Sluggish total factor productivity (TFP) growth has been a key feature of the Eurozone over the last years. In particular during the recent recessionary phase, TFP negatively contributed to real GDP growth in all Eurozone countries, albeit to a greater extent in the Southern countries. In mature economies, reallocating resources across sectors contributes little to aggregate productivity growth, accounting for at most 10% according to Denis et al. (2014). The remaining 90% is driven by within-sector productivity gains, which stem from two sources: technology and productivity improvements within firms (within-firm TFP growth), and reallocation of resources from the least to the most productive firms within each sector (between-firm TFP growth). Plausible estimates of the relative magnitude of the contributions of within-firm and between-firm productivity growth based on US manufacturing data suggest that, on average, the two components contribute approximately the same, though there are of course cross-country and sectorial differences.
Upward trend in capital misallocation, flatter labour misallocation dynamics
In a recent paper, we examine the evolution of capital and labour misallocation in five Eurozone countries (Belgium, France, Germany, Italy, and Spain) during the period 2002-2012 across nine macro-sectors (Gamberoni et al. 2016a). This contrasts with previous literature on the topic, which has mainly focused on one country and/or one sector (typically manufacturing).
Following the seminal work of Hsieh and Klenow (2009), we measure input misallocation by the dispersion in the marginal revenue product of capital (MRPK) and labour (MRPL), as in Gopinath et al. (2015), García Santana et al. (2016), and Gamberoni et al. (2016b). Three stylised facts emerge. First, misallocation in capital has been trending upwards while developments in labour misallocation have been flatter during the period 2002-2012 (Figure 1). Second, both MRPK and MRPL dispersion dropped sharply in 2008-2009 across most countries and sectors. In other words, the pace of productivity-enhancing resource reallocation picked up during the Great Recession relative to ‘normal’ times. This effect was temporary in nature, however.
Figure 1. Input misallocation dynamics in selected Eurozone countries
Capital misallocation (dispersion in MRPK)
Labour misallocation (dispersion in MRPL)
Source: Own calculations based on CompNet data. For more information on the dataset see Lopez-Garcia et al. (2014).
Notes: Weighted averages, where the weights are the country-specific time-varying sectorial value added shares. The value-added series for Belgium ends in 2010.
Third, MRPK dispersion in services has been more markedly upward-trending since the early 2000s as opposed to the manufacturing sector. This is particularly the case for the information and communication sector and for professional and administrative activities. This is worrying for at least two reasons. First, if services continue to expand their weight, then large capital misallocation in services will negatively influence future aggregate TFP growth. Second, resource misallocation in upstream service sectors indirectly dampens productivity growth in downstream activities also, often manufacturing. With respect to dispersion in MRPL, we observe broadly stable developments across the service sectors, whereas labour misallocation in manufacturing modestly increased over the entire period vis-à-vis a decline in construction.
What is behind these trends?
Product and labour market regulations are the traditional structural determinants put forward by the literature as potential distortions which obstruct the productivity-enhancing flow of inputs across firms. In particular, product market regulation may result in poor allocation of resources because low-productivity firms will continue operating instead of downsizing or exiting (Restuccia and Rogerson 2013, Andrews and Cingano 2014). Stringent labour market regulation, in the form of e.g. elevated hiring and firing costs, may affect resource allocation – especially in sectors characterised by high job churning rates and risky technologies, where firms need to scale up or down quickly after a demand or technological shock (Haltiwanger et al. 2014). Although a positive correlation is indeed found between product market regulation and capital misallocation and between both product and labour market regulation and labour misallocation, these factors cannot wholly explain the observed misallocation trends. Indeed, over the period considered, deregulation occurred in most countries. This suggests that other factors may be at play, especially in the case of capital misallocation.
After controlling for realised demand, demand uncertainty – which we measure as the dispersion in the replies of firms interviewed in the monthly European Commission Business Survey to questions on their demand expectations – appears to be strongly and positively correlated with capital misallocation. While it is well known that demand uncertainty reduces investment (Barbku et al. 2015, Busetti et al. 2016), recent micro-founded literature also shows that this reduction tends to materialise to a larger extent in the more productive firms, those with ‘more to lose’, thereby affecting resource allocation and TFP dynamics (Bloom et al. 2014, Riley et al. 2015). In periods of high uncertainty on the future prospects of the economy – which do not necessarily coincide with recessionary periods (which anyhow we control for) – firms adopt a ‘wait-and-see’ strategy, so that productive firms do not expand and unproductive firms do not contract. High demand uncertainty thereby shuts off much of the productivity-enhancing reallocation.
Credit market frictions are also associated with an increase in capital misallocation. This supports the idea that the existence of frictions in the financial markets tend to prevent productive firms from obtaining the resources needed to expand, so that input choices differ systematically across firms in ways that are unrelated to their productivity (Gilchrist et al. 2013).
Finally, controlling for the negative aspects of the recent crisis, such as lower realised demand, heightened uncertainty and a spike in the stringency of credit standards, the Great Recession is found to have dampened misallocation dynamics, thereby playing a ‘cleansing’ role, albeit temporary.
From a policy perspective, sustainable growth in the Eurozone therefore hinges not only on individual firms’ productivity, but also on the ability to boost TFP growth through the reallocation of capital and labour from the least to the most productive firms within each sector. The evidence discussed in this column suggests that measures that remove structural barriers and reduce uncertainty, such as structural reforms and macroeconomic stabilisation, tend to foster TFP growth through a more efficient allocation of resources.
Authors’ note: The views expressed herein are those of the authors and not necessarily those of the ECB and the Banca d’Italia.
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