Asymmetries in the euro area and TFP growth: evidence from three major European economies

Abstract

PurposeIn this paper, the authors study the long-run determinants of total factor productivity (TFP) in three major European economies over the period 1983–2017, namely Germany, France and Italy.Design/methodology/approachThe authors focus on the capital misallocation effects, scale effects and labor misallocation effects. To this end, the authors study how real interest rate shocks, real exchange rate shocks, real wage shocks and changes in labor regulation affected TFP in major European countries over the last decades. The authors employ a theoretical and an empirical model to investigate the issue. The empirical results are obtained using a VAR model for estimation.FindingsA stripped-down model of labor market in open economy with technology progress allows to identify the relevant variables affecting TFP. On the empirical ground, the authors find a positive relationship between TFP and real interest rate in the long run. Importantly, the authors detect a positive relationship between TFP and real exchange rate. Further, the authors show that the TFP can respond positively to a stricter labor market regulation and to a higher real compensation per employee. The results provide support to the idea that TFP has a positive relation with prices in the long run, while it may be biased along the cycle because of price rigidity.Research limitations/implicationsThe present model is stylized and may not capture all of the details of reality. The analysis should be extended to a larger number of countries. Technology progress could be proxied using different variables, as the R&D expenditure or the number of patents. Micro data, for specific sectors and industries, can improve the quality of the empirical investigation.Practical implicationsMainly the authors find that TFP has a positive relationship with price changes in the long run, while it may be biased along the cycle because of price stickiness. Capital misallocation and labor misallocation can negatively affect TFP. Thus, the observed divergences in European TFP can be traced back to the misallocation effects attributable to the decrease of real interest rate and real wages, together with the raising labor flexibility. Mainly, the authors detect a positive long-run relationship between TFP and real exchange rate. This outcome strengthens the supply-side view of the relationship between productivity and real exchange rate.Social implicationsThe authors believe that the present setup can be helpful to reflect critically on the nodes at the core of the productivity slowdown and asymmetries in the eurozone. The aim is to implement renewed policies in order to favor economic growth, convergence and stability in the euro area.Originality/valueThis research addresses the issue of asymmetries among European economies by focusing on the role played by real prices in the long run. Traditionally, the dynamics of TFP have been attributed only to technological components, human capital and knowledge. This work shows that the dynamics of prices such as the real interest rate, the real exchange rate and the real wage can also influence the technological process by pushing the production system toward choices that are not always optimal for economic growth. An interesting result of this research concerns the positive relationship between real exchange rates and TFP in the long term, evidence of an important supply-side effect on the technological process.

What drives TFP long-run dynamics in five large European economies?

“…Thus, TFP growth depends not only on businesses-ability to innovate, but also on the environment that fosters competition, reduces administrative burdens, provides modern and efficient infrastructure, and allows easy access to finance (Bellocchi et al. 2020 ; Calcagnini et al 2019 ). Indeed, real, financial and institutional factors have all been analyzed both from a theoretical and empirical point of view.…”

“…Therefore, starting from these stylized facts, and some recent theoretical and empirical contributions (Bellocchi et al. 2020 ), we estimate two different specifications where interest rate and saving are employed alternatively to by-pass their positive correlation and the potential distorting effect of it on the dynamics of TFP. We specify the TFP relationship as follows: where is the error term with all unobserved factors, it denotes the observation on the cross-section unit at time t , for and .…”

“…But, monetary policy also affects the nominal (and real) exchange rate. In addition, changes in labor market regulation, and wage policy, can determine changes in labor cost, affecting firms investment decision and their attitude towards innovation (Bellocchi et al 2020). Therefore, to empirically investigate the TFP determinantes in the long-run, we focus on a large set of variables, usually neglegted in the standard growth models, enhancing the role of "prices".…”

“…The existence of a strong and significant correlation between these variable and technological progress may potentially account for variations in TFP both in crosscountry and time-series perspective. Therefore, starting from these stylized facts, and some recent theoretical and empirical contributions (Bellocchi et al 2020), we estimate two different specifications where interest rate and saving are employed alternatively to by-pass their positive correlation and the potential distorting effect of it on the dynamics of TFP. We specify the TFP relationship as follows:…”

“…He conceives productivity as a productive input that differs in quantity or quality across firms, and provides a list of potential determinantes, such as differences in management practice, higher quality labor and capital, differential investment in ICT and R&D, learning by doing, the firm structure, productivity spillovers, regulatory behavior, and differences in the competitive regimes. Thus, TFP growth depends not only on businesses-ability to innovate, but also on the environment that fosters competition, reduces administrative burdens, provides modern and efficient infrastructure, and allows easy access to finance (Bellocchi et al 2020;Calcagnini et al 2019). Indeed, real, financial and institutional factors have all been analyzed both from a theoretical and empirical point of view.…”