Labor productivity in Europe is very weak, and as discussed in earlier notes, to the degree that it is likely to bias the ECB against cutting rates too early or too fast. While all productivity outcomes are the result of the complex functioning of modern economies, there are at least five principal reasons for why European labor productivity is so weak right now, especially relative to the United States. Labor productivity is not likely to grow much faster in Europe in the coming years.
- Increased employment; The EU has, despite flat growth since mid-2022 seen continued increased employment, continuing a rising post-GFC trend. As figure 1 shows, the employment rate differential between the United States and EU is now much lower than in earlier times. This means that a lot of people with limited work experience and correspondingly low productivity has been brought into employment in the EU, reducing the recorded average labor productivity. Low current labor productivity in the EU is therefore today partially reflecting “good employment news” from “job rich EU growth”, but also that there is no such thing as a free lunch when it comes to macroeconomic outcomes. over time, the productivity of newly employed “marginal workers” in the EU will rise, but this will take years and likely require increased capital investments.
- Low corporate investments; CAPEX in Europe has been quite low in many member states for many years. Reflecting the business structure with many SMEs and small family-owned businesses, many are often too small to undertake adequate CAPEX and reap economies of scale, reducing overall labor productivity levels. Similarly, EU capital markets not fully developed, so many firms often find costs of capital too high. This is a particular problem in times when banks are under financial pressure (not the case now, but during the euro crisis and during the in the negative nominal rate era until 2022 it was) and more reluctant to lend. Europe’s bank centered financial system and higher cost of capital for many firms is also part of the reason for low investment levels.
- Labor regulation issues; these continue to be a barrier to rising productivity, even if perhaps less so than earlier. This is noticeably an issue in periods of “disruptive technologies” like IT, AI or green tech, requiring that you reorganize your entire firm to fully reap the benefits from these innovasions. This is harder in Europe than in the US, with regulations often not just making it harder to fire workers, but also more difficult to reassign them to new tasks, dragging long term productivity down in the process.
- Covid responses; the US has ended up in a very good macroeconomic position for productivity after Covid. It had enormous labor market dislocation during Covid and now massive fiscal stimulus including investment subsidies, generating job opportunities for those dislocated during Covid in (generally) higher paying jobs. This is a very very good cocktail for labor productivity in the US, and one that Europe has not experienced. Europe relied on wage subsidies for existing jobs during Covid and hereby minimized labor market dislocation and shifts into higher paying jobs. Europe also today has a far smaller fiscal stimulus and arguably too tight a monnetary policy stance to spur investments to generate many new higher paying jobs.
- Country variations; labor productivity is meaningfully only measured at market exchange rates (rather than PPP) and output per hour. This makes the poorer EU members invariably perform much worse than the United States (figure 2), while the richer Western European members generally are close to US levels (and a number of smaller ones well above). This is too a degree a “levels issue” from lower GDP, but recorded dynamic growth will also be low in poorer EU members.
In figure 2, Ireland (tax domicile), Luxembourg (financial center) and Norway (oil) should likely be ignored, but as can be seen Germany and France are quite close to US levels, while the productivity levels problem lies mostly in Southern and Eastern Europe. The fact that US GNI/hour worked is lower than GDP is one of the ways the very large US investment deficit manifests itself. Noticeable too in a per hour basis is the very low levels of labor productivity in both Japan and South Korea.
