Introduction

The late 1990s saw a major change in the comparative growth performance of Europe and the United States. After the Second World War labour productivity growth in Europe outstripped that of the United States, leading to rapid catch-up. This provided a strong foundation for rapid improvements in the standards of living across the continent. However, since 1995 US labour productivity growth has nearly doubled compared to earlier periods, while European growth rates have declined. The slowing growth and faltering emergence of the knowledge economy in Europe led to an ambitious action programme of the European Commission, called the ‘Lisbon Agenda’, aimed at boosting competitiveness and productivity through innovation. It emphasised the need to increase spending on research and development and higher education, and was combined with the aims of completing the single market, opening up sheltered sectors, improving the climate for business and reforming the labour markets while ensuring growth was environmentally sustainable. The urgency was reinforced in reviews of the Lisbon Agenda, in the Sapir report on economic growth in Europe and in various post-Lisbon strategy debates and conferences (European Commission 2004; Sapir et al. 2004).

The purpose of this book is to provide a comprehensive analysis of economic growth in Europe over the past three decades that allows an evaluation of progress in achieving the Lisbon goals.

Paths for productivity growth in Europe

In this book we have documented and analysed Europe's productivity performance since the mid 1990s and compared it to growth since the 1970s, as well as to the productivity record of the United States. On both counts, Europe's performance has been disappointing as labour productivity growth has seriously slowed since 1995, while it has accelerated in the United States. In this book we have analysed the determinants of Europe's poor productivity performance using a new database on productivity at the industry level, the EU KLEMS database.

While our findings confirm the established view that the growing role of ICT and continued improvements in human capital are important drivers of labour productivity growth, this appears not to be the main reason that Europe has failed to show faster productivity growth. While there are differences across European countries and between Europe and the USA, ICT investment has become a more important source of growth everywhere, as illustrated in Chapter 3. Slower productivity growth in Europe since the mid 1990s has been mainly related to a slowdown in the efficiency with which labour and capital are used, as measured by multi-factor productivity (MFP) growth. Indeed one key finding of Chapter 2 is that European growth could benefit from exploiting the increased potential for productivity growth in market services. In contrast to earlier suggestions in the literature, services industries such as trade and business services may see rapid labour productivity growth, as evidenced by the US experience.

Introduction

The purpose of this chapter is to examine in more detail the industry origins of growth. This involves analysing how the growth of inputs and MFP of each industry contributes to aggregate value added. Thus we not only look at which industries contribute most to productivity growth but also which industries contribute most to the increased use of ICT and skilled labour. In addition, we will provide analyses based on data for twenty-six detailed industries, rather than for broad sectors as done so far. These yield much richer information on the sources of growth than those in earlier chapters as the latter could miss sizeable within-group heterogeneity. As before, we focus on two areas: the performance of the European Union over the period 1980–2005, and a comparison of the EU with the USA for the 1995–2005 period.

The chapter is organised as follows. Section 5.2 outlines the methodology used to determine industries' contributions to aggregate growth. This is based on the direct aggregation over industries approach, outlined in Jorgenson et al. (2005). Section 5.3 examines labour productivity trends at the industry level and analyses contributions to aggregate productivity growth in the EU and USA. In the following sections this contribution is further dissected. In section 5.4 the contribution of input growth in industries to aggregate growth is determined for ICT capital, non-ICT capital and labour composition separately. Section 5.5 is devoted to the contributions from industry-level multi-factor productivity (MFP) growth.

Economic growth is a key factor in the improvement of our living standards and hence of great interest to academics and policy makers alike. This book aims to explain why growth across Europe has been disappointing since the mid 1990s, both compared to earlier periods and compared to the United States, which showed resurgent growth after 1995. In the process we present the EU KLEMS database, a rich data toolbox that can be used to explore these and other growth-related questions. The main message of this book is that an industry perspective on growth and the sources of growth is essential because of the great diversity in the drivers of growth in agriculture, manufacturing and services industries, including trade, transport, financial, business and personal services.

The empirical study of sources of economic growth has a long tradition in Europe, starting as far back as the seventeenth century when William Petty began to construct measures of economic performance including comparisons of output and productivity in industry, trade and transportation. Over the centuries, with the emergence of standardised national accounts and other internationally comparable statistical sources, the measurement of sources of growth has become more sophisticated. During the second half of the last century, growth accounting evolved as a standard methodology. In 1987, Jorgenson, Gollop and Fraumeni published a pioneering study laying out what has become known as the KLEMS approach.

Introduction

Until recently, internationally comparable studies of the relationships between skill formation, investment, technological change and growth have been hampered by the lack of a readily available standard database covering a large set of countries. As a result, researchers had often to compile their own databases, making replication and comparability of studies difficult. In our analysis of European growth and productivity in Chapter 2 we made use of a new database which can serve as a useful tool for empirical and theoretical research in the area of economic growth: the EU KLEMS Growth Accounts database. This database includes measures of output and input growth and derived variables such as multi-factor productivity at the industry level. The input measures include various categories of capital (K), labour (L), energy (E), material (M) and service inputs (S). The measures are developed for twenty-five individual European Union member states, the United States and Japan and cover the period from 1970 to 2005. The variables are organised around the growth accounting methodology, a major advantage of which is that it is rooted in neo-classical production theory. It provides a clear conceptual framework within which the interactions among variables can be analysed in an internally consistent way.

The data series, publicly available on www.euklems.net, can be used by researchers employing growth accounting to consider sources of output and productivity growth in cross-country comparisons or studies of particular industries and different time periods, such as discussed in the previous chapters.

Introduction

After World War II productivity growth in Europe boomed, providing a strong foundation for rapid improvements in the standards of living across the continent. But since the mid 1990s, Europe has experienced a significant slowdown in productivity growth. Average annual labour productivity growth (measured as GDP per hour worked) in the fifteen countries that constituted the European Union up to 2004 declined from 2.4% in the period 1973–95 to 1.5% in 1995–2006. Conversely, productivity growth in the United States significantly accelerated from an annual average of 1.2% in the period 1973–95 to 2.3% 1995–2006. While the USA was able to reap the benefits of the dawning knowledge economy, the European Union seems to have missed the opportunity to revive economic growth. In this chapter we will argue that there are distinct reasons for the European productivity slowdown and US acceleration since the mid 1990s. Our detailed industry-level analysis reveals that traditional manufacturing and other goods production no longer acted as major engines for the European economy. At the same time, Europe has been slow in taking up the benefits from the knowledge economy. In contrast to the USA, productivity growth in market services has not accelerated. We consider various explanations that are not mutually exclusive. The European growth slowdown might be related to long-term trends in the structure of the economy, such as the increasing demand for low-productive services and a gradual exhaustion of the potential for growth based on catching up in traditional technologies.