Eurozone Productivity Europe’s Productivity Conundrum: Cyclical, Structural or Both? Jeremy Batstone-Carr Economics and Macrostrategy Consultant Visiting Practicing Professor Global Finance UWE 23rd April 2018

Introduction and Context Eurozone productivity growth since the financial crisis has been weak. This may be due to cyclical factors…but not entirely. Weakness is broad-based. Not simply a handful of states or one or two sectors. Is it a measurement issue? Why is regional business investment so lacklustre? Subdued global productivity growth suggests structural forces are at work. An ageing workforce Increased significance of the service sector Technology “slowdown” and limited diffusion

Will Productivity Growth Revive? Why is productivity so important? Why do investors in financial assets need to consider this?

A Look Back Eurozone Output Per Worker (% y/y) Eurozone Output Per Hour Worked (% y/y)

Productivity has Slowed Across Member States

Average Labour Productivity (Output per Worker, % y/y) 1997-2007 2013-2017 Agriculture, Forestry & Fishing 3.1 2.2 Industry 3.0 2.1 Construction -0.6 0.7 Wholesale & Retail Trade, Transport, Accommodation & Food Services 1.1 0.6 Information & Communication 3.8 1.6 Financial & Insurance Activities 1.7 0.4 Real Estate Activities -1.2 0.1 Professional, Scientific and Tech. Activities -1.5 0.1 Arts, Entertainment, Recreation -0.2 -0.2 Source: Thomson Reuters

Is Productivity Simply Being Mis-measured? Might data not be picking up growth in output per worker? Might data not capture improvements in technology or the rising importance of the digital economy? Where do the PMI surveys fit in to this? Will subdued productivity last or not?

Why has it Happened? Are cyclical factors to blame?

The Eurozone Experience in Context The regional recovery from the crisis period has been slower than elsewhere. In certain individual economies this is even more pronounced. Why? Falling construction investment has played a role. Prolonged weakness in the regional banking sector. SME’s are still struggling to secure financing.

Cyclical Factors are not Confined to the Zone

Structural Drivers A shift to the less productive service sector. An ageing regional population. Relentless decline in technological innovation. A reduction in the technology “diffusion” rate.

Changes in Economic Structure

Demographics

Technology

Slower Technology Diffusion Manufacturing Productivity (2003=1) Service Sector Productivity (2003=1)

What Does the ECB Think? Persistently weak levels of business investment. Too many “zombie” firms. An overweighted and inefficient public sector.

What About the World Bank’s View? Ease of Doing Business Index (1= Most Business Friendly Regulations)

The Outlook for Productivity Growth Will regional productivity always be sluggish or is there scope for a pick-up? We need to check the composition of labour productivity growth. The Contribution from capital The quality of the workforce Total factor productivity

1. Capital Intensity Current data suggests regional firms are operating at normal levels of capacity. To meet growing demand they must increase capital investment.

Annual Machinery Investment Growth Picking Up Machinery Investment and Firms’ Demand for Credit to Fund Investment

Capital Deepening is “AWOL” Contribution to Capital Deepening

2. Labour Quality Here the outlook is less positive. Scope exists for a short-term boost Labour law reforms Improved participation rates

Medium Term Concerns Selected Countries Average PISA Scores (2015)

3. Total Factor Productivity Here there are reasons for considerable pessimism. High regional barriers to entry. Limited scope of recent technological innovation. Reluctance to adopt new technology.

Structural Impediments to Continue Estimated Breakdown of Productivity (%-pts) 2017 2018 2019 2020-2022 Capital Deepening 0.1 0.2 0.3 0.3 Labour Quality -0.1 -0.2 -0.2 -0.2 Total Factor Productivity 0.8 0.8 0.8 0.9 Total Productivity (% y/y) 0.8 0.8 0.8 1.0 Source: Goldman Sachs, Deutsche Bank

Implications and Conclusions Why is the productivity conundrum so important now? Some near-term cyclical improvement seems likely. But structural forces will hold productivity growth back. Do not extrapolate a surge in nominal wage growth The erosion of workers’ bargaining power is ongoing. Together this implies no surge in unit labour costs. The ECB can continue with its very gradual policy normalisation programme. The region’s economic expansion will continue (outwith exogenous shocks) but trend GDP growth will remain sluggish and weaker than elsewhere.

Disclaimer and Accreditation The views contained and expressed within this presentation are those of the presenter. Slides are provided with the permission of Thomson Reuters, The Conference Board (Fig 5), Eurostat, OECD, CBS and Fundacion Rafael del Pinto (Fig 6, 9, 10,14), the ECB (Fig 9), the World Bank (Fig 11), Goldman Sachs and Deutsche Bank data (Table 1) and Capital Economics (Table 2).