THE BENEFITS OF THE MODERN KNOWLEDGE economy differ greatly between advanced economies. The EU-15, that is the 15 European Union countries that constituted the Union up to 2004, experienced a sharp slowdown in labour productivity growth (measured as GDP per hour of work) from an annual rate of 2.7 per cent during 1973-1995 to 1.5 per cent during 1995-2007. At the same time, labour productivity in the United States increased sharply from 1.3 per cent to 2.1 per cent between 1973-1995 and 1995-2007 respectively. While differences in the timing of business cycles in the United States and the European Union may have some effect on this comparison, they do not explain these divergent trend growth rates.
The slower labour productivity growth rates in Europe compared to the United States since 1995 reverse a long-term pattern of convergence. This article first reviews the productivity and economic growth of Europe since 1950, identifying three periods characterized by different drivers of productivity. In the period 1950-1973, European growth was characterized by a traditional catch--up pattern based on the imitation and adaptation of foreign technology, coupled with strong investment and supporting institutions. However, the traditional postwar convergence process came to an end by the mid-1970s (Crafts and Toniolo, 1996; Eichengreen, 2007). Then, in the period from 1973 to 1995, output and productivity growth in both Europe and the United States began to slow. However, while the gap in output (and average per capita income) growth rates narrowed between the two regions, Europe's productivity growth remained much faster than in the United States. During this time, Europe experienced a strong decline in labour force participation and a fall in average hours worked, which in turn triggered a substitution of capital for labour bringing capital-labour ratios in some major European economies to levels well above those of the United States by the mid-1990s. Since 1995, U.S. productivity growth accelerated until around 2004, after which it began to slow, whereas the rate of productivity growth in Europe fell throughout the period, with the exception of two brief positive spells during the peaks of the business cycle at the end of the 1990s and around 2006-2007. Finally, during the Great Recession in 2008-09, the productivity growth rates in Europe and the United States rapidly diverged, as the United States saw a pickup in productivity growth as the labour market shrunk well beyond that in the European Union. The EU saw a decline in productivity parallel to the contraction of the economy.
In the second section of this article, we focus on the European growth experience, especially in the period from 1995 to 2007, using a new and detailed database called the EU KLEMS Growth and Productivity Accounts. (2) The level of detail in this database allows a discussion of a number of developments during this period: changes in patterns of capital-labour substitution; the increasing importance of investment in information and communications technology; the use of more high--skilled labour; the different dynamics across sectors, like those producing information and communications technology, or manufacturing and services more generally; and the diversity of productivity experiences across the countries of Europe.
We show that the productivity slowdown in Europe since the mid--1990s is mainly attributable to the slower emergence of the knowledge economy compared to the United States. In the third section we consider various explanations for the slowdown which are not mutually exclusive: for example, lower growth contributions from investment in information and communication technology in Europe, the relatively small share of technology--producing industries in Europe, and slower multifactor productivity growth (which can be viewed as a proxy for advances in technology and innovation). Underlying these explanations are issues related to the functioning of European labour markets and the high level of product market regulation in Europe. …