The Slowdown in Productivity After the Financial Crisis

The Slowdown in Productivity after the Financial Crisis

Within the European Union (EU-28)

The 2008 financial crisis rapidly developed and spread into a global economic shock, which resulted in a number of European bank failures and stock market declines. Economies worldwide slowed during this period due to tightening credit and drops in international trade. As a result, the global economic crisis strained the ties that bound together the member of the European Union (EU-28) and presented a significant challenge to the ideals of solidarity and common interests.

Following the outbreak of the financial crisis the EU proposed a European stimulus plan, accounting to US$256 billion, which aimed at limiting the economic slowdown through national economic policies extending over a period of two years. The measures include supporting medium-term growth through increased public spending on infrastructures (road networks and railway), assisting the housing sector (construction and renovation), and increasing the benefits and allowances to low-income and unemployed households. For the entire world, the estimated US$2 trillion total in stimulus packages amounts to approximately 3% of world Gross Domestic Product (GDP), exceeding the call by the International Monetary Fund (IMF) for fiscal stimulus by 2% of global GDP to counter worsening economic conditions worldwide. As of mid-2012, several European countries were still suffering from sovereign debt problem and need international assistance. Statistic revealed that some EU countries are much more heavily indebted than others, as a result of borrowing recklessly at the cheap interest rate available inside the Euro. The escalating debt threatened to reduce their economies to a fragile level and when the financial crisis hit, they were powerless to fend it off, leading to a sovereign debt crisis.

The serious debt problem that trashed the economic and banking systems of many EU countries traces its roots back to the previous decade, when very low (sometime even negative) real interest rates coupled by weak financial regulation and supervision encouraged a significant increase in risk taking. This situation led to an increase of the current account deficits such that by 2008 Portugal, Greece and Spain had accumulated net foreign liabilities of over 70% of the national GDP; while Italian national debt had reached around US$2.0 trillion – three times greater than the national debt of Portugal, Ireland and Greece combined.

Eight years after the global financial crisis, GDP growth remains below pre-crisis rates in most countries, leading to concerns that the global economy has been stuck in a “low-growth trap”, with the post-crisis period being described by some analysts as the “decade of lost growth”. A striking feature of the post crisis period has been a continuation of a long-term slowdown in productivity growth that has gone hand-in-hand with weak levels of investment. The aim of this paper is thus to understand how the European Union’s (EU-28) productivity performed since the recent global slowdown and to analyze which key factors may have been behind this evolution. It concludes with a brief review of the main findings in the context of future prospect, along with the presentation of some of the most relevant policy recommendations found to increase productivity growth.

“Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living per time depends almost entirely on its ability to raise its output per worker.”

– Paul Krugman, The Age of Diminishing Expectations (1994)

Productivity is considered a key source of economic growth and competitiveness, commonly defined as a ratio between the output volume and the input volume, which measures how efficiently production inputs are being used in an economy to produce a given level of output. From the many different productivity measures, the most relevant economy-wide indicators of productivity growth considered in this paper are essentially focused on Labor Productivity, regarding GDP per capita, per hour worked, Labor Utilization and Unit Labor Costs, as well as with some references to Multifactor Productivity.

Gross Domestic Product (GDP) per capita measures economic activity or income per person. Growth in GDP per capita can result from changes in labor productivity (GDP per hour worked) and labor utilization (hours worked per capita). It is known that a slowing or declining rate of labor utilization combined with high labor productivity growth can be indicative of a greater use of capital and/or of structural shifts to higher-productivity activities – the exact opposite of what Figure 1 below indicates. After the recent financial crisis (2007-2016) we may notice great differences in GDP per capita growth within the EU-28 which are mainly attributed to differences in labor productivity growth.[pic 1]

Labor Productivity is a key dimension of economic performance and an essential driver of changes in living standards which represents the volume of output produced per unit of labor input. The ration between output and labor input depends largely on the presence of other inputs, such as physical capital and increasingly intangible fixed asses used in production, as well as technical efficiency and organizational change. As previously stated, and supported in the attachment of Data Set 4, the EU-28 seems trapped in a decade of lost growth.

The dynamics of EU’s GDP per capita show that the largest economic activity slowdown and largest GDP per capita negative change took place in 2008, revealing the peak point of the EU economy. However, eleven (Denmark, Estonia, Ireland, Greece, France, Italy, Latvia, Luxembourg, Portugal, Sweden and the UK) out of twenty eight countries already experience the crisis in 2008, with an observed peak point in 2007 (Data Set 1). Moreover, over the recent years, many EU countries, such as Germany, Ireland, Poland and Portugal, managed to improve their relative competitiveness by keeping Unit Costs of Labor^[1] (UCLs) in check, as low increases in UCLs reflected relatively strong labor productivity growth and/or moderate wage increases. Nevertheless, Greece, Ireland, Portugal and Spain saw strong falls in their UCLs since the onset of the financial crisis.

The fact that included in the group of countries which experienced this economic recession first were three of the five largest EU economies – France, Italy and the UK – led to the gradual slowdown of economic development in the common market. The above-mentioned eleven countries accounted for 54% of the total EU economy in 2007; henceforward, the statistical data indicated that a half of the EU economy was in recession already in 2007. In this sense, we may conclude the years of 2007 and 2008 as the breaking points. The analysis of the unstable GDP per capita annual growth and labor productivity slowdown has launched many academics and researchers on the lively debate regarding the causes and the future of productivity, which underpin the collapse in potential output growth of the EU-28. So what could have been the key factors behind this evolution?