A Productivity Paradox

On the surface, Europe and the U.S. have been beset by increasingly divergent economic problems. Although all industrial economies have experienced a slowdown in productivity growth since the early 1970s, Europe's gains have remained larger than those in the U.S. And European real wages, including those of lower-income workers, have continued to climb, while U.S. real wages have slowed and actually fallen sharply at the lower end of the scale.

On the other hand, joblessness has skyrocketed in Europe in the past decade, while it has stayed relatively low in the U.S. And Europe has exhibited stagnant job growth compared with substantial U.S. employment gains.

The upshot is that Europeans have been far less concerned with productivity than with reducing unemployment --perhaps by adopting the greater flexibility of U.S. labor markets. By contrast, Americans have focused on the need to boost productivity as a way to foster real wage growth and reverse the trend toward income inequality.

In a new study, Robert J. Gordon of Northwestern University suggests that economists on both sides of the Atlantic may be missing the boat. Europe's productivity gains, he says, appear to have been partly a byproduct of its rising unemployment. And a source of America's lagging productivity may actually have been the sluggish wage growth it purportedly caused.

In Europe in recent decades, for example, union militancy and minimum- wage hikes have periodically boosted labor costs. Initially, such developments, says Gordon, raise both unemployment and productivity, since reduced hiring means existing plant and equipment are spread over fewer workers.

In America, meanwhile, waning unionization and a plunging real minimum wage have tended to depress wages. And the falling cost of labor relative to capital has encouraged hiring and lessened the appeal of labor-saving investment, putting downward pressure on productivity growth.

Moreover, Europe's situation may well be worsening, warns Gordon. Although an initial side effect of rising European labor costs may have been to raise productivity, they also lowered profits and eventually investment. Thus, reduced capital accumulation has now hurt Europe's ability to promote productivity gains and put its jobless to work.

What are the implications of Gordon's thesis? For one thing, Europeans may well find that achieving higher employment via labor-market reforms will hurt productivity (though such steps may still be desirable). And Americans need to weigh not only the impact of sluggish productivity on incomes but also the degree to which wage dispersion is impeding productivity growth.

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