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Europe’s Productivity Gap:Catching Up or Getting Stuck?

Bart van ArkUniversity of Groningen

and The Conference Board

KNOWLEDGE ECONOMY - Challenges for MeasurementSession: “Competitiveness and Growth”

8-9 December 2005, Luxembourg

Europe is the productivity laggard of the advanced and emerging economies

Labour Productivity (per hour), annual average growth

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

EU-15 new EU-10

EU-25 USA Japan China* India*

1987-1995 1995-2004 * Per person employed, to 2003

Productivity Gaps of EU-15 Countries Relative to the U.S. Countries vary Strongly

GDP per hour, 2004, US=100%

0%

20%

40%

60%

80%

100%

120%

140%

PT GR ES SW UK IT EU-15 FI DK DE AU US NL IR BE FR LUX

GDP/hour

But for almost all EU-15 Countries Income Gaps are Larger than Productivity Gaps

GDP per hour and Income per capita, 2004, US=100%

0%

20%

40%

60%

80%

100%

120%

140%

PT GR ES SW UK IT EU-15 FI DK DE AU US NL IR BE FR LUXGDP/hour Income per capita

The Eroding Productivity Gap is becoming a Threat to European Living Standards

GDP per capita and labour productivity, EU-15 as % of US

50%

60%

70%

80%

90%

100%

110%

1960 1965 1970 1975 1980 1985 1990 1995 2000

EU-1

5 as

% o

f the

U.S

.

GDP per hour

GDP per capita

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The Productivity-Employment Trade-Off is Not the Fundamental Problem

Elasticity of employment/population ratio on labour productivity is -0.3 in large sample of OECD countries since 1970s (McGuckin and van Ark, 2005)

Negative elasticities peter out within 3-5 years … … as new entrants adjust to labour productivity

performance of incumbents (little effects of low skilled labour)

No effects of declining hours per person on productivity Reasons for productivity slowdown or of more

structural nature related to interaction innovation, investment and market environment

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Structural Indicators are not the perfect instrument to monitor the Lisbon Agenda

Indicators are useful as a detection device, but weaknesses for policy evaluation and monitoring

Structural indicators have too many policy variables to focus on

Structural indicators lack an analytical framework that establishes links and trade-offs between policy variables

Growth accounting provides framework to structure economic policy variables (growth, employment, investment) …

… and extend to analyse interaction with other policy variables (technology, social, environment)

Productivity is Key to Economic Performance and Competitiveness

output Total Output or GDPmeasure

input Total Hours Worked Capital Goodsmeasure (Machinery, Structures, ICT)

productivity Labour Productivity Total Factor Productivity Capital Productivitymeasure (= efficiency)

sources Motivation and Markets, Institutions and Innovation andthat competencies Regulations Technological Change

impactproductivity

growthIntangible Investment

- education & skills- R&D, patents, licencies

- organisational innovations- marketing of new products

Measures of Productivity, Input Varables and Sources of Growth

Main Aspects of EU KLEMS Project EU KLEMS project is 3-year statistical and analytical research project

funded by 6th Framework Programme Purpose is to create a database on growth accounts by industry (NACE

60+) for EU member states with a breakdown into contributions from capital (K), labour (L), energy (E), materials (M) and service inputs (S)

Full coverage of “old” EU-15 plus 5 new member states (PL, SK, HU, CZ and SI)

Limited coverage of other 5 new member states (CY, MT, LT, LV and EE) Also comparisons with U.S., Canada and Japan 1970-2005, with greatest detail for post-revision period 14 research institutes across Europe, led by GGDC and NIESR In 2nd phase conduct a number of analytical research projects

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How does ICT Contribute to Productivity Growth?

Three channels through which Information and Communication Technology (ICT) impacts on productivity growth: 1st channel: Effect of ICT investment on labour

productivity growth through ICT capital deepening

2nd channel: Rapid technological change in ICT producing industries leading to TFP growth

3rd channel: Total Factor Productivity (TFP) growth in industries that make intensive use of ICT (incremental innovation, knowledge spillovers, etc.)

Faster Total Factor Productivity Growth Accounts for Difference between EU15 and U.S.

Sources of labour productivity growth, EU-15 and U.S., 1987-2004

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1987-1995 1995-2000 2000-2004 1987-1995 1995-2000 2000-2004

EU-15 U.S.

ICT capital deepening Non-ICT capital deepening ICT-production TFP Other TFP

Source: based on Van Ark and Inklaar (2005)

Manufacturing Labour Productivity (per hour),annual average growth

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

EU-15 USA Japan new EU-10*

Mexico China** India***

advanced economies emerging economies

1987-1995 1995-2003

For Manufacturing, Europe needs to look East !

* average Czech, Hungary, Poland, Slovakia** per person employed, 1987-94 & 1994-2002*** per person employed, to 2002

Labour Productivity (per Hour) and Unit Labour Cost, USA=1.0, 2002

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

EU-15 Japan US EU-10* Mexico China India

advanced economies emerging economies

Value added per hour Unit Labour Cost

Relative Unit Labour Cost Levels also point to need to Focus on Productivity

* Average for Czech, Hungary, Poland & Slovakia

The technological capabilities in Europe are under threat from its main competitors

19

15

60

61

68

95

151

487

655

862

1 011

1 276

150 100 50 0 50 100

Mexico (1999)

Hungary

Brazil (2000)

Poland

Taiwan

India (1998)

Korea

Russian Federation

Japan

China

EU15 (2002)

United States (1999)

Number of researchers (FTE) per 10 000 employmentBusiness enterprise reseachers as a % of total researchers (FTE)

Number of researchers (FTE)

Source: OECD, STI Scoreboard

For Market Services, Europe needs to look West !

Industry contributions to market economy labour productivity growth EU-15 and U.S., 1987-2003

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1987-1995 1995-2000 2000-2003 1987-1995 1995-2000 2000-2003

EU-15 U.S.

ICT production* Production industries**Market services** Reallocation

* Includes ICT manufacturing, telecom and software services** Excludes ICT producing industries

Service industries that invest most in ICT show the biggest productivity advantages

Difference in labour productivity contribution in market services, U.S.-EU-15, 1995-2003

-0.1 0.0 0.1 0.2 0.3 0.4

ConstructionInsurance

Water transportInland transport

CommunicationsSocial & personal services

R&DRenting of mach. & eq.

Computer servicesTransport services

Air transportHotels & catering

Professional servicesMotor vehicle trade

Other business servicesBanking

Retail tradeSecurities trade

Wholesale trade

Productivity effect Share effect

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Measurement issues in services are big but not impossible to overcome

Measurement problems of output in services is problematic

Problems have increased with higher ICT intensity in services

Problems are concentrated in heterogeneous service industries and non-market services

There may be “errors” (which can be controlled for in analysis) but little evidence of systematic bias

More transparency on measurement is needed

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Implications for Europe’s Innovation Policies

The 3% R&D-intensity target should not become the holy grail

Non-technological innovations (organisational) are at least as important

Little room for targeted innovation policies to facilitate service innovation: invest to improve the quality of the workforce Invest in physical and technological infrastructure to

foster innovation activities Much of the productivity-enhancing innovations in services

originate from suppliers and clients in the value chain

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Implications for Europe’s Reform Policies Reforms should concentrate on:

Help increase entry and exit in industries Make price-quality relationships transparent Put pressure on margins in existing markets; … but also allow firms to exploit new markets; … and to exploit not abuse scale advantages

Reform management is complex: Many measures are industry-specific Reforms need to be comprehensive & complementary Time lags before productivity effects emerge Reforms need to tackle vested interests; … raise awareness of opportunities; … and facilitate transition not the status quo

23Source: Fostering Excellence, Ministry of Economic Affairs, Netherlands, 2004

Europe shows lack in dynamics of firms at the top

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In sum … NOT the U.S., but Europe is the outlier in terms of productivity

performance in the advanced world The cause of Europe’s productivity is NOT due to the short term

productivity-employment trade-off Productive USE of ICT is the key to productivity Manufacturing competition with emerging economies is NOT just

a cost matter, but also relates to innovation capabilities Faster productivity growth in a small number of service industries

accounts for US-EU differential There is little room for targeted innovation policies in services –

quality of workforce and infrastructure is the key Reforms should support reallocation of resources to most

productive uses

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Priorities for measurement Sectoral and industry measures are important Extend framework to include intangible investment Breaks in time series are unavoidable but need to be

well-documented More transparency on measurement is generally

needed More harmonization across Europe (and beyond) is

helpful Interaction between research and statistics, and

between producers and users of statistics is important Good statistics require funding !