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 From 1950 to 1995 EU productivity growth was faster than in the US From 1950 to 1995 EU productivity growth was faster than in the US But in the past decade since 1995 we have witnessed But in the past decade since 1995 we have witnessed An explosion in US productivity growth An explosion in US productivity growth A slowdown in EU productivity growth equal in size A slowdown in EU productivity growth equal in size An explosion in research on the US takeoff and but much less research on Europe’s slowdown An explosion in research on the US takeoff and but much less research on Europe’s slowdown The magnitude of the shift The magnitude of the shift EU/US level of labor productivity (ALP) EU/US level of labor productivity (ALP) %94%85% 77%94%85%

Bringing Together the Two Disparate Literatures Literature #1, why did Europe’s hours per capita decline (hereafter H/N) Literature #1, why did Europe’s hours per capita decline (hereafter H/N) High taxes, regulations, high minimum wages High taxes, regulations, high minimum wages Europe made labor expensive Europe made labor expensive Movement up Labor Demand curve => low employment + high ALP Movement up Labor Demand curve => low employment + high ALP Literature #1 misses the turnaround Literature #1 misses the turnaround Since 1995 decline in tax rates and employment protection measures Since 1995 decline in tax rates and employment protection measures Big increase in hours per capita, turnaround in both absolute terms and relative to the US Move back down L D curve Big increase in hours per capita, turnaround in both absolute terms and relative to the US Move back down L D curve

Literature #2 on EU-US Productivity Growth Gap Central Focus of Lit #2 on post-1995 turnaround Central Focus of Lit #2 on post-1995 turnaround Since 1995 EU H/N has grown faster than US Since 1995 EU H/N has grown faster than US Fully 85% of EU productivity slowdown has its counterpart in a speed-up of EU H/N Fully 85% of EU productivity slowdown has its counterpart in a speed-up of EU H/N Europe paid for lower ALP mainly with higher hours rather than less consumption Europe paid for lower ALP mainly with higher hours rather than less consumption

Primary Attention in Lit #2: The US Revival TFP accounts for most of the ALP gap, capital- deepening relatively little TFP accounts for most of the ALP gap, capital- deepening relatively little ICT production TFP explains a relatively small share of EU- US difference ICT production TFP explains a relatively small share of EU- US difference Most of the difference is TFP in ICT-using industries Most of the difference is TFP in ICT-using industries Of these, the most important are: Of these, the most important are: Wholesale trade Wholesale trade Retail trade Retail trade Financial/securities Financial/securities Caveat – Groningen definition of ICT-Use is obsolete, retail is not ICT-intensive (See Stiroh 2006) Caveat – Groningen definition of ICT-Use is obsolete, retail is not ICT-intensive (See Stiroh 2006)

Textbook Labor Economics

The Labor Demand Curve EU climbs to the left EU climbs to the left Hours per capita decline, average labor productivity increases Hours per capita decline, average labor productivity increases In this sense much of Europe’s productivity catchup was “artificial,” propelled by policies making labor expensive In this sense much of Europe’s productivity catchup was “artificial,” propelled by policies making labor expensive No busboys, grocery baggers, stores open less, no valets… No busboys, grocery baggers, stores open less, no valets… EU slides right EU slides right Hours per capita start increasing while they decline in the US Hours per capita start increasing while they decline in the US Effects are magnified by slow reaction of capital Effects are magnified by slow reaction of capital

This Paper: There is Another Half to the Puzzle The EU-US “turnaround” is the US acceleration minus the EU deceleration The EU-US “turnaround” is the US acceleration minus the EU deceleration About 1/3 of the turnaround represents Europe’s deceleration, the rest the US acceleration About 1/3 of the turnaround represents Europe’s deceleration, the rest the US acceleration Almost none of the literature on the EU productivity slowdown relates it to the slide down the labor demand curve. Almost none of the literature on the EU productivity slowdown relates it to the slide down the labor demand curve. Exception: recent paper by Saltari-Travaglini Exception: recent paper by Saltari-Travaglini

ALP Growth,

Output vs. Hours 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

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 Tigers: Ireland, Finland, Greece Tigers: Ireland, Finland, Greece Pop Share: 5%ALP 4.79% Pop Share: 5%ALP 4.79% Middle: Sweden, Austria, UK, Germany, Portugal, France Middle: Sweden, Austria, UK, Germany, Portugal, France Pop Share: 61%ALP: 2.45% Pop Share: 61%ALP: 2.45% Tortoises: Belgium, Netherlands, Denmark, Luxembourg, Spain, Italy Tortoises: Belgium, Netherlands, Denmark, Luxembourg, Spain, Italy Pop Share: 34%ALP: 0.72% Pop Share: 34%ALP: 0.72%

Within EU, big change from homogeneity to heterogeneity Standard deviation of ALP growth rates across 15 countries, to Standard deviation of ALP growth rates across 15 countries, to Mainly accounted for by non-ICT TFP Mainly accounted for by non-ICT TFP Tortoises actually have negative non-ICT TFP growth Tortoises actually have negative non-ICT TFP growth Spain and Italy are negative overall Spain and Italy are negative overall Where is this coming from? Is it concentrated in one industry like retail or across many industries? Where is this coming from? Is it concentrated in one industry like retail or across many industries? No spillover effect from capital deepening to non-ICT TFP growth No spillover effect from capital deepening to non-ICT TFP growth

Comparison of Heterogeneity within Europe and within the United States Use gross state product per employee in the US vs GDP per employee in the EU – thanks, Susanto Use gross state product per employee in the US vs GDP per employee in the EU – thanks, Susanto The three American Tigers are Arizona, Massachusetts, and Oregon The three American Tigers are Arizona, Massachusetts, and Oregon Acceleration ‘80-’95 vs ‘95-’04 was exactly 1.91 in both the EU and US Tigers Acceleration ‘80-’95 vs ‘95-’04 was exactly 1.91 in both the EU and US Tigers Comparing eight BEA regions to five large EU nations, Comparing eight BEA regions to five large EU nations, US eight regions, 1.77 to 2.77 US eight regions, 1.77 to 2.77 Big EU countries, 0.0 to 2.10 Big EU countries, 0.0 to 2.10 Initial obvious explanations: automatic fiscal stabilizers in the US, labor mobility Initial obvious explanations: automatic fiscal stabilizers in the US, labor mobility

Productivity vs. Share Effects in EU-US, Manufacturing is nearly as important as retail But ICT is tiny Only ~2% hours share

ALP growth multiplied by nominal shares US acceleration is widespread, not just in retail and manufacturing. EU weakness is also widespread

Tigers vs. Middle, It’s All Manufacturing Of the 1.95 percentage point gap, ~3/4 is due to manufacturing

Tortoises vs. Middle 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 Failure is across the board Failure is across the board Consistent with basic theme of paper, that there is a macro cause, a reduction in taxes and in regulations Consistent with basic theme of paper, that there is a macro cause, a reduction in taxes and in regulations Understanding Share Effects Understanding Share Effects ICT Share higher in US vs EU and also middle vs tortoises ICT Share higher in US vs EU and also middle vs tortoises Big EU share deficit in retail/wholesale and services, consistent with high tax story Big EU share deficit in retail/wholesale and services, consistent with high tax story Part of Tiger success is moving resources, out of agriculture for Greece and Ireland, into ICT mfg for Ireland and Finland 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 Y/H is only half the welfare story – H/N tells us the other half Y/H is only half the welfare story – H/N tells us the other half Decline in H/N in Europe vs US -- 88% to 74% Decline in H/N in Europe vs US -- 88% to 74% In 1960, US was lowest; by 2004 it’s highest In 1960, US was lowest; by 2004 it’s highest Big turnaround after 1995 Big turnaround after 1995 Growth rate of H/N Growth rate of H/N % % % % Our current empirical investigation of H/N vs. taxes and regulations is still in its early stages 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? Tortoise growth in H/N was 1.74 percent post 1995, vastly outstripping the US and EU Middle countries Tortoise growth in H/N was 1.74 percent post 1995, vastly outstripping the US and EU Middle countries But Ireland also grew at 1.8% But Ireland also grew at 1.8% Reflects massive investment and associated TFP growth Reflects massive investment and associated TFP growth

Average Tax wedge 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 Regressions of H/N on tax wedge Regressions of H/N on tax wedge Using H/N is a first approximation, need to study separate effects on E/N and H/E Using H/N is a first approximation, need to study separate effects on E/N and H/E Double-log specification, estimated elasticity of H/N to tax wedge is -0.4 Double-log specification, estimated elasticity of H/N to tax wedge is -0.4 Changes after 1995 don’t match the tax changes very well, but they go in the right direction Changes after 1995 don’t match the tax changes very well, but they go in the right direction Middle countries are the exception Middle countries are the exception While everybody else was increasing H/N, middle countries were working less – counter to tax story While everybody else was increasing H/N, middle countries were working less – counter to tax story

Add in reaction of capital to hours In the short run, unit elasticity – i.e. capital moves slowly In the short run, unit elasticity – i.e. capital moves slowly Long run, zero reaction – capital adjusts Long run, zero reaction – capital adjusts 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. 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. In other words, a 5% tax increase could be expected to lower short run ALP growth by ~.66%. In other words, a 5% tax increase could be expected to lower short run ALP growth by ~.66%.

Conclusion EU productivity growth decline is across-the-board and not concentrated in retail. Durable manufacturing and ICT are culprits EU productivity growth decline is across-the-board and not concentrated in retail. Durable manufacturing and ICT are culprits Similarly, failing in Tortoises compared to EU average is across the board, with a significant contribution of manufacturing Similarly, failing in Tortoises compared to EU average is across the board, with a significant contribution of manufacturing Our bottom line is a mix of exogenous tax effects and exogenous decline in TFP growth Our bottom line is a mix of exogenous tax effects and exogenous decline in TFP growth Analogies with US slowdown, Europe ran out of ideas Analogies with US slowdown, Europe ran out of ideas

What to Remember from this Paper Recent Reports by the OECD and others join together high unemployment and slow productivity growth as part of a general malaise. Recent Reports by the OECD and others join together high unemployment and slow productivity growth as part of a general malaise. Our focus is different Our focus is different Labor market and tax reforms have raised hours per capita after three decades of decline. Labor market and tax reforms have raised hours per capita after three decades of decline. Rising hours per capita and declining growth of output per hour are signs of victory for European labor market reforms, not signs of defeat. Rising hours per capita and declining growth of output per hour are signs of victory for European labor market reforms, not signs of defeat.