_Source:_ World Bank staff calculations based on _Doing Business_ , World Economic Forum, World Development Indicators, Eurostat.

# **6. Conclusion**

Using a panel of micro-data on firms from 12 EU countries<sup>43</sup> from 2003 to 2008, this paper addresses the confusing proliferation of suggested determinants of productivity growth and seeks to provide clear policy implications. The literature has generated theories attributing growth to country, industry, firm, and even product characteristics. Studies have thus far found support for each of these, but have failed to determine which among the many correlates are most critical for growth. We specify a model incorporating initial conditions, firm age, size, international affiliation, business environment indices, and FDI to assess the relative importance of each in explaining growth in labor productivity. We divide our sample into two groups, New Europe and Old, and obtain results for each.

In the economies of the EU12, country-level variables dominate—the most important of which are the stock of inward FDI, business regulations facilitating foreign investment, and the availability of private credit. The most important firm-level characteristic is international affiliation, either as headquarters of a multinational corporation or as subsidiary of a foreign firm. These results suggest that accession to the EU has been beneficial for new members because the ease with which foreign firms may now penetrate these new markets has facilitated the transfer of technology and the diffusion of best practices. The clear policy implication is that developing countries may realize significant productivity gains by taking the relatively easy steps of improving their regulatory regimes and creating environments attractive to inward FDI before addressing the more costly requirements of improving infrastructure and better educating their workforces.

With the EU15, firm-level characteristics dominate. Among these, the most critical are international affiliation and firm size. The most important country-level factor is outward FDI. Taken together, these results argue strongly for the role played by multinational corporations in driving productivity growth in developed countries. Thus, it is not surprising that firm size contributes to productivity growth in the EU15: as the large amount of FDI shows, firms in Western Europe are transforming themselves into headquarters of multinational corporations, and thus require more personnel to manage their global interests.

However, the success of the EU15 was not shared equally by all member countries. The four southernmost nations of Greece, Italy, Portugal, and Spain suffered productivity losses. Our analysis suggests that the failure of these nations to perform may be attributed to disadvantageous and restrictive regulatory regimes, leading to a relative preponderance of smalland medium-size firms. These factors discourage international participation and sharply limit the EU15 South’s ability to benefit from knowledge transfers from abroad, economies of scale, and production-reallocation efficiencies. However, these states may still achieve gains by reforming their regulatory regimes to encourage the expansion of outward FDI.

The experience of the EU15 South in relation to the rest of the EU15 raises an interesting implication for the EU12. While this paper divides Old and New Europe into two separate regions, implying at some level a fundamental difference, it may be that this difference is not necessarily intrinsic. Indeed, as Demekas et al. (2007) suggest, it may simply be the case that different characteristics matter more at different levels of economic development. The research

> 43 For sample 2 (with firms with at least 50 employees), the sample comprises 17 countries.

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