The Slowdown in European The Slowdown in European Productivity Growth: A Productivity Growth: A

Tale of Tigers, Tortoises, Tale of Tigers, Tortoises, and Textbook Labor and Textbook Labor

EconomicsEconomicsIan Dew-Becker, NBER Ian Dew-Becker, NBER

and Robert J. Gordon, Northwestern and Robert J. Gordon, Northwestern University and NBERUniversity and NBER

NBER Summer InstituteNBER Summer Institute

Macroeconomics and Productivity WorkshopMacroeconomics and Productivity Workshop

July 20, 2006July 20, 2006

The US Accelerates,The US Accelerates,Europe DeceleratesEurope Decelerates

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

But in the past decade since 1995 we have But in the past decade since 1995 we have witnessedwitnessed An explosion in US productivity growthAn explosion in US productivity growth A slowdown in EU productivity growth equal in A slowdown in EU productivity growth equal in

sizesize An explosion in research on the US takeoff and An explosion in research on the US takeoff and

but much less research on Europe’s slowdownbut much less research on Europe’s slowdown The magnitude of the shiftThe magnitude of the shift

EU/US level of labor productivity (ALP)EU/US level of labor productivity (ALP) 1979 1979 1995 1995 20042004

77%77% 94%94% 85%85%

Bringing Together the Bringing Together the Two Disparate LiteraturesTwo Disparate Literatures

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

employment + high ALPemployment + high ALP Literature #1 misses the turnaroundLiterature #1 misses the turnaround

Since 1995 decline in tax rates and Since 1995 decline in tax rates and employment protection measuresemployment protection measures

Big increase in hours per capita, turnaround in Big increase in hours per capita, turnaround in both absolute terms and relative to the US both absolute terms and relative to the US Move back down LMove back down LDD curve curve

Literature #2 on EU-USLiterature #2 on EU-USProductivity Growth GapProductivity Growth Gap

Central Focus of Lit #2 on post-1995 Central Focus of Lit #2 on post-1995 turnaroundturnaround

Since 1995 EU H/N has grown faster Since 1995 EU H/N has grown faster than USthan US

Fully 85% of EU productivity Fully 85% of EU productivity slowdown has its counterpart in a slowdown has its counterpart in a speed-up of EU H/Nspeed-up of EU H/N Europe paid for lower ALP mainly with Europe paid for lower ALP mainly with

higher hours rather than less consumptionhigher hours rather than less consumption

Primary Attention in Lit #2: Primary Attention in Lit #2:

The US RevivalThe US Revival TFP accounts for most of the ALP gap, TFP accounts for most of the ALP gap,

capital-deepening relatively littlecapital-deepening relatively little ICT production TFP explains a relatively small ICT production TFP explains a relatively small

share of EU-US differenceshare of EU-US difference Most of the difference is TFP in ICT-using Most of the difference is TFP in ICT-using

industriesindustries Of these, the most important are:Of these, the most important are:

Wholesale tradeWholesale trade Retail tradeRetail trade Financial/securitiesFinancial/securities

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

Textbook Labor Textbook Labor EconomicsEconomics

-2

-1

0

1

2

3

4

5

6

7

1 2 3 4 5 6 7 8 9 10 11

Labor Input

Re

al W

ag

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 CurveThe Labor Demand Curve

1970-95 EU climbs to the left1970-95 EU climbs to the left Hours per capita decline, average labor Hours per capita decline, average labor

productivity increasesproductivity increases In this sense much of Europe’s 1970-95 In this sense much of Europe’s 1970-95

productivity catchup was “artificial,” propelled by productivity catchup was “artificial,” propelled by policies making labor expensivepolicies making labor expensive

No busboys, grocery baggers, stores open less, no No busboys, grocery baggers, stores open less, no valets…valets…

1995-2004 EU slides right1995-2004 EU slides right Hours per capita start increasing while they Hours per capita start increasing while they

decline in the USdecline in the US Effects are magnified by slow reaction of capitalEffects are magnified by slow reaction of capital

This Paper: There is This Paper: There is Another Half to the PuzzleAnother Half to the Puzzle

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

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

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

TravagliniTravaglini

ALP Growth, 1981-2004ALP 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

Per

cent

Output vs. HoursOutput vs. Hours

-3

-2

-1

0

1

2

3

4

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 ratherthan 6400, so we’re picking up businesscycle level movements

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

Turnaround in TFP GrowthTurnaround in TFP Growthbut not Capitalbut not Capital

-1

0

1

2

3

4

5

6

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

Perc

ent

0

1

2

3

4

5

6

1981 1986 1991 1996 2001

U.S. Capitital DeepeningE.U. Capital Deepening

Per

cent

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

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

Defining Tigers and Defining Tigers and Tortoises, Tortoises,

Pop Shares and Private ALP Pop Shares and Private ALP GrowthGrowth

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

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

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

Within EU, big change from Within EU, big change from homogeneity to homogeneity to heterogeneityheterogeneity

Standard deviation of ALP growth rates across Standard deviation of ALP growth rates across 15 countries, 0.80 1979-95 to 1.23 1995-2004.15 countries, 0.80 1979-95 to 1.23 1995-2004.

Mainly accounted for by non-ICT TFPMainly accounted for by non-ICT TFP Tortoises actually have Tortoises actually have negativenegative non-ICT TFP growth non-ICT TFP growth

Spain and Italy are negative overallSpain and Italy are negative overall

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

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

Comparison of Comparison of Heterogeneity within Heterogeneity within Europe and within the Europe and within the

United StatesUnited States Use gross state product per employee in the Use gross state product per employee in the US vs GDP per employee in the EU – thanks, US vs GDP per employee in the EU – thanks, SusantoSusanto

The three American Tigers are Arizona, The three American Tigers are Arizona, Massachusetts, and OregonMassachusetts, and Oregon

Acceleration ‘80-’95 vs ‘95-’04 was exactly Acceleration ‘80-’95 vs ‘95-’04 was exactly 1.91 in both the EU and US Tigers1.91 in both the EU and US Tigers

Comparing eight BEA regions to five large EU Comparing eight BEA regions to five large EU nations,nations, US eight regions, 1.77 to 2.77US eight regions, 1.77 to 2.77 Big EU countries, 0.0 to 2.10Big EU countries, 0.0 to 2.10

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

Productivity vs. Share EffectsProductivity vs. Share Effectsin EU-US, 1995-2003in 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 importantas retail

But ICT is tinyOnly ~2% hours share

ALP growth multiplied by nominal sharesALP growth multiplied by nominal shares

-0.2 -0.1 0 0.1 0.2 0.3 0.4 0.5

Real Estate

Communications

Services

Finance

Transportation

Retail/Wholesale

Manufacturing

Construction Utilities

Farms/Mining

U.S.

E.U.

US acceleration is widespread, not just in retailand manufacturing.

EU weakness is also widespread

Tigers vs. Middle, It’s AllTigers vs. Middle, It’s AllManufacturingManufacturing

-0.4 -0.2 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8

Farms/mining

Const./utilities

Manufacturing

Retail/wholesale

Trans.

Finance

Serv.

Comm.

Real estate

Prod

share

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

Tortoises vs. MiddleTortoises vs. Middle

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

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 declineNote that this is largely driven by productivity, not share effects

Interpreting the TortoiseInterpreting the TortoiseProblem after 1995Problem after 1995

Failure is across the boardFailure is across the board Consistent with basic theme of paper, that Consistent with basic theme of paper, that

there is a macro cause, a reduction in taxes there is a macro cause, a reduction in taxes and in regulationsand in regulations

Understanding Share EffectsUnderstanding Share Effects ICT Share higher in US vs EU and also middle vs ICT Share higher in US vs EU and also middle vs

tortoisestortoises Big EU share deficit in retail/wholesale and Big EU share deficit in retail/wholesale and

services, consistent with high tax storyservices, consistent with high tax story Part of Tiger success is moving resources, Part of Tiger success is moving resources,

out of agriculture for Greece and Ireland, out of agriculture for Greece and Ireland, into ICT mfg for Ireland and Finlandinto ICT mfg for Ireland and Finland

ALP and Simple Labor ALP and Simple Labor EconomicsEconomics

Y/H is only half the welfare story – H/N tells Y/H is only half the welfare story – H/N tells us the other halfus the other half

Decline in H/N in Europe vs US -- 88% to Decline in H/N in Europe vs US -- 88% to 74%74% In 1960, US was lowest; by 2004 it’s highestIn 1960, US was lowest; by 2004 it’s highest

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

1979-95 -0.6%1979-95 -0.6% 1995-2004 +0.5%1995-2004 +0.5%

Our current empirical investigation of H/N Our current empirical investigation of H/N vs. taxes and regulations is still in its early vs. taxes and regulations is still in its early stagesstages

The Tortoises are on a The Tortoises are on a Hours Growth Tear,Hours Growth Tear,

How Much Due to Taxes?How Much Due to Taxes? Tortoise growth in H/N was 1.74 percent Tortoise growth in H/N was 1.74 percent

post 1995, vastly outstripping the US and post 1995, vastly outstripping the US and EU Middle countriesEU Middle countries

But Ireland also grew at 1.8%But Ireland also grew at 1.8% Reflects massive investment and associated Reflects massive investment and associated

TFP growthTFP growth

Average Tax wedgeAverage Tax wedge

0

5

10

15

20

25

30

35

40

45

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

USMiddle

Tigers

EU-15

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 Reactions of Hours to TaxesTaxes

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

separate effects on E/N and H/Eseparate effects on E/N and H/E Double-log specification, estimated elasticity Double-log specification, estimated elasticity

of H/N to tax wedge is -0.4of H/N to tax wedge is -0.4 Changes after 1995 don’t match the tax Changes after 1995 don’t match the tax

changes very well, but they go in the right changes very well, but they go in the right directiondirection

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

middle countries were working less – counter middle countries were working less – counter to tax storyto tax story

Add in reaction of capital Add in reaction of capital to hoursto hours

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

Long run, zero reaction – capital adjustsLong run, zero reaction – capital adjusts We can multiply the labor elasticity (.4) by the We can multiply the labor elasticity (.4) by the

reaction of capital to hours (1) by capital’s reaction of capital to hours (1) by capital’s share (.33) to get the short run reaction of share (.33) to get the short run reaction of ALP to a 1% tax shock: .4*1*.33=.132. ALP to a 1% tax shock: .4*1*.33=.132.

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

ConclusionConclusion EU productivity growth decline is across-EU productivity growth decline is across-

the-board and not concentrated in retail. the-board and not concentrated in retail. Durable manufacturing and ICT are culpritsDurable manufacturing and ICT are culprits

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

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

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

What to Remember from What to Remember from this Paperthis Paper

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

Our focus is differentOur focus is different Labor market and tax reforms have raised Labor market and tax reforms have raised

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

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