Euro Zone: Rethinking The Productivity Lag

How much worse is the performance of the euro-zone economy than that of the U.S.? Maybe less than generally perceived.

To be sure, over the past decade, euro-zone real gross domestic product has grown about a percentage point per year slower than in the U.S., and last year per capita GDP was 30% lower after adjusting for currency and inflation differences. But at the same time, the euro zone's return on capital and total equity returns compare favorably with those in the U.S.

Goldman, Sachs & Co. (GS ) economist Kevin Daly offers a possible explanation. Using data from the Organization for Economic Cooperation & Development that are consistent for both regions and adjusting for timing differences in the business cycle, he concludes that weaker productivity growth isn't the cause of the euro zone's growth gap.

The Ruro Zone's Growth Gap
Daly shows that when euro-zone and U.S. productivity are measured the same way, they grew at similar rates over the past decade. Europe measures productivity as output per worker -- not output per hour, as in the U.S. The euro-zone measure ignores demographic effects that yield slower growth in the labor force and misses the impact of a shorter workweek. Measured as output per hour worked, productivity in the euro zone grew at a pace close to that in the U.S., he says.

If that's true, then all of the euro zone's underperformance in the past decade reflects demographic factors, notably population growth in the U.S. of 1.2% a year vs. 0.5% in the euro zone. Indeed, per capita GDP in both regions has grown at similar rates. The study shows that about half of the 30% gap in the per-capita GDP levels is due to Europe's employees working about 15% fewer hours, and the rest reflects a smaller proportion of the population that is employed.

The upshot: Given demographic trends, the Goldman data imply that euro-zone growth in the next decade is unlikely to top 2% a year without labor market reforms aimed at longer work hours, an extended retirement age, or efforts to encourage a higher employment rate. Nevertheless, slower growth as a result of demographics need not imply a lower rate of return on euro-zone assets.

By James C. Cooper & Kathleen Madigan

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