The Productivity Gap

Year after year throughout the 1990's, Europe's productivity grew at a pace 18% slower than in the United States. The European experience varied from country to country, but no one did better than the US. By the end of the decade, Europe's productivity gap with the U.S. was 7% in Italy, 9% in France and 12% in the Netherlands, three relatively good cases, but a whopping 25% in Denmark, and 23% in the UK. What explains these sharp differences?

An economy's productivity - that is, how much it produces per worker employed - depends on three factors: its endowment of capital, the quality of the country's workers and its ability to combine workers and capital efficiently to produce goods and services, what economists refer to as "total factor productivity." Availability of capital is not the explanation. European firms have plenty of capital! Indeed, European firms, probably in a response to rigid labor markets, have for at least twenty years been using technologies that are much more capital-intensive than that of US firms.

Capital intensity is 80% higher in Denmark than in the US, 60% higher in France, 50% in Italy, 40% in Germany. Even in Spain, the endowment of capital per worker is 30% higher than in America. The shift into labor-saving technologies shows no sign of reversal: since the mid 1980s the capital intensity of European firms has increased 6% relative to US firms.

To begin understand the differences between the US and Europe, look at the quality of the labor force. The average number of years spent in school is a good indicator of a worker's quality, especially because improvements in output nowadays mostly arise from the ability to adopt new technologies. The number of schooling years of the typical worker is 13% lower in Europe than in the US, ranging from 8% lower in the UK to 36% in Spain.