Jürgen Stark: Knowns and unknowns about the creation of economic
wealth in the euro area
Speech by Mr Jürgen Stark, Member of the Executive Board of the European Central Bank,
at the joint European Central Bank, Bank of France and The Conference Board Conference
on "The Creation of Economic and Corporate Wealth in a Dynamic Economy", Frankfurt am
Main, 16 January 2008.
* * *
It is a pleasure for me to welcome you today. I would like to start by thanking you all for
coming to Frankfurt to participate in this conference. We are happy to have a good mix of
people from academia, industry and European policy institutions in this room. I am sure that
sharing your experiences and insights with each other will prove fruitful.
Understanding the sources of economic and corporate wealth in the euro area is challenging,
and in my view there remain many unanswered questions. I am hopeful that you will shed
some light on them.
Allow me to start by reviewing labour productivity developments in the euro area, and in
doing so highlighting the knowns and the unknowns.
In the sixteenth century the French mathematician Viète, building on the arithmetical work
done by others before, proposed the use of literal notation for knowns and unknowns, and
subsequently introduced the language of formulas into mathematics.
His initial proposal of using consonants for knowns and vowels for unknowns was
subsequently modified by Descartes to what is now common practice, namely the use of the
final letters of the alphabet for unknowns (x, y, z) and the first letters for knowns (a, b, c).
Viète's seminal, work on symbolic algebra contributed to improving the productivity of
mathematicians by allowing them to write a mathematical statement in just a few lines rather
than in several pages.
In the same spirit, I will try to keep my introductory remarks short and thus contribute to the
productivity of our meeting. But, rest assured, I will not go as far as to reduce my speech to a
few lines of symbols.
Demographic developments and growth
As the title of this conference indicates, the euro area finds itself in a very dynamic economic
environment characterised by rapid technological developments and the progressive
integration of regional economies, not simply through trade but also in increasingly
modularised supply chains. In addition to these dynamic forces, and in contrast to other
regional economies, the euro area is facing now, and even more so in the future, the
prospect of an ageing population. In the euro area, a broad decreasing trend in the
contribution to growth from demographic factors has been observed since 1990. This reflects
of both a decline in population growth and the ageing of the population. Over this same
period, the contribution from labour productivity growth has also decreased gradually. As a
result, real GDP growth has fallen from 3.6% to 2.0%. Demographic factors contributed 0.3
percentage point to this decline.
Future demographic trends in the euro area are likely to be driven by lower fertility rates and
rising life expectancy. Available projections suggest that the population of the euro area will
start to shrink in absolute terms after 2020, and that one out of three will be older than 65.
Simulations of the impact of demographic projections on real GDP and real GDP per capita
growth do not offer a reassuring picture.1 Under the assumption of
a) unchanged labour productivity growth rates, of
b) an unchanged percentage of people of working age in employment, and of
c) an unchanged number of average weekly hours worked,
the projected demographic trends imply a decline in average real GDP growth between 2020
and 2050 to 1%. Importantly, the deterioration in GDP growth per capita would also be
noticeable.
One could argue that demographic projections are highly unreliable. One could also argue
that the adverse demographic developments on growth could be offset by increasing the
average number of hours worked and the percentage of people of working age in
employment, and also by raising the retirement age. However, individual measures for
raising labour utilisation face natural limits. Therefore, the inevitable implication of such
demographic developments is that the key to a prosperous future lies in raising labour
productivity growth. Indeed, without higher productivity growth, the euro area is destined to
see its growth potential remaining low or declining significantly over the next few decades.
Allow me next to briefly review a few known facts about labour productivity developments in
the euro area in recent decades.
Labour productivity developments in the euro area
Labour productivity growth in the euro area has been declining since the early 1960s. This
slowdown in labour productivity mainly reflects less innovation and other efficiency gains (as
proxied by the concept of total factor productivity, TFP). Over more recent decades, lower
growth in capital used per unit of labour has also contributed to the decline. However, the
reduction in the growth rate of capital deepening can probably be seen as the flip side of the
employment-rich growth which the euro area has experienced over recent years. This
reflects an environment of wage moderation and progress with labour market reforms which
may have partly reversed the earlier trend to substitute labour, which had become more
expensive due to wage increases outpacing productivity gains, in favour of capital, in the
1980s and early 1990s.
The flagging of labour productivity in the euro area contrasts sharply with the very positive
developments in other major economies, most noticeably the United States. Up until the
mid1990s, labour productivity growth was lower in the US than in continental Europe. The
second half of the 1990s saw, however, a period of sharp acceleration in labour productivity
in the US, at that time seen by observers as permanent. In the eyes of many, this was driven
primarily by innovations in the information and communication technology (ICT) sector. The
rate of growth of GDP in the euro area in the second half of the 1990s was significantly lower
than in the US. Nonetheless, advocates of the new economy, i.e. believers in the radical
implications that the new technologies have for potential growth, expected that similar
developments would take place on this side of the Atlantic.
The contributions from ICT to labour productivity growth come from three main sources:
a) a direct impact from the production of ICT capital,
b) an additional direct contribution from the use of ICT capital in the production of other
goods and services, and
c) possible indirect "spillover" effects from the use of ICT capital.
These spillover effects stem among other things, from the introduction of more advanced
management techniques in production processes. When comparing the euro area with other
major industrialised economies, we see that the direct contribution from ICT capital increased
everywhere between 1980 and 1995 and between 1995 and 2005, but remained at a higher
level in the United States than in the euro area. In this respect, it is commonly acknowledged
that the higher TFP growth, in particular in the US, reflects at least partly the spillovers from
the development and adoption of ICT technologies as a so-called "general purpose
technology" that affects the entire production sector.2
When looking at euro area productivity at sectoral level, we do not find any immediate
evidence for such spillover effects in the non-high-tech ICT producing sectors.
First, the performance of traditional non-high-tech manufacturing industries deteriorated
significantly. They are responsible for most of the labour productivity slowdown in the euro
area.
the performance of non-high-tech services remained weak. Certainly, their
Second,
contribution in relative terms is not as sizeable as that of traditional manufacturing industries.
However, this should be little consolation, as in absolute terms, labour productivity in these
services industries has remained subdued.
The question is then: why have there been no gains from the more intensive use of ICT in
the euro area? However, there is another twist to this question. Recent data and analysis
conducted for the US may suggest that the large gains in labour productivity growth during
the second half of the 1990s and the early years of the new century are evidence of a one-off
event rather than of sustainable labour productivity growth. It is important to know if this was
indeed the case.
Economic policies to foster sustainable growth
It is probably uncontroversial to say that any increase in our economic and corporate wealth
over the long run depends on innovation. Following Schumpeter's definition, innovation
refers mainly to the introduction of new goods, new methods of production, the opening of
new markets, the procurement of new sources of supply and the introduction of new
organisational schemes and management practices.3 Putting aside the opening of new
markets and, to a certain extent, the procurement of new supplies, innovation goes hand in
hand with new ideas.
History has taught us that Archimedes devised his famous principle while in the bath. His
"Eureka!" moment is commonly used as an example by those who suggest that inspiration
plays the key role in the development of new ideas. Many others, however, disagree and
regard scientific discoveries as the outcome of the combined effort of large communities of
scientists. It is my view that in Europe today we are not waiting for people to come up with
good ideas while in the bath, but instead we expect governments to create an environment in
which innovation thrives. I think this requires governments to draw up policies that support
economic freedom and a vibrant, growth-creating private sector. This requires an
acknowledgement that undermining economic incentives and freedom is detrimental to
entrepreneurial activity. Allow me next to elaborate further on what should constitute a
growth-friendly economic environment.
The role played by education and research and development is key for innovation. This is a
known fact. A highly educated labour force improves the prospects for innovation and
facilitates the adoption of new technologies from abroad.4 However, in translating this
principle into policy, some puzzles emerge. Recent research shows that there is no clear link
between spending on education and the performance of pupils in the EU. This issue needs to
be explored further as it may suggest that there might be scope for efficiency gains in
education or, in other words, it is the quality of education spending which matters.5
The key role of R&D in promoting growth is also a known fact. It is also fairly uncontroversial
to suggest that promoting R&D investment includes a better use of public procurement, more
innovation-friendly regulation and stepping up the provision of targeted fiscal incentives to
the private sector. The level of R&D funding by the private sector in Europe lags that in other
modern economies, most notably the US. Finland is currently the only country in the euro
area which has achieved the Lisbon target of 3% spending on R&D. Adequate systems to
support R&D are of course not only a quantitative issue; increasing the efficiency of research
at the same time is essential. Further policy measures to correct this situation need to be
found.
Another key ingredient of a growth-friendly economic environment is well-functioning product
and labour markets.
Flexible labour markets benefit both firms and workers. Contractual flexibility is essential in a
world of technological change and globalisation where workers can no longer count on job
security. It means greater opportunities to move into new positions and it leads to higher
employment security. Education and training systems need to help workers master
transitions between jobs and keep up with technological developments. Flexible labour
markets and efficient active labour market policies contribute to shorter periods of
unemployment. Longer periods could lead to a decline in a worker's skills and productivity.
Lack of flexibility in labour markets also discourages innovation. The combined effect of
hiring and firing costs and the type of industrial relations regime have an impact on in-house
training incentives.6 Labour market regulations may also have an impact on participation
rates, a fact which should not be overlooked.
An environment where competitive forces reduce price margins will in turn encourage
entrepreneurs to allocate their resources in the most efficient way. Numerous economic
studies have documented the positive link between competition and innovation.7 However,
the nature of this link is not simple and we should deepen our knowledge of a number of
issues here.
First, recent empirical evidence on the impact of mergers on productivity growth suggests
that they may induce welfare-improving efficiency gains, which may conflict with regulators'
concerns about their negative impact on competition.8
4
See J. Temple (2001): "Growth effects of education and social capital in the OECD countries". OECD
Economic Studies, No 33, pp. 57-101. See also B. P. Bosworth and S. M. Collins (2003): "The Empirics of
Growth: An Update." Brookings Papers on Economic Activity, No 2.
5
See The EU economy review: moving Europe's productivity frontier. European Commission 2007.
6
OECD (2003): The Sources of Economic Growth in OECD Countries. OECD, Paris.
7
For a further extension of this topic, see European Commission (2004), "The link between product market
reforms and productivity: direct and indirect impacts", the EU Economy: 2004 Review. Further evidence is also
to be found in Griffith, R., R. Harrison and H. Simpson (2006): "The link between product market reform,
innovation and EU macroeconomic performance", DG-ECFIN Economic Papers No 243, February 2006.
8
See M. D. Giandrea (2006): "Industry Competition and Total Factor Productivity Growth", Bureau of Labor
Statistics Working Paper No 399, September 2006.
BIS Review 6/2008
Second, there is evidence that for some countries there might be an inverted U-shaped
relationship between competition and incentives to invest in innovation. This means that high
as well as low levels of competition may discourage innovation.9 This, in my view, may
simply be a sign of the international reallocation of capital. Studies that have indicated an
inverted U-shaped relationship usually employ price cost margins as a measure of
competitiveness. In traditional industries, such as textiles, these have been trending
downwards as a result of the increasing competition from developing economies. The
pressures exerted by developing economies on traditional industries in developed countries
are mounting, suggesting that it may be also advisable to promote economic policies which
encourage the development of high-tech industries.
Another key ingredient of a growth-friendly economic environment is, of course, a sound
macroeconomic policy setting. In particular, recent studies have emphasised the benefits of
maintaining price stability. Economic research has shown that higher average inflation has a
negative impact on growth and welfare, while higher inflation volatility has a negative impact
on welfare and, most likely, a negative effect on growth.10 Maintaining price stability is the
best contribution the ECB can make to promoting growth in the euro area.
Conclusions
Let me conclude by saying that Europe is reforming its economy so as to adapt to the
challenges of globalisation, technological change and ageing. Considerable progress has
been achieved, as reflected in the significant rise in employment growth. Monetary Union has
been effective - and very successful - in supporting growth through a credible monetary
policy which creates a stable macroeconomic environment. It has lowered financing costs for
a number of euro area countries by reducing risk premia. The challenge now is to raise the
level of productivity growth in all euro area countries.
I am very grateful to the Banque de France and The Conference Board for joining forces with
us to convene this conference. We share a common interest in learning more about the
mechanisms that promote the creation of economic and corporate wealth in Europe, and we
all hope to learn a lot from this event. I wish you all a fruitful discussion.