Europe's productivity paradox

Mary McCaughey (00:00:00:00 – 00:03:07:00): Welcome to this edition of Eurofound Talks. Today I am really excited to be talking about Europe's productivity paradox. The reason for that is that for those of you who have been following the European agenda over the last while, you'll know that there is a super drive for greater competitiveness for Europe vis-à-vis our trading partners across the globe.

We're wanting to push Europe into a more competitive arena. We're wanting to see more growth. And clearly with that, we would assume we want to see greater productivity. Or do we? That's what I want to talk about today with our guest. We're looking at it as a conundrum. We've seen the EU labour market grow over many decades. We've seen millions and millions of net new jobs since 1995. It's actually an undeniable indicator of the continent's ongoing structural transformation that we see this success in terms of the labour market. However, we're also seeing that at the same time, this expansion has not generated the kind of economic returns that we would like to see.

And of course that feeds into this whole aspect of competitiveness. Without those economic returns, we cannot expect to see Europe's competitiveness rise. And in fact, it would seem that we're seeing a more profound slowdown in productivity growth than the other trading blocs, for example, the US and China. And there is a question here. Why have we seen with greater labour input and higher human capital, why has that not translated into higher output per worker, or as we would say here, greater productivity? We've been looking at this issue in Eurofound, and my guest today is an expert in this area. It's a particularly interesting discussion for us to have today when we're looking at this drive towards greater competitiveness.

What is the European social model in this context? How can we see the European social model working to help us deliver greater competitiveness? Or indeed, are we going to hear that the European social model may be a drag on our system and prevent our growth and competitiveness into the future? So to discuss this, I'm joined by the person who will tell us all of these things, I hope, Senior Research Manager here at Eurofound, John Hurley. Welcome, John.

John Hurley (00:03:07:00 - 00:03:09:00): Thank you very much, Mary.

Mary McCaughey (00:03:09:00 – 00:03:27:00): So, John, before we get started, I would really like to just try and decouple all of these words that we use. We talk about productivity, we talk about growth, we talk about development and competitiveness. What is actual productivity?

John Hurley (00:03:27:00 - 00:04:25:00): Productivity is the output either per person working or per hour worked. Per hour worked is probably the most common definition of productivity. I mean, just to say that output is basically the value that any worker adds in the course of working to the inputs that he uses in his work, he or she uses in his work. So effectively, yeah, productivity is a measure of how efficiently we do things.

And yeah, it's something that we can measure at the aggregate, we can measure at a country level, we can measure at a company level. So it's the basis, I guess, of our material prosperity as a rich world economy. The reason that we are a rich world economy is that we tend to have quite high levels of productivity. We excel at producing things, services and goods, and we do it better every year. We hope at least.

Mary McCaughey (00:04:25:00 – 00:04:28:00): And yet we might be seeing that that's not the case so much any longer.

John Hurley (00:04:28:00 - 00:05:16:00): Well, this is the, you know, this is the, it's part of the paradox that we're trying to explore. I mean, one of the kind of amazing things about the last 30 years is that there's been a decline in productivity levels across the advanced world. It's not just in Europe. It's particularly acute in Europe, but basically we had productivity growth levels of around 2% between 1995 and 2005. It then halved in the succeeding 10 years and it's gone down even further ever since. So that's a productivity measured on a per hour basis. And that's in the EU. Something very similar has happened in the United States as well. So it's a bit of a conundrum, yeah.

Mary McCaughey (00:05:16:00 - 00:05:24:00): But as you, as it was one of the questions I was going to ask you was, are we seeing a decline which is very different from the other trading blocks?

John Hurley (00:05:24:00 - 00:06:25:00): Well, the big comparison and the one which I think policymakers at an EU level are particularly focused on is the differential between our productivity growth trajectories and those in the United States. And it's true that, you know, it's true that basically the same, we see the same pattern across the US and the EU, but the decline and the decline in the level of productivity growth has been more marked in Europe. And one of the reasons that's generally adduced for, you know, to explain this is that America has had superior performance in some particularly important high growth sectors such as in IT, information technology, also retail and perhaps even financial services compared to Europe. So these are important, increasingly important sectors in advanced economies and America seems to be doing better in them than the EU.

Mary McCaughey (00:06:25:00 - 00:07:04:00): And maybe we could come back to why that would be. Is it about greater investment in these areas? For example, I'm thinking about AI, but we can come down to that. I'm interested particularly here though because what I said in the introduction is about this huge boost in labour figures. So we're seeing a growth in employment and we've seen a fairly massive growth in employment despite the odds to a large degree. But that employment growth in recent decades, how have we seen that develop? You know, you talked about the development in terms of the numbers, but you've been tracking these employment rates. Talk to me a little bit about that.

John Hurley (00:07:04:00 - 00:07:34:00): Well, this is a very positive story and it's maybe a little bit less heralded because we tend not to look at things over a long period, over 20 or 30 years, but that's what we do in this report. And basically, Europe has added 30 million net new jobs over the last generation. So it's gone from being, broadly speaking, a workforce of 170 million people to one of 200 million people.

Mary McCaughey (00:07:34:00 - 00:07:40:00): And that's of course bringing in women who weren't in the labour force quite so much with disabilities, you know, all of that dimension.

John Hurley (00:07:40:00 - 00:08:40:00): Sure, sure. Yeah, there's a change in the composition of employment. And as you say, in particular, employment rates have increased for women and for older people. But that's a very significant additional, you know, significant additional workforce to be generated in 30 years, especially in the context of demographics, which as you noted in your introduction actually represent headwinds and tailwinds as they used to do.

We have a working age population that's more or less been in decline since 2009. We have 10 million fewer people in the EU27 now compared to 10 or so years ago of working age. So this growth of employment is going against kind of these demographic headwinds. And it's a very positive story. I mean, we have unemployment rates at the lowest level in a generation in Europe as a whole.

Mary McCaughey (00:08:40:00 - 00:08:47:00): And also, John, from other work that I know that you've done, I mean, we know that a lot of these jobs, in fact, the majority of these jobs tend to be good jobs.

John Hurley (00:08:47:00 - 00:09:17:00): Well, this is one of the things that we do in a thing called the European Jobs Monitor. We try and identify where this net new employment is occurring in terms of the wage distribution. And yes, one of the things we find is that increasingly, nearly all of the net new employment in the EU over the last five years, since just before the COVID pandemic, has come in top quintile jobs. So in jobs paying the top 20 percent of jobs in our economies.

Mary McCaughey (00:09:17:00 - 00:09:26:00): So we have more people in the labour market, more people employed, more jobs, more better quality jobs, but we're still not delivering on greater productivity.

John Hurley (00:09:26:00 - 00:10:17:00): That's the conundrum. And that is, you know, that's the paradox that, you know, is not easy to resolve. One would think that with more people in employment, with a much higher share of those people with third level education achieved, so 30 percent of our workforce now have graduate degrees, compared to 15 percent at the beginning of the century. So again, you know, these are very significant enhancements of the human capital reservoir, if you like, of the EU.

So despite these things, yeah, productivity has been declining in the way that it's been ratcheting down in the way that I described earlier. You know, we're barely achieving half a percent increases per annum in productivity.

Mary McCaughey (00:10:17:00 - 00:10:24:00): And in that labour market, I mean, have we seen during that time great changes in terms of income, in terms of skills levels?

John Hurley (00:10:24:00 - 00:11:03:00): Well, I mean, again, income and education tend to follow each other. As I've said already, the growth in employment has really been very, very significantly concentrated and increasingly concentrated in the top quintile of paid jobs, with really very little growth in any of the bottom 80 percent of the wage distribution, some minor shuffling to and from. But really, the concentration in well-paid top quintile jobs. And these tend to be, just to answer your question, yeah, these tend to be jobs requiring third level educations increasingly.

Mary McCaughey (00:11:03:00 - 00:11:12:00): And so, John, I mean, at this stage, and I don't expect you to have all of the answers right now, but I mean, are there signs as to why that is the case?

John Hurley (00:11:12:00 - 00:12:16:00): Well, that's kind of the million euro question. You know, it's very hard to disentangle why this is happening and why it's a common pattern across advanced economies. It can be to do, I mean, in terms of some of the explanations that have been put forward for these declines in productivity growth rates. Some people point to declining levels of investment, in particular in research and development, but also in IT and IT infrastructure, which are seen as very, very important, very important pushers of growth, if you like. There in the EU, we could talk about the lack of scaling of businesses, that businesses aren't actually growing faster in the way that they possibly do in, well, they certainly do in China or the China or the US, where the number of, for example, of unicorns, these billion dollar startup businesses, there's a much, much higher number of them in both China.

Mary McCaughey (00:12:16:00 - 00:12:20:00): And we tend to have many more small, medium sized enterprises.

John Hurley (00:12:20:00 - 00:13:38:00): We tend to have, yeah, we tend to have a higher share of our employment in smaller and medium sized enterprises. That can be a strength. But again, it's in terms of productivity, a lot of productivity growth actually occurs in larger and larger businesses and productivity growth, productivity levels and growth rates tend to be higher in larger businesses. So that could be part of the answer. There are plenty of other explanations or potential explanations. One of them, which I particularly, I think maybe behind this decline in productivity growth is one that was advanced by an American economist many years ago, William Baumol, who talks about technologically stagnant sectors, sectors where which a lot of our employment now is in contact services, in-person services. Those types of services are very hard to automate. They're very hard to improve the level of productivity in those because they rely on one person doing something for another person. And so they're not amenable to productivity improvements in the way that, for instance, manufacturing or agriculture have been. And because we have a higher share of our employment in those types of sectors, that that could well be one of the things that represents a drag on growth.

Mary McCaughey (00:13:38:00 - 00:13:46:00): And that the future of manufacturing in Europe is tending to decline.

John Hurley (00:13:46:00 - 00:14:38:00): Well, manufacturing is now accounts for 15 to 16 percent of total employment. You know, it's about half of the share that it represented maybe 40 or 45 years ago. So, yeah, it represents a declining share of employment. But at the same time, that declining share of employment and those declining manufacturing workers generates much greater output now than they did when they were much bigger share. Well, not just relatively speaking, but in absolute terms.

That's an indication that manufacturing and agriculture, these are two sectors which have been very, very amenable to productivity increases using new technologies over a very, very long period. And they've become progressively more and more efficient. And we need fewer and fewer of the people working in those sectors to produce the output that we need, that we want as a society to consume.

Mary McCaughey (00:14:38:00 - 00:14:49:00): So it's also a lot about where we as Europeans would decide to invest in the future, and where we would this question of where are we going to look for creating more employment or more growth?

John Hurley (00:14:49:00 - 00:15:57:00): Yeah, I think that's that's certainly part of the answer, because, you know, in this, I talked about this decline decade and decade on decade in European productivity growth and data. And one of the things that my colleague Dragos does in the chapter in this report on productivity, that we actually had sectoral drivers of productivity growth back in the period 1995 to 2005, in particular in manufacturing, that the contribution of those sectors declined very markedly over the succeeding 20 years. They contributed much less to productivity growth in the decades afterwards. The other thing, clearly, in any comparison with the United States, is that the information technology, both the manufacture of equipment, but also the IT services, that has been a much, much bigger constituent of a growth in America and has led to higher productivity.

Mary McCaughey (00:15:57:00 - 00:16:07:00): And also, I suppose, John, down to the huge, massive scale of investment that is going into some of these areas, in the US, for example, I'm thinking of the AI.

John Hurley (00:16:07:00 - 00:16:32:00): We're looking, I guess, at the longer period, looking at basically a period of 30 years. It's true that the last couple of years, there's been this enormous investment in artificial intelligence, in particular in generative AI and large language models. And it's clear that a huge share of that investment has been in the United States and probably also in China, and a very small share of it has been in the EU.

Mary McCaughey (00:16:32:00 - 00:16:38:00): And is liable, I suppose, to bear fruit even more for them over the coming period in terms of greater productivity?

John Hurley (00:16:38:00 - 00:17:13:00): Well, that's an open question. We're talking about productivity. What we know is that it's not necessarily the case that investment necessarily leads to profits and productivity growth. The gamble of a lot of the big tech firms in the US is that it will, and that it's worth the chalk and the hundreds of billions of euros that are being poured into it, will actually generate gains in time. But again, that's something of an open question. We have the example of the dot-com boom busting in 2001 to know that in fast-growing sectors, there can be speculative bubbles which burst.

Mary McCaughey (00:17:13:00 - 00:17:52:00): I mean, John, just to go back to what you're talking about there, about manufacturing, about agriculture, I mean, does that then mean that within the European Union itself, the kind of older member states are perhaps less involved in these areas now, whereas the newer member states, even though we don't want to make this divide on an ongoing basis, are still perhaps more traditionally invested in agriculture, in manufacturing? Are we seeing a great divide there between different member states in terms of productivity? That's a good question.

John Hurley (00:17:52:00 - 00:19:18:00): I mean, one of the points that Dragos makes in the third chapter is that there's a difference in productivity growth rates between the older member states and the post-2004 member states. To me, and I think also to Dragos, that is largely a story of catch-up growth of economies which had lower levels of GDP per head being integrated into a higher GDP single market and taking advantage of that and converging upwards, exactly. It has been accompanied by a very, very strong transformation of the labour market in most of these economies. As I said earlier, you have in Romania and Poland, you've gone from economies which were between a quarter and a third of their employment on the land as recently as 40 years ago, and that's down to 10% or less in both countries.

So you've had this very, very rapid transformation of these economies, and it's been generally a transformation which has involved the passage of employment from less productive sectors to more productive sectors, and they're experiencing the same service shift that all of the rest of the economies are experiencing. They're doing it from a lower base, and therefore their growth rates have been higher.

Mary McCaughey (00:19:18:00 - 00:19:46:00): Okay, I mean, so essentially what we're seeing is that we are converging, if you like, in a space where almost all economies are going to look similar across the European Union, both in terms of where the focus is, but also in terms of composition of the labour force. So, you know, women's participation in the labour, you mentioned that earlier, that has been a big boost to increasing employment in the European Union over the last number of decades.

John Hurley (00:19:46:00 - 00:20:28:00): It's been probably the biggest single change in terms of, you know, if you were to explain why there are 30 million net new workers in the EU compared to 30 years ago, well, the main fact is that this is due to much higher female employment rates, which is largely a socio-cultural phenomenon as much as a labour market phenomenon. There's just a much greater likelihood that young women enter the labour market and stay in the labour market than was the case a generation ago. So 20 million of those 30 million net new workers have been women, more than half.

Mary McCaughey (00:20:28:00 - 00:21:08:00): And in terms of this business to do with our competitiveness, I mean, there's all the talk about growth, about development, about pushing us forward. Is it all down to productivity? I mean, when we're talking about development and competitiveness vis-a-vis the US and China, do you think that it really does come down to the bottom line of greater productivity? Or are there other elements that we should be considering to ensure that we shore up our solid labour market in terms of job quality, in terms of working conditions and need in terms of living conditions?

John Hurley (00:21:08:00 - 00:22:36:00): Yeah, I mean, I think we can over fixate on productivity. It's not the measure of everything. I mean, I think it's certainly right that policymakers pay attention to it and pay attention to the fact that there's been this drift in particular between productivity growth rates between ourselves and the US. That's something that we should look at and we should try and address. But, you know, there are many, many things in Europe which we do well. And you talk about competitiveness at the beginning. There is this tendency to kind of equate competitiveness and productivity. But Europe is, it may be less productive than it was, or at least it's more productive, but it's the rate of growth of productivity is lower than it probably should be and certainly lower than it was 20 or 30 years ago. But we're still competitive. We have a very significant trade balance with the rest of the world. We have higher living standards, you know, probably only comparable to those in the US. So, you know, on many fronts, we have an enviable quality of life. And arguably, part of that is, we actually work fewer hours now than we did a generation ago, in order to generate higher living standards. So there are trade-offs that are made in Europe, which maybe aren't made to the same extent in China or the US.

Mary McCaughey (00:22:36:00 - 00:22:40:00): Which are maybe value trade-offs as well?

John Hurley (00:22:40:00 - 00:23:23:00): Well, these are effectively social societal choices. And it's clear that in Europe, we probably work to live somewhat more than they do in other parts of the world. And that's something that we, that's a value that we do cherish. And, you know, arguably, obviously, that's not something that's going to enhance your productivity statistics. If you're working in Germany, they work 1400 hours per annum. In America, it's near 1800 hours. So yeah, there are going to be sacrifices to be made for those 400 hours of extra leisure.

Mary McCaughey (00:23:23:00 - 00:23:40:00): And I suppose that is also perhaps there's another sort of paradox or conundrum at play, which is, I mean, from the genesis of the Treaty of Rome, that is what prosperity, economic prosperity was about was to bring greater improved living conditions and working conditions for its citizens.

John Hurley (00:23:40:00 - 00:24:15:00): Yeah, I mean, I think that the from the Treaty of Rome onwards, the EU has been about striving for material prosperity as the basis of peaceful relations between the member states. And obviously, this has been an attractive proposition. We've grown from six member states to 27. We were 28 not so long ago.

Mary McCaughey (00:24:15:00 - 00:24:40:00): And so it's been an attractive proposition for other European countries. And I'm sure it will continue to be so. I mean, just to finalise here, just on the aspect of the improving the job quality and the labour supply. In your research up until now, you have also looked at technological unemployment and sort of what's coming from that is that the focus should be less on that and more on improving job quality and labour supply. Can you just kind of, you know, elaborate a little bit on that?

John Hurley (00:24:40:00 - 00:28:18:00): Okay. Well, there has been the spectre of technological unemployment for generations. You know, going back to John Maynard Keynes, but it's been something that economists have thought a lot about. They thought that, okay, we're introducing all of this new technology. One of the main impacts of new technologies is to replace human labour.

In fact, in many cases, it's been designed to do so. So we need to prepare for a world where the machines actually take up such a volume of human labour that there aren't enough jobs for humans to do. And there's been a lot of academic work done in the last 10 or 15 years by Frey and Osborne, looking at the automatability of jobs. But also a lot of work in the last few years looking at the extent to which jobs are exposed to artificial intelligence, to AI, as the tasks within jobs are exposed to AI. And all of these, all of this work and all of this research work tends to come to some figure about the degree to which human tasks or human jobs can be replaced. And they're often fairly scarily high.

They're 40%, 50%, often in reasonably short time horizons, 10, 20 years. My personal hunch about this, and this is, you know, borne out by the data, is that we've never really had to worry about this spectre of a mass technological displacement of human labour. We have 30 million more jobs in the EU now, compared to a generation ago. We have employment rates which are higher. So the actual share of people who are in employment is higher. Unemployment is lower. We have labour shortages probably as more of an issue for labour market policy makers than unemployment in many countries. And I don't really see that that's going to change. I think that the evidence from the past is that new technological improvements end up generating more work for more people than they destroy. Different jobs, new jobs. It's interesting, we're looking at the Working Condition Survey data from 2024, our own European Working Condition Survey.

And one of the questions in the survey this year asks about whether technology is removing tasks from your job or generating new tasks in your job. And there's a much higher figure of people saying that it's adding new tasks to their jobs and removing tasks from their job. And that kind of concords with my general sense that we needn't be worried about technology stealing our jobs anytime soon. I think that's not going to happen. Why the emphasis on job quality rather than on technological unemployment? Well, job quality is part of the answer of trying to actually encourage people who are on the margins of the labour market to re-enter the labour market to do jobs that we need done. We know that there are still significant under-representation in the labour market of various groups of people, including women, but also older people, people with disabilities: The long-term unemployed. There is a nexus of job quality which, you know, if you can give people stable, decent, reasonably well-paying jobs, you can encourage them to step off the margins of the labour market and actually contribute to growth.

Mary McCaughey (00:28:18:00 - 00:28:53:00): Okay, John, I'm sure that's not the only answer to increasing Europe's productivity, but I suppose being an expert in this area and having such a broad spectrum of research expertise behind you in terms of jobs, labour market, etc. If you were talking to the policymakers and our president, von der Leyen, was speaking to you in the escalator after having delivered the State of the Union address, what would you be saying to her that she should be focussing on to ensure competitiveness by addressing this productivity paradox?

John Hurley (00:28:53:00 - 00:32:05:00): One of the first things I would say is that the EU is not gaining the benefits that it should from the human capital improvements that we've seen over the last generation. As I said, we've doubled the share of graduates in the workforce that we had 30 years ago. One would expect that that would lead to productivity enhancements and that has not been the case. We went through a few of the potential explanations for why that human capital improvement has not translated into productivity growth rates which are higher, but one of the things that we noticed in the productivity data is that a lot of the shortfall in productivity growth over the last two decades has come in a thing called total factor productivity, which is basically if you think of the inputs in the economy as capital and labour, maybe energy as well, you can identify the individual contribution of each of those strands to productivity growth. But there's also the combination of all of those elements, how you actually put them together. And that is an area where we have been particularly poor or at least where our improvement has disapproved.

And to me, that strikes me as an argument for looking at how how we work and how work is organised and how we actually put together the things put together people and resources in order to generate outputs. So there may be, there may be improvements in work organisation which could, could help us to start addressing these, these declining levels of productivity growth.

A second area, one that I've already mentioned was that you know, you are, if we look at the productivity data and we're able to identified that there were sectoral drivers of productivity growth in the past, which kind of disappeared after 2005. And so Europe does lack a sectoral driver of renewed productivity growth. We need to identify one.

The Dragos report was a brilliant overview of where the European economy is at the moment, with all of its strengths, but also with all of its weaknesses. And it identifies some sectors in which Europe is reasonably strong where it does have the possibility of being a world leader. Artificial intelligence isn't one of them. Let's just be clear about that. I mean, we're, I think, it's fair to say that we're probably always going to be behind the US and China. But in areas like clean technologies, high performance computing, advanced materials production in these kind of emerging high growth sectors, Europe has a good base of knowledge, a good base of human capital and prospects of actually of doing very well in international context.

Mary McCaughey (00:32:05:00 - 00:33:32:00): So thank you very much for that, John. I know there's no easy answer, no silver bullet. Nobody is expected to be able to manage this immediately as of tomorrow, but I think it is a conversation that was certainly worth having. Very interesting discussion on Europe's productivity at a time where competitiveness has never been more to the fore. So again, thank you for joining European Talks this morning, John. And as you know, those of you who follow us, you can access all of the information. It's all available on our website. You can access the survey also that John reference by the European Working conditions Survey and the Jobs Monitor, which are also online. You can follow us on our social media channels, sign up to our newsletter and until next time when Eurofound talks to you.