Global Economic Perspectives:Productivity in the Euro-area

Deutsche Bank Research Eurozone Economics Date 23 May 2016 Global Economic Perspectives Productivity in the Euro-area ________________________________________________________________________________________________________________ Deutsche Bank Securities Inc. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. Peter Hooper Chief Economist (+1) 212 250-7352 peter.hooper@db.com Michael Spencer Chief Economist (+852 ) 2203 8303 michael.spencer@db.com Mark Wall Chief Economist (+44) 20 754-52087 mark.wall@db.com Torsten Slok Chief Economist (+1) 212 250-2155 torsten.slok@db.com Matthew Luzzetti Economist (+44) 20 754-73288 matthew.luzzetti@db.com  In this article we take a closer look at the evolution of labour productivity in the euro-area since the creation of the Euro, with a particular focus on recent trends. Prior to the Great Financial Crisis and during the crisis years, the evolution of labour productivity was very different across the Big 4 countries. But, in the last two years, as unemployment started falling, the euro-area countries appear to have converged to the UK/US labour productivity nexus with familiar symptoms: lack of investment and low total factor productivity growth. The fact that the ills of the euro-area are not euro-area specific anymore could at least be seen as a positive.  Many European countries face very low fertility rates and human capital losses due to crisis-legacy high levels of long-term and youth unemployment. Combined with the general slowdown in productivity observed in the rest of the developed world, this paints a very grim outlook for the euro-area’s long-run growth prospects. Immigration and family policies could be a solution to the demographic outlook.  Labour productivity in the euro-area could be pushed up: the Periphery could jump the productivity backlog it has accumulated relative to the “technological frontier”; evidence of this is emerging in Spain. France’s favourable demographics combined with reforms could limit the drag on investment and consumption associated with ageing societies. Germany could invest in infrastructure capital and education. This difficult balancing act requires policy makers to ensure that demand is sustained in the short-run while long-run reforms are implemented.  Labour productivity in Germany is unlikely to pick up significantly in the coming years. Combined with increases in domestic wages aligned to the ECB’s long-term inflation objective, this may create inflationary pressures in Germany. If labour productivity improves in other euro-area countries, on the back of efficiently allocated investment and reforms, such developments would help bridge the competitiveness gap between the euro-area members. If labour productivity does not improve in other euro-area countries, the euro-area would struggle to avoid economic stagnation. Euro-area countries converging to low-productivity nexus -0.5%0.0%0.5%1.0%1.5%EAGERFRAITSPEAGERFRAITSP2004-072014-15Average yoy growth Total factor productivityCapital deepeningLabour productivityEuro-area labour productivity Source: Deutsche Bank, Eurostat, Haver analytics 23 May 2016 Global Economic Perspectives: Productivity in the Euro-area Page 2 Deutsche Bank Securities Inc. Productivity in the Euro-area Determinants of long-run GDP growth In the long-run, for developed economies, GDP growth is typically determined by population growth and productivity. Productivity is linked to technology but may also be determined by country-specific factors. Productivity is a driver of wages and living standards, and is the component that delivers increases in GDP per capita. In the long-run, the physical capital of an economy usually adjusts so that labour productivity is driven by innovation and technological progress. In recent years, labour productivity growth has disappointed in every developed economy and has often been described as “secular stagnation”. The reasons behind the phenomenon are still hotly debated but are generally split between demand-side and supply-side explanations:  On the demand-side: the ageing of societies lead to high savings rates and low consumption today as well as lower anticipated consumption in the future. When combined with increased global economic uncertainty of the last ten years, this results in low investment. This leads to low labour productivity though lower physical capital available to workers.  On the supply-side: Robert Gordon1 (2016) advances that the pace of innovation has gradually slowed in the last fifty years. The important argument of Gordon is that the new technologies developed today are not as useful to produ