Labour productivity growth in the euro area has been significantly slower over the past 20 years. This development was not least due to structural factors, the Bundesbank explains in its current Monthly Report. In addition to enterprises’ diminishing ability to innovate and adapt in certain economic sectors, demographic change could also have a negative impact on labour productivity, according to the Bundesbank’s experts.

Labour productivity is an important measure of the long-term growth potential of an economy and is often regarded as a measure of prosperity. It is defined as the ratio of aggregate output to labour input.

Significant differences between euro area countries

Between 1999 and 2019, productivity growth in the euro area slowed markedly, according to the Monthly Report. A particularly steep deceleration was observed in the manufacturing sector and in the communication and information sector. Marked differences between the Member States were also revealed. While labour productivity in Estonia, Ireland, Latvia, Lithuania, Slovakia and Slovenia rose more strongly than the euro area average, growth in the five largest euro area countries has been much more subdued, according to the Bundesbank’s economists.

Labour productivity growth had plummeted in most euro area countries as a result of the global financial and economic crisis that began in 2008 and the subsequent sovereign debt crisis in the euro area. “Although productivity growth picked up again in the years that followed, it never returned to its pre-crisis rate in most euro area countries,” the Bundesbank’s experts write.

Various structural influences

As the analysis shows, labour productivity growth began to slow down even before the global financial and economic crisis, indicating that structural as well as cyclical factors are behind this development. There is evidence to suggest that enterprises’ ability to innovate and adapt has diminished in some areas of the economy, the report states. This refers not only to their ability to develop new products and processes, but also to the integration of new technologies into their own production processes. The quality of factor allocation across enterprises within economic sectors has also deteriorated, according to the Bundesbank’s experts. They write that business dynamism, measured by the rate of enterprise births and deaths, has ultimately tended to decline; it was relatively weak between 2013 and 2017 in particular, despite an economic upturn.

The authors also cite the ageing of the population as another impeding factor. As various studies have shown, demographic change can negatively affect enterprises’ ability to innovate and adapt, as well as their dynamism. “An empirical analysis for the euro area suggests that demographic change has indeed dampened productivity growth,” the Bundesbank writes.

Moreover, in recent years, the relative loss of importance of industry has hampered growth in aggregate productivity. Jobs have increasingly been shifted to sectors with comparatively low productivity growth. Higher productivity gains in some services were unable to offset this, according to the economists.

Impact of the pandemic difficult to assess

Currently, it remains difficult to assess how labour productivity might develop in the future. The experts assume, however, that the ageing of the population will continue to dampen labour productivity going forward. The overall effect of the coronavirus pandemic is currently still unclear. The massive economic slump is likely to weigh on productivity growth. That said, a boost to innovation triggered by the challenges posed by the crisis – in the form of increased digitalisation, for example – could counteract this.