The Productivity Gap between Europe and the US: Trends and Causes Marcel P. Timmer Groningen Growth and Development Centre The EU KLEMS project is funded by the European Commission, Research Directorate General as part of the 6th Framework Programme, Priority 8, "Policy Support and Anticipating Scientific and Technological Needs".

EU-15 Labour productivity convergence to US has ended

Alternative Explanations Proximate causes: slower emergence of knowledge economy Small ICT-producing sector Limited role of ICT-investment Lower levels of skilled labour Less innovation (product and process) Ultimate causes: institutions Role of labour markets (Blanchard, 2004) Product market regulations (Nicoletti and Scarpetta, 2003) End of catch-up (Aghion and Howitt, 2006): More R&D investment, Higher education system reform (Statistical myth)

Sector Contribution to Labour Productivity Growth based on Shift Share Analysis Source: Stiroh (2002)

Sector contribution to market economy labour productivity growth, Source: Updated from van Ark, OMahony and Timmer, Journal of Economic Perspectives, Winter 2008

Market services important source of growth differences across Europe & US Sector contribution to market economy labour productivity growth, Source: Updated from van Ark, OMahony and Timmer, Journal of Economic Perspectives, Winter 2008

EU KLEMS Growth Accounts (1) Gross output PF: Growth accounting equation: where Y is output, K is an index of capital service flows, L is an index of labour service flows and X is an index of intermediate inputs, Assumptions: competitive factor markets, full input utilization, constant returns to scale and using the translog functional form

EU KLEMS Growth Accounts (2) Capital services based on 8 asset types (ICT and non- ICT) Labour services based on hours worked by 18 types (education, age, gender)

Measurement of capital services Aggregate capital services and with contribution of capital services based on user cost equation Capital stocks for each asset

What is new in EU KLEMS? Data available for at least 30 industries and over 20 countries Systematic data collection based on national accounts and complementary official sources (LFS and other surveys) Long time coverage , with greatest detail for post-1995, harmonized methodologies on industry classification, deflation and aggregations Decomposition of inputs: Capital assets in 7 asset types Labour input in 18 categories (3 x skill; 3 x age and gender) Intermediate inputs: energy, materials and services input Broad coverage of EU countries: Growth accounts coverage of 14 EU new member states Limited coverage of 11 other EU countries Also comparisons with U.S. Korea, Canada, Australia and Japan Updated each year.

Explaining growth in value added based labour productivity Labour composition ICT-capital per hour Non-ICT-capital per hour Multi factor productivity

ICT investment contributes to labour productivity growth in market services growth in all countries,

PLUS Improvement in labour composition

PLUS Non-ICT deepening

… but MFP contribution makes the big difference between fast and slow growth

What is MFP growth? Ratio of output growth over input growth Disembodied technological change, under assumptions: Constant returns to scale Technical efficient Allocative efficient Competitive output and input markets Outputs and inputs are measured without error All outputs and inputs are included Measure of our ignorance (Abramovitz)? Deviation from assumptions above

What is MFP growth? Constant returns to scale ? Perhaps at sector level justified Technical efficient? Many firms/sectors are not on the frontier. Allocative efficiency? ICT investments…. Competitive output and input markets? If not, prices do not reflect marginal revenues and costs Non-competitive product markets: Mark ups? Regulation in capital and labour markets Outputs and inputs are measured without error? Capital (and labour) capacity utilization Quality adjusted quantities of inputs Quality adjusted quantities of outputs All outputs and inputs are included? Missing inputs (R&D, intangibles, management) Measure of our ignorance (Abramovitz)? Deviation from assumptions above Good news: many of this are (or can be) tackled

How to explain differences in MFP growth? Distance to the frontier-approach MFP-level (US=1) in Market Services Source: Inklaar and Timmer (2008) GGDC Productivity level database

Distance to the frontier-approach InnovationImitation Unconditional convergence : Conditional convergence: Interaction Potential conditions include: 1.Skills, 2. ICT-capital and 3. Product market regulation (Inklaar, Timmer and van Ark (2008), Market Services Productivity, Economic Policy)

Regulation Some evidence at detailed industry-level Source: Inklaar, Timmer and van Ark (2008), Market Services Productivity, Economic Policy, Table 10

Main findings Importance of having detailed measures of productivity at industry level, both growth and level estimates End of convergence in productivity across Europe and the US, mainly driven by differences in MFP growth in market services New productivity gap has opened up Regulatory practice shows no clear impact on MFP, only for post and telecommunications Market regulation, competition and Scale and/or lagged adjustment to ICT in Europe?

Some ideas for future research based on methods teached in this course Breakdown of TFP growth (DEA,SFA)? Allow for increasing returns to scale? Imperfect competition? Localised innovation? (DEA) Stochastic frontier estimation of MFP-gaps Efficient use of ICT? (.Dot boom and bust) Complementarity skills and ICT Variable lags and interactions in effects of skills, ICT and regulation Innovation, trade and R&D (manufacturing) Sectoral convergence in the world economy?