Productivity Measurement Analysis series – Europe, Q1 2023 analysis by Klaas de Vries
Labour productivity in the Euro Area, defined as real GDP per hour worked, fell in the first quarter of 2023 compared to the previous quarter by 0.4 percent, according to figures released on June 8. However, excluding data for Ireland which tends to be quite volatile due to profit shifting behaviour by US multinationals, the fall was 0.1 percent.
Labour productivity falls were recorded in 14 out of the 20 member states, with Germany being a notable exception. Among the larger economies, the data for France are the most concerning, noting another drop in Q1 of 2023 and with an overall labour productivity level that is 3.5 percent below its pre-pandemic level of Q4 of 2019. Declines in productivity were also widespread across industries, with only manufacturing, construction, and the recreation sectors as exceptions. However, labour productivity levels in the latter two industries remain well below their pre-pandemic level of Q4 of 2019.
Why has productivity slowed?
Labour productivity is not observed directly, rather it is derived from observed data on outputs (real GDP) and inputs (employment). Demand for workers has been very strong since the pandemic. The growth in employment has far outstripped the growth in output. In other words, firms have found it more beneficial to expand production by hiring more workers rather than increasing productivity.
Stepping back from these simple arithmetic, broader forces that likely have negatively impacted productivity recently include high inflation, supply chain bottlenecks, the energy crisis and overall macro-economic uncertainty and volatility. These factors may have spurred firms to increase headcount rather than make longer-term commitments by raising investment. Extremely elevated labour shortages could be another factor, though the causality may just as well run the other way around (i.e., labour shortages as a consequence of weak productivity growth).
What about the pandemic impact?
Barring volatility in the data series, labour productivity levels in the Euro Area (excluding Ireland) have virtually been stuck since the onset of the pandemic. Does this suggest that the pandemic had a negative impact on productivity, despite earlier promises of improvements due to changes such as telework and the overall increased digitalisation? This is probably not the case, as in many sectors, the increased use of digital tools (e-commerce, telework, etc.) was a life saver. And this is partly reflected in the macro data, with above-average increases in productivity levels in telework-friendly sectors such as for example professional services. Hence, it could be the case that improvements due to the increased digital transformation are outweighed by negative factors as mentioned above.
What’s the outlook for labour productivity?
Labour productivity growth was already on a slowing trend going into the pandemic, which raised many alarm bells. Are we now stuck with an even lower trend of virtually no productivity growth? Though it’s extremely difficult to predict productivity with any certainty, there are probably more reasons to believe that productivity will eventually pick up rather than continue to stagnate, though the pace of the increase is very much in doubt.
While the near-term macro-environment remains anything but rosy, some of the bigger issues such as high inflation, the energy crisis and elevated supply-chain bottlenecks have either reversed or are in the process of reversing. And as firms realize labour shortages are likely to be a more structural phenomenon rather than a temporary one, this could eventually spur them to invest more in labour saving technologies.
There is certainly no dearth of new technologies that could help them with that, witness for example the breakthrough in generative artificial intelligence. Finally, the impact of increased interest rates may be a neutral factor in the short-term outlook for productivity. On the hand increased cost of capital deters potentially productivity-enhancing investments, while on the other hand it could improve the allocative efficiency of resources across the economy by forcing uncompetitive and unproductive firms out of the market and thereby raise productivity in the broader economy.