# **1. Introduction and Main Findings**

Between 2002 and 2008, the European Union (EU) experienced significant structural changes, including the introduction of the Euro, the 2004 expansion of the European Union, and the proliferation of international linkages worldwide. Responses to these changes among the EU member states included technological upgrades, adoption of new management processes, and regulatory reform.<sup>2</sup> Recent research efforts have revealed extensive heterogeneity in productivity growth across countries and sectors, even within narrowly defined industries.<sup>3</sup> The twelve newest members of the European Union (EU12, the “New Europe”)<sup>4</sup> experienced vigorous productivity growth, three to four times greater than the growth of the fifteen elder members of the European Union (EU15)<sup>5</sup> . However, as New Europe raced to catch up with Old, the southernmost states of Western Europe fell drastically behind, and experienced productivity contractions. What factors led to these disparate outcomes across members of the European Union? This paper disentangles the effects of country- and firm-level variables on productivity to answer the policy question of what countries may do to encourage greater productivity growth.

We use the 2010 Amadeus database,<sup>6</sup> which provides firm-level data on employment, sector, age, and international affiliations. We augment this with country-level business environment indicators from the World Bank’s Doing Business (DB) database, foreign direct investment (FDI) data from Eurostat, infrastructure quality indicators from the Global Competitiveness Report, and credit availability data from the World Development Indicators (WDI). Using ordinary least squares (OLS) regression, we estimate the contribution of each factor to productivity growth between 2003 and 2008, both individually and as sets of either firm- or country-level variables.

For the EU12, country-level characteristics contribute the most toward explaining productivity growth. Of the variables included, the most influential are DB indices of government business regulation, the availability of credit, and the stock of inward foreign direct investment. The FDI is especially important in manufacturing sectors. Firms with international owners or affiliates grew significantly faster than purely domestic firms.<sup>7</sup> These two effects suggest a role for government policies promoting FDI in improving productivity growth.

Among the EU15, we find that firm-level variables are the most important determinants of productivity—specifically, firm size and ownership. Smaller firms grow more quickly than large firms. Meanwhile, foreign-affiliated firms show much greater productivity gains compared with purely domestic firms: global headquarters grow most quickly, followed by domestic

> 2 Aghion, Acemoglu, and Zilibotti (2006).

> 3 For surveys of the literature, see Wagner (2007); Foster, Haltiwanger, and Krizan (2001); Bartelsman, Haltiwanger, and Scarpetta (2004); Barba Navaretti and Venables (2004).

> 4 The EU12 consists of Bulgaria, Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, the Slovak Republic, and Slovenia. However, Cyprus and Malta are excluded from the analysis due to lack of data.

> 5 The EU15 consists of Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom. However, Luxembourg and Ireland are excluded from the analysis due to lack of data.

> 6 Amadeus is a comprehensive firm-level database containing financial information for over 11 million public and private companies throughout Europe produced from the Bureau van Dijk

> 7This result is common in the literature. See Dunne, Roberts, and Samuelson (1989); Ilmakunnas and Maliranta (2004); Smarzynska Javorcik (2004).

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