was very much in line with standard economic textbook theory. however, it ’ s a pattern that has gone into reverse since the mid - 1990s. labour productivity growth ( per hour worked ) was 2. 4 % in the euro area from 1981 to 1990 compared to just 1. 5 % in the us. however, during the period 1996 to 2004 productivity came down to 1. 3 % in the euro area while it recorded a value of 2. 5 % in the us. this rise in the us may partly reflect cyclical factors, but the apparent resilience of us productivity growth during the recent downturn and the significant further pick - up over the last two years tends to support the widespread view that the mid - 1990s saw a structural improvement in us productivity growth. i should perhaps add that downward trends in productivity growth are observed for the euro area, irrespective of whether productivity is measured per person employed, or per hour worked. however, it is worth noting that due to the trend decline in average hours worked in the euro area ( in contrast to stable hours in the us ), the productivity growth gap with the us has become more marked in terms of employed persons than in terms of hours worked. in sum, the growth differential between the euro area and the us since the mid - 1990s reflects a more intensive use of labour and higher labour productivity. it is important to note that there is a limit to how much labour utilisation can grow, and hence this factor cannot explain growth differentials between countries over long periods of time. in the long run, the main source of growth differentials between countries is due to differences in labour productivity. productivity growth is therefore the key factor in long - term economic growth. 2 given the striking recent divergence in productivity growth between the euro area and the us, it ’ s worth considering productivity developments since the mid - 1990s in greater detail. productivity developments since the mid - 1990s the decline in euro area labour productivity growth since the mid - 1990s can be discussed in terms of its main immediate sources, i. e. total factor productivity ( tfp ) growth, changes in labour quality and capital deepening. although the decomposition of labour productivity is subject to significant measurement uncertainty, there is robust evidence that slower productivity growth in the euro area since the mid - 1990s reflects both lower growth in tfp and less capital deepening. tfp, sometimes called multi - factor productivity or the solow residual, is often associated with the theoretical concept of technological

a greater stock of high productivity investments. countries that export capital would put their saving to better use. both countries would gain, and the world economy would also gain because scarce saving is better allocated to capital markets around the world. this all may sound a bit academic, but the process has been very important in the world ’ s economic development. countries undergoing development can sometimes squeeze the requisite saving out of their poor economies, as the united kingdom did in the 19th century and japan did in the 20th century. or they can import capital to supplement domestic saving, as the united states, canada, and australia did in the 19th century and several countries in eastern europe and asia have done in the 20th century. this imported capital has been very important in the world ’ s development process, and it has often brought with it other benefits, such as the international spreading of technological improvements. without world capital flows, the general level of development in the world would be far less. problems if that ’ s the story, what ’ s the problem? why do world capital markets seem to be causing such anguish, in country after country? why are countries turning away from open capital markets? it turns out that there is some fine print that goes with the neoclassical model, and the world economy has had some trouble with the fine print. here are some of the ways. • exchange rate volatility. countries trade in different currencies, and exchange rates are necessary to make the conversions. but in addition to being the devices for converting currencies, exchange rates play another important role in the world economy - they also represent the mechanisms for bringing countries price structures in line in international trade. suppose one country ’ s prices are too high for it to compete in world trade, either because it has suffered an adverse trade shock, has had too much inflation, has too rigid labor contracts, or for some other reason. the country can suffer a painful recession to get its prices back in line. or it can let its currency depreciate. depreciations are not absolutely necessary, as is asserted by advocates of fixed exchange rates. but depreciations, or currency fluctuations in general, are often far less costly ways to make international adjustments. the next time you hear someone complain about exchange rate changes, ask them what else they had in mind to restore international equilibrium. while exchange rate changes have this potentially stabilizing effect, they can also be destabilizing. when exchange rates are allowed to flu