1.77 to 2.77 n  Big EU countries, 0.0 to 2.10

n  Initial obvious explanations: automatic fiscal stabilizers in the US, labor mobility

Productivity vs. Share Effects in EU-US, 1995-2003

-0.7 -0.6 -0.5 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2

Farms/mining

Const./utilities

Manufacturing

Retail/wholesale

Trans.

Finance

Serv.

Comm.

Real estate

ProdShare

Non-ICT share

Non-durables share

Non-ICT prodICT prod

Non-durables prod

ICT share

Manufacturing is nearly as important as retail

But ICT is tiny Only ~2% hours share

ALP growth multiplied by nominal shares

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Real Estate

Communications

Services

Finance

Transportation

Retail/Wholesale

Manufacturing

Construction Utilities

Farms/Mining

U.S.

E.U.

US acceleration is widespread, not just in retail and manufacturing. EU weakness is also widespread

Tigers vs. Middle, It’s All Manufacturing

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Farms/mining

Const./utilities

Manufacturing

Retail/wholesale

Trans.

Finance

Serv.

Comm.

Real estate

Prod

share

Of the 1.95 percentage point gap, ~3/4 is due to manufacturing

Tortoises vs. Middle

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Farms/mining

Const./utilities

Manufacturing

Retail/wholesale

Trans.

Finance

Serv.

Comm.

Real estate

Share

Prod

Failure is more widespread. Totally unrelated industries account for the decline Note that this is largely driven by productivity, not share effects

Interpreting the Tortoise Problem after 1995

n  Failure is across the board n  Consistent with basic theme of paper, that there is a

macro cause, a reduction in taxes and in regulations n  Understanding Share Effects

n  ICT Share higher in US vs EU and also middle vs tortoises n  Big EU share deficit in retail/wholesale and services,

consistent with high tax story

n  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 n  Y/H is only half the welfare story – H/N tells

us the other half n  Decline in H/N in Europe vs US -- 88% to 74%

n  In 1960, US was lowest; by 2004 it’s highest

n  Big turnaround after 1995 n  Growth rate of H/N

n  1979-95 -0.6% n  1995-2004 +0.5%

n  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? n  Tortoise growth in H/N was 1.74 percent post 1995,

vastly outstripping the US and EU Middle countries n  But Ireland also grew at 1.8%

n  Reflects massive investment and associated TFP growth

Average Tax wedge

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1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002

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Tortoises

Note that the Tortoises are always highest, followed by Middle countries, followed by the Tigers and then the US All countries markedly reduce taxes around 1997

Reactions of Hours to Taxes

n  Regressions of H/N on tax wedge n  Using H/N is a first approximation, need to study separate

effects on E/N and H/E

n  Double-log specification, estimated elasticity of H/N to tax wedge is -0.4

n  Changes after 1995 don’t match the tax changes very well, but they go in the right direction

n  Middle countries are the exception n  While everybody else was increasing H/N, middle

countries were working less – counter to tax story

Add in reaction of capital to hours

n  In the short run, unit elasticity – i.e. capital moves slowly

n  Long run, zero reaction – capital adjusts n  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.

n  In other words, a 5% tax increase could be expected to lower short run ALP growth by ~.66%.

Conclusion

n  EU productivity growth decline is across-the-board and not concentrated in retail. Durable manufacturing and ICT are culprits

n  Similarly, failing in Tortoises compared to EU average is across the board, with a significant contribution of manufacturing

n  Our bottom line is a mix of exogenous tax effects and exogenous decline in TFP growth

n  Analogies with US 1972-95 slowdown, Europe ran out of ideas

What to Remember from this Paper

n  Recent Reports by the OECD and others join together high unemployment and slow productivity growth as part of a general malaise.

n  Our focus is different n  Labor market and tax reforms have raised hours per

capita after three decades of decline. n  Rising hours per capita and declining growth of output

per hour are signs of victory for European labor market reforms, not signs of defeat.