Why did Europe experience uneven growth after the financial crisis?

The Global Crisis and its aftermath have been deeply damaging for European output – the 2008-09 recession was the deepest in Europe since WWII, the sovereign crisis drove southern Europe into a second recession in 2012, and the recovery elsewhere has been lacklustre.

To better understand the nature of this weakness, in a new paper (Daly and Munday 2015), we use a simple Solow (1957) growth accounting framework to decompose pre-Crisis (2000-2007) and post-Crisis (2007-2014) European real GDP growth into the following components:

• Population growth;
• Labour productivity (whole-economy output per hour, which we break down further into contributions from capital deepening and total factor productivity); and
• Labour utilisation (hours worked per head of population, which we break down further into changes in the employment rate, the average number of hours worked per worker and the working age ratio).

Our analysis covers the Eurozone as a whole; Germany, France, Italy, and Spain individually; the UK, Sweden, Norway, and Switzerland; and, for comparison, the US. We use data from the OECD and the European Commission’s AMECO database. Our methodology is described in more detail in Daly and Munday (2015).

Eurozone weakness accounted for by a fall in employment and hours worked

We start by comparing the pre- and post-Crisis performance of the Eurozone and the US (Table 1). In the years leading up to the Global Crisis, Eurozone and US per capita GDP growth were comparable (averaging +1.5% per year in both cases).

Exhibit 1. Euro area weakness accounted for by a sharp reversal in hours worked per head of population

*Totals may not sum due to rounding
Sources: Goldman Sachs Global Investment Research, AMECO, OECD

Pre-Crisis real GDP growth in the US was built on relatively strong increases in labour productivity (+1.8% per year), due, in roughly equal parts, to capital deepening and TFP growth. In the Eurozone, labour productivity growth was weaker (+1.1% vs. +1.8% in the US) but there was a significant increase in labour utilisation (hours worked per head of population rose at a rate of 0.4% per year, whereas they fell at a rate of 0.3% per year in the US), albeit from a much lower level of labour utilisation than in the US. The increase in hours worked per head of population in the Eurozone was due entirely to a rise in the employment rate, as both average hours and the working age ratio fell over this period.

In the seven years since the Crisis began (2007-2014), GDP per capita growth in the Eurozone has been much weaker than in the US (averaging -0.4% per year vs. +0.3%). All of the deterioration in Eurozone per capita GDP growth has been due – at least in an accounting sense – to a reversal of the previous strength in labour utilisation (hours worked per head of population fell at a rate of 1.2% per year, having risen by 0.4% per year previously). This weakness in Eurozone labour utilisation has, in turn, been due to developments in the employment rate (-0.4% per year since 2007 vs. +0.8% per year before the crisis) and an accelerated decline in average hours worked (-0.5% per year since 2007 vs. -0.2% per year before the crisis).

In comparison with the sharp decline in labour utilisation, labour productivity in the Eurozone has held up reasonably well since the crisis (+0.7% per year since 2007 vs. +1.1% before the crisis). Based on our estimates, all of this growth has been due to capital deepening (i.e. an increase in capital per hour worked). While this may seem encouraging, much (but not all) of the increase in capital per hour worked has been a direct result of the fall in hours worked per head of population.

Significant cross-country diversity in post-Crisis performance

Decomposing growth in the Eurozone as a whole conceals significant differences across the Eurozone and Europe more broadly. Table 2 provides the same post-crisis (2007-14) breakdown for Germany, the UK, France, Italy, Spain, Sweden, Norway, and Switzerland.

Exhibit 2. The sources of post-crisis growth have been diverse

*Totals may not sum due to rounding
Sources: Goldman Sachs Global Investment Research, AMECO, OECD

Germany stands out for the strength of its post-Crisis performance. Although average headline GDP growth (+0.7% per year) has been slower than in the US (+1.1%), with zero population growth over this period it has had the strongest GDP per capita growth of any of the nine economies that we consider (+0.7% per year vs. the US in second place with +0.3%). At the other end of the spectrum, the performance of Italy (where GDP per capita has fallen at an average annual rate of 1.9% per year) and Spain (-1.3%) has been especially poor. The UK (-0.2%) and France (-0.2%) stand together in the middle of the pack, with France performing relatively well in the immediate aftermath of the Crisis and the UK performing relatively well since 2012.

There has also been a striking cross-country diversity in the performance of factor inputs. For example, in Spain, the weakness of real output has been concentrated in a fall in employment; in the UK, it has been concentrated in a drop in total factor productivity; in Italy, it has been due in roughly equal parts to declines in average hours worked, employment and TFP. This diversity in the performance of factor inputs across Europe argues against a simple supply-side explanation for the weakness of post-Crisis growth.

References

Solow, R (1957), “Technical change and the aggregate production function”, Review of Economics and Statistics 39 (3): 312–320

Daly, K and T Munday (2015), “Accounting for differences in Europe’s post-crisis growth”, Goldman Sachs European Economics Analyst, October 15, 2015.

Publication does not imply endorsement of views by the World Economic Forum.

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Authors: Kevin Daly is the Managing Director and Senior Economist in the Research Division at Goldman Sachs. Tim Munday is an Economic Research Analyst at Goldman Sachs.

Image: A worker adjusts a European flag during a celebration in Brussels’ Jubilee Park to mark the expansion of the European Union. REUTERS/Francois Lenoir.