Why did Europe’s productivity catch-up sputter out? a tale of tigers and tortoises

Abstract

This paper takes a different approach to examining the sharp turnaround in EU relative to U. S. labor productivity growth since 1995. The vast majority of the literature focuses on the American growth revival. But close to half of the turnaround was caused by a European retardation. What caused that retardation? Our paper shows that none of the consensus explanations of the American revival provide any help at all in explaining the European retardation. It is sui generis and therein lies a tale that has not previously been told. ; Europe has faltered across the board. The deceleration of its productivity growth is not explained at all by ICT production and only to a small degree by retailing/wholesaling. Rather, the big European countries have failed in nearly every dimension. The retardation of Europe is illuminated by dividing up the EU-15 countries into Tigers, a Middle group, and Tortoises. ; Our first surprise in examining the data is to find that the EU-US turnaround in labor productivity growth was not just a reflection of an equivalent turnaround in total factor productivity growth. Capital deepening also faltered in Europe, indicting all the macroeconomic determinants of economy-wide investment as part of Europe’s problem. ; The most striking aspect of our results is that the failing of the Tortoise countries is widespread, spanning industries as diverse as agriculture, wholesale trade, mining, chemicals, construction, fabricated metals, and clothing. Our explanation is that Europe’s previous catch-up to the U. S. productivity level before 1995 was artificial – by making labor expensive, Europe raised its average product. But after 1995 as labor market reforms have helped to make labor cheaper, so the average product of labor has been pushed down and its growth rate has faltered. The falling behind of Europe is quite simple to explain; European regulations defied the laws of labor market equilibrium for decades, and a slight leak in the dam holding back market forces has already led to faster growth in European employment and slower growth in productivity.