NBER WORKING PAPER SERIES

THE ROLE OF LABOR MARKET CHANGES IN THE SLOWDOWN OF EUROPEAN

PRODUCTIVITY GROWTH
Ian Dew-Becker
Robert J. Gordon
Working Paper 13840
http://www.nber.org/papers/w13840

NATIONAL BUREAU OF ECONOMIC RESEARCH

1050 Massachusetts Avenue
Cambridge, MA 02138
March 2008

Thanks to Bobby Krenn for superb research assistance, including his authorship of the Data Appendix.
We are grateful to Bart van Ark, Susanto Basu, Nick Bloom, Allan Drazen, Richard Freeman, Greg
Mankiw, Bill Nordhaus, Barbara Petrongolo, and Charles Wyplosz for their perceptive comments
on earlier versions and to Andrea Bassanini, Romain Duval, Magnus Henrekson, and Guido Schwerdt
for providing data. The views expressed herein are those of the author(s) and do not necessarily reflect
the views of the National Bureau of Economic Research.
2008 by Ian Dew-Becker and Robert J. Gordon. All rights reserved. Short sections of text, not to
exceed two paragraphs, may be quoted without explicit permission provided that full credit, including
notice, is given to the source.

The Role of Labor Market Changes in the Slowdown of European Productivity Growth
Ian Dew-Becker and Robert J. Gordon
NBER Working Paper No. 13840
March 2008
JEL No. E0,E23,E24,E60,J20,J21,J23
ABSTRACT
Throughout the postwar era until 1995 labor productivity grew faster in Europe than in the United
States. Since 1995, productivity growth in the EU-15 has slowed while that in the United States has
accelerated. But Europe's productivity growth slowdown was largely offset by faster growth in employment
per capita, leaving little difference in growth of output per capita between the EU and US going back
to 1980. This paper is about the strong negative tradeoff between productivity and employment growth
within Europe. We document this tradeoff in the raw data, in regressions that control for the two-way
causation between productivity and employment growth, and we show that there is a robust negative
correlation between productivity and employment growth across countries and time. Our primary explanatory
variables to explain both the revival of EU employment growth and the slowdown in productivity
growth include six policy and institutional variables. We find that several of these variables have significant
negative effects on employment per capita, both before and after 1995. We also find a significant
time effect, that the increase in European employment per capita increased after 1995 for reasons that
go beyond our six explanatory variables, and we link this time effect to a secular increase in the labor-force
participation of women, particularly in southern European countries. We conclude by suggesting that
evaluations of alternative policy reforms in Europe should take into account any offsetting effects
on employment and productivity by examining the ultimate impact on changes in income per capita.

Ian Dew-Becker
Department of Economics
Harvard University
Cambridge, MA 02138
idew@fas.harvard.edu
Robert J. Gordon
Department of Economics
Northwestern University
Evanston, IL 60208-2600
and NBER, and CEPR
rjg@northwestern.edu

1. INTRODUCTION

Throughoutthepostwarerauntil1995laborproductivitygrewfasterinEurope
thanintheUnitedStates.Butsince1995,productivitygrowthintheEU15hasslowed
whilethatintheUnitedStateshasaccelerated.Whatcausedthisreversal?Inprinciple
onecouldimagineanynumberofcauses,includingaspontaneousaccelerationintotal
factorproductivity(TFP)growthintheU.S.,aspontaneousdecelerationofTFPgrowth
inEurope,achangeinlabormarketpoliciesandinstitutionsinEuropethatmadelabor
bothcheaperandlessproductive,achangeinthelevelofinvestmentinEurope,orany
combinationofthese.

Thestartingpointforthepaperistheobservationthatafter1995,justasEuropes
laborproductivitygrowthsloweddownrelativetotheUS,itsrelativegrowthinhours
workedpercapitasurged.Moreover,thecountrieswithinEuropethathadthelargest
decelerationsinproductivitygrowthalsohadthelargestincreasesinhours.Asaresult,
thegrowthofEuropeanoutputpercapitahasfallenbehindthatoftheUSbyamuch
smallermarginthanitsshortfallinthegrowthoflaborproductivity.Arethe
simultaneousturnaroundsofproductivityandhourspercapitainoppositedirections
independentorrelatedevents,andifrelatedinwhichdirectiondoesthecausationrun
andwhatweretheunderlyingcauses?Isthereatradeoffbetweengrowthinhoursand
productivity,andwhataretheimplicationsforpolicy? 1

WhilewebeginwithcontrastsbetweentheUSandEU15,mostofthispaperis
aboutheterogeneitywithintheEU15.Tofacilitategeneralizationsaboutheterogeneity
withinEurope,wegroupEuropeancountriesintothesamegeographicalsubaggregates
asinBoerietal.(2005),namelytheNordic,AngloSaxon,Continental,and
Mediterraneancountries. 2 Wepayparticularattentiontothecontrastbetweenthe
Mediterraneangroupandtheotherthreegroups,becausetheslowdowninproductivity
growthandrevivalofgrowthinhourspercapitahasbeenparticularlypronouncedin
thetwolargestMediterraneancountries,ItalyandSpain.Theaveragepopulationshares
ofthefourgroupsover19802004were5percentfortheNordicgroup,17percentfor
theAngloSaxongroup,49percentfortheContinentalgroup,and29percentforthe
Mediterraneangroup.

Ourfirstempiricaltaskistodescribethebehavioroftheleadingpolicyand
institutionalvariablesthathavebeenidentifiedasrelevantinthepastliteratureonthe
pre1995declineinEuropeanhourspercapitarelativetotheUS.Ourlistofpolicyand

Thephrasetradeofftodescribetheoffsettingeffectsoflaborsupplyshiftsonproductivityand
employmentmayoriginateinGordon(1997)andwasimplicitinBlanchard(1997).
2
TheonlydifferenceisthatwelabeltheirOtherEuropegroupasContinentalandwegroup
IrelandwiththeUKintheAngloSaxongroupratherthanintheOtherEuropegroupasthey
do.
1

institutionalvariablesincludesfourpolicyvariablesthelabortaxwedge,theaverage
replacementrateofunemploymentinsurance,andindicesofemploymentprotection
legislationandproductmarketregulation.Alsoincludedaretwoinstitutionalvariables
describingoutcomesratherthanpoliciesthemselves,tradeuniondensityandanindex
ofhighcorporatism.

Weexaminechangesinthesepolicy/institutionalvariablesoverthetimeperiod
between1978and2003andfindthattheturnaroundfrommakinglabormoreexpensive
tolessexpensiveoccurredwithadifferenttimepathforeachvariable.Thisdifferencein
thetimepathofthepolicy/institutionalvariablesprovidessomecautiontotheeasy
verdictthateverythingpolicy,institutions,andoutcomesallturnedaround
simultaneouslyafter1995.Weattributethepolicyturnaroundinthepolicy/institutional
variablestotwomajorsetsofimpetustochangetheEUpolicyframework,the1994
OECDJobsStrategyandthe2000LisbonAgenda.

Nextweaskiswhetherthereisanysystematicrelationshipbetweenthese
sourcesoflowerpost1995laborcostsandthesubsequentpost1995upsurgein
Europeanemploymentpercapita.Before1995,Europecouldhavebeendescribedas
makinglabormoreexpensive,drivingitslabormarketnorthwestalongthelabor
demandcurvewithanaccompanyingdeclineinemploymentandincreasein
productivity.Startingatdifferentdatesfordifferentpolicies,Europebegantheprocess
ofshiftingtothesoutheast,towardhigheremploymentpercapitabutloweraverage
productivityperhour.

Standardeconomictheorytreatsthissoutheastmovementasatemporary
phenomenonthatoccursduringashortperiodwhilethelabordemandcurveisheld
fixed.Soondynamicresponsesshouldemergethatbegintorestorethenowreduced
ratioofcapitaltolaborinputtowarditsinitiallevel.However,wefindthatthis
stimulusfromhigheremploymenttocapitalgrowthhasnothappenedyetinmost
Europeancountries;growthincapitalpercapitafellsubstantiallyfrom2000to2004for
mostEuropeancountriesandregions.Thus,whileourpaperquantifiesonlythe
immediatestaticresponseoflaborsupplyshiftsonlaborproductivity,wefindthatthere
hasbeenthusfarnodynamicmediumtermturnaroundeitherinthegrowthratesof
productivityorincapitalpercapita.

Ourresultsneedtobehighlyqualified.Policyandinstitutionalvariablesdonot
explainallorevenmostofthepost1995upsurgeinEuropeanemploymentpercapita.
Muchofthepost1995employmentincreasehasoccurredforfemales,notmales,andwe
interpretthisnotasaresultofspecificpolicyinterventionsbutratherasashiftinculture
andsocialnormstowardagreateracceptanceoffemalesinthelaborforce,especiallyin
SouthernEurope.

WedistillalargeEuropeanliteratureontheadverseeffectsofpoliciesand
institutionsindampeningEuropeanemploymentpercapitaandraisinglabor
productivitybefore1995andinreversingthisprocessafterafter1995. 3 Wedevelop
regressionmodelsbuildingonthebestrecentresearchtoidentifywhichpoliciesand
institutionschangedandhowmuchoftheemploymentturnaroundcanbeexplainedby
thesemodels.Thesizeofourdataset23yearsofdatafor14countriesgivesus
substantialpowerforidentifyingtherelevanteffects.Ourpaperisalsouniquein
developingpost1995simulationsthatquantifytheeffectofthepolicyandinstitutional
variablesonbothemploymentpercapitaandproductivitygrowth. 4

Thepaperthenproceedstotherelationshipbetweenemploymentand
productivity.Wedevelopanexpliciteconometricmodelthatattemptstoexplain
changesinlaborproductivitygrowthasafunctionoftheturnaroundinemployment
percapita.Thismodelusesstandardstatisticalprocedurestoeliminatethefeedback
fromproductivitygrowthtoemploymentgrowthandallowsustomeasurethefeedback
frompolicychangesinexplainingslowerproductivitygrowthafter1995.

Ourresultsdonotexplainthemajorityofthepost1995productivityturnaround
inEurope.Rather,ourfocusisonidentifyingaspreciselyaspossiblethemagnitudeof
theeffectsofpolicyonemploymentandproductivitygrowth.Wefindthatthereisa
strongandrobustnegativecorrelationbetweenthegrowthoflaborproductivityand
employmentpercapitaacrosstheEU15.Last,westudythecompleteeffectsofpolicy
changesoutputpercapita.

OurstoryofdecliningEuropeanproductivitygrowthemergeswithmultiple
dimensions,includingtheimpetusfromchangesinpoliciesandinstitutions,andfrom
otherpossibleindependentcausesofemploymentgrowth,particularlytheincreasing
roleoffemaleemploymentintheMediterraneancountriesduetoacombinationof
changesinsocialnorms,theinnovationoftemporaryemploymentcontracts,andthe
roleofimmigration.

TwoimportantbooksontheEuropeanreformagendaareBailyandKirkegaard(2004)and
AlesinaandGiavazzi(2006).Backgroundonthe1994OECDjobsstrategyisgiveninOECD
(2006,p.24)andontheLisbonagendainPissarides(2005,pp.910).
3

Evensomeofthemostrecentpapersinthisliterature,e.g.,Ohanian,Raffo,and
Rogerson(2007),carryoutanalysesthatfocusonpre1995relationshipswithoutany
attempttotesttheirpre1995hypothesesonpost1995data.

2. DATA ON THE TWIN TURNAROUNDS

2.1 The Opposite Movements of Growth in Labor Productivity and
Hours per Capita

Thestoryofthejointpost1995turnaroundinproductivityandhourspercapita
isbesttoldinFigure1.Figure1plotsourthreecorevariables,laborproductivityor
outputperhour(Y/H),versushourspercapita(H/N),andtheirproduct(outputper
capita,orY/N),inaformthatsmoothstheannualyeartoyearwigglesofthedatainto
longruntrends. 5 Weexpresshoursandoutputonapercapitabasis,whichpartly
levelstheplayingfieldduetothe0.7percentperannumslowerrateofpopulation
growthintheEUthanintheUS. 6

TheupperframeofFigure1exhibitsthegrowthtrendsofEUandUSoutputper
hoursince1970inthetotaleconomy(notthemorefrequentlycitedprivatebusiness
sector).TheEUgrowthtrenduniformlyfallsfromabout5to1percentperyear,witha
briefhiatusinthedeclinebetween1988and1996.TheUSgrowthtrenddeclinedinthe
1970stoatroughin1981,thenexhibitedamodestrecoveryintheearly1980sanda
muchmoresignificantrevivalafter1996.ThedifferencebetweentheEUandUSgrowth
trendschangedfrom+2.2percentagepointsin1970to0.6percentagepointsin2006.

ThebottomframeofFigure1expressesgrowthinbothoutputandhoursper
capita.ThegraphshowsthattheUStrendgrowthinhourspercapitawaspositivein
mostyearsuntil2000,butnegativefrom2000to2005.Incontrast,trendgrowthin
Europeshourspercapitawasstronglynegativefrom1970to1995,withabrief
interruptionin198689.Thisnegativetrendreverseditselfoverthepastdecade,
recordingapositivetrendgrowthrateofhourspercapitaineachyearafter1995.

WhenY/HismultipliedbyH/N,thedivergenttrendgrowthratesof
productivityandhourspercapitaimplyasurprisinglysmallEUUSdifferenceinthe
growthrateofoutputpercapita(Y/N).WhileEuropedidshowfastergrowthinthe
early1970s,sincethentherehasbeenatiegame,withaveragetrendgrowthratesover
19752006of1.92percentperyearfortheEUand1.97percentfortheUS.Theproblem
isthatEuropehasfailedtocatchuptotheUSlevelofoutputpercapitasince1975,with
theEUUSratioofoutputpercapitaroughlyfixedataround70percentoftheUSlevel.
ThetrendsarecreatedbyaHodrickPrescottfilterappliedtoannualdatawithasmoothing
parameterof12.5.TheUStrendsarebasedontakingtheannualaverageoftrendsfittedto
quarterlydatathrough2007Q2,inordertohighlightthe200406downturninUSproductivity
growth.
6ThedifferencebetweenEU15andUSpopulationgrowthdiffersbyconceptanddatasource.
WithGGDCdataEU15growthintotalpopulationgrew0.7percentslowerthanintheUSover
19702006.WithOECDdatathedifferencefortotalpopulationwas0.54percentandfor
populationaged15andoverwas0.53percent.
5


Growthofhourspercapitaisequalbydefinitiontothegrowthofhoursper
employee(H/E)plusthegrowthofemployeespercapita(E/N).Wechooseinthispaper
tofocusouranalysisontheEuropeanturnaroundinE/N.AsshowninFigure2,the
post1995turnaroundinE/NismuchmoredramaticthaninH/N.Fortherestofthis
paper,wewillusethemetricofE/NtosummarizetheEuropeanpost1995turnaround.

Figure1raisesanimportantquestionrelevanttotheinterpretationofthispaper.
Weareintriguedbythejointturnaroundinoppositedirectionsafter1995betweenthe
USandEU15inthegrowthratesofemploymentpercapitaandinlaborproductivity.
Butclearlythisturnaroundtradeoffstoryisnotadequatetocharacterizetheentirepost
1970periodplottedinFigure1,whereinthetopframethegrowthoflaborproductivity
slowedmuchmorebetween1970and1980andwithnoapparentcorollaryofrapid
growthinhoursoremploymentpercapita.Weviewthestoryofdecliningproductivity
growthinthe1970sinboththeUSandEU15asoutsideofthescopeofthispaper.The
focusandregressionanalysisofthispaperconcentratesontheturnaroundinthe
behaviorofbothproductivityandemploymentgrowthbetweentheperiods198095as
contrastedtotheperiod1995until2003. 7

2.2 The Turnaround by Country and EU Country Group

Table1summarizesthe197095and19952006growthratesofY/H,H/N,andY/N
fortheUS,theEU15,eachEUcountry,ourfourEUcountrygroups,andfortheEU15
excludingtheMediterraneancountries.Wefocushereprimarilyontheturnarounds,
thatis,thedifferencebetweenthe19952006and197095growthratesforeachofthe
threevariables.TheEUUSturnarounddifferenceis2.20percentagepointsforY/H,
+1.99pointsforH/N,andamere0.19pointsforY/N.Thesenumbersarenotlisted
explicitlyinTable1;theyarecalculatedbytakingtheEUlineandsubtractingtheUS
lineinthecolumnlabeleddifference.

TheroleoftheMediterraneancountriesisshownbyaseparateEU15xMed
aggregatethatexcludesthethreeMediterraneancountries.ThenegativeY/H
turnaroundwhentheEUxMedcountriesarecomparedwiththerowfortheUSbecomes
smallerfrom2.20pointsto1.65,theH/Nturnaroundbecomessmallerfrom+1.99to
+1.50points,andtheY/Nturnaroundbecomessmallerfrom0.19to0.15points.Thus,
whiletheMediterraneancountriescontributedisproportionatelytothepost1995
turnaroundsinY/HandH/N,stillasubstantialturnaroundinbothproductivityand
employmentgrowthremainsintherestoftheEU15.Thenegativecorrelationbetween
growthinH/NandY/HremainsintactwhentheMediterraneancountriesareexcluded,
andthisisanimportantfactthatisreplicatedinoursubsequenteconometricanalysis.

WearegratefultoourdiscussantAllanDrazenforpointingoutthatthedataforthe1970sand
1980sdoesnotexhibitanytradeoff.

AnimportantdevelopmentinEuropesince1995hasbeenanincreasein
heterogeneityacrosscountries.ThebottomlineinTable1showsthattherehasbeenan
increaseinthestandarddeviationacrossEUcountriesofallthreevariables,witha
doublinginthestandarddeviationforH/NandY/N.Withonlyafewexceptions,pre
1995growthinY/Nwasintherangeoftwotothreepercent,butafter1995therange
wasfromalowof1.18percentforItalytoahighof6.17percentforIreland.

2.3 Labor and Capital Ratios and Total Factor Productivity

WenowbringtogetherdataoncountriesincludingtheUS,theEU,andthefour
EUcountrygroups,andcomparetheturnaroundinY/HandE/Nwithother
componentsofgrowthaccounting,namelythegrowthofhoursperemployee(H/E),in
capitalinputperhour(K/H),capitaldeepening(theincomeshareofcapitaltimes
growthinK/H),andgrowthintotalfactorproductivity(TFP).ThenumbersontheY/H
andE/Npost1995turnaroundsareslightlydifferentinFigure3andTable2,which
appliesto19802004,thaninTable1thatcoversthelongerperiod19702006.This
differenceindatesisduetodataavailabilityregardingcapitalandTFP.

Figure3examinesdataonthetrendgrowthrateincapitalperhour(K/H)andin
totalfactorproductivity(TFP).ThetimepathofEUgrowthinK/Hroughlyparallels
thatofY/H,withrespective19802004decelerationsbetween5and2percentannual
growthforK/Hversusbetween3and1percentannualgrowthforY/H.Asshownin
thebottomframeofFigure3,thegrowthrateofTFPslowedsteadilyintheEUfrom
1983to2004whilethatintheUSacceleratedinstages.ThedifferenceinTFPgrowth
betweentheEUandUSmaybeexaggeratedbydatadiscrepancies. 8

WefindseveralinterestingfactsinthebottomsectionofTable2.FortheUSthe
turnaroundsofY/HandTFPwereidenticalandtherewasnoturnaroundinthecapital
deepeningeffect.Thisoccurredastheresultofslowdownsinthegrowthofcapitalper
capitaandhourspercapitabythesameamount,0.49percent.IntheEUasawhole,the
capitalgrowthturnaroundwasaboutthesameastheoutputgrowthturnaround,as
shownbythesmallpositiveturnaroundintheK/Yratioatthebottomofthetable.This
impliesthatthenegativeturnaroundinK/Hgrowthwasalmostaslargeasthepositive
turnaroundinH/Ngrowth.Asaresultofthisturnaroundinthecapitaldeepening
effect,theturnaroundofTFPgrowthwas0.80percentagepoints,slightlylessthanthe
0.93turnaroundofY/Hgrowth.

Thefourcountrygroupsdisplayinterestingdifferences.Towhatextentwas

StandardgrowthaccountingdatafortheUSfromUSsourcesobtainedfromKevinStiroh
suggestsmuchslowerK/HgrowthandmuchfasterTFPgrowthinthe1980sthanimpliedbythe
EUKLEMSdatadisplayedinFigure3.

growthincapitalstimulatedbygrowthinemployment?Aneasywaytoobtainthis
informationfromTable2istocomparetheturnaroundincapitalpercapitagrowthwith
thatinemploymentpercapitagrowth.TheNordicgrouphadamodestnegative
turnaroundinY/HgrowthandhardlyanynegativeturnaroundinTFPgrowth.This
differencebydefinitionisduetothefactthatthenegativeturnaroundincapital
deepeningwasnearlytwiceaslargeastheTFPturnaroundandthusaccountsformost
ofthenegativeY/Hturnaround.ThenegativeturnaroundintheK/Hratiowasentirely
duetotheincreaseinH/N,astheK/Nturnaroundwasclosetozero.Thusourmain
impressionisthattheNordiccountrieshadadisappointingperformanceofinvestment
despitealargeturnaroundinemploymentandarelativelystrongproductivity
performance.

TheAngloSaxongroupismainlydrivenbytheUK.Thisgrouphadthesmallest
Y/HturnaroundofthefourEuropeangroupsbyanarrowmargin,andthesecond
smallestTFPturnaround.TheslowdowninK/Hwasmuchsmallerthantheincreasein
hours,duetoasubstantialincreaseinthegrowthrateofK/N.TheAngloSaxongroup
thushasthebestperformanceoverall,withamodestslowdowninlaborproductivity
andgrowthincapitalpercapitathatwasalmosthalftheturnaroundinemploymentper
capita.

Notsurprisingly,withits49percentpopulationshareintheEU15,the
performanceoftheContinentalgroupwassimilartotheEUasawhole.Thedeclinein
bothY/HandTFPgrowthwassimilartotheEU,whilethesluggishrevivalofgrowthin
E/Nwaspartlycompensatedforbyanatypicalturnaroundtowardpositivegrowthin
H/E.Theslowdowninthecapitaldeepeningeffectwasdampenedbothbyamodest
increaseingrowthofK/Nandasmallincreaseintheincomeshareofcapital.The
modestpositiveturnaroundincapitalpercapitagrowthwasroughlyonethirdofthe
sizeoftheturnaroundinemploymentpercapitagrowth.

Aswehavealreadyseen,theMediterraneangrouphadthemostnoteworthy
turnaroundsforY/H,E/N,K/H,capitaldeepening,andTFP.Theslowdownin
Mediterraneancapitaldeepeningwasrelativelymodest,becausethesharpnegative
turnaroundinK/Hgrowthwaspartiallyoffsetbyasizeableincreaseintheincomeshare
ofcapital(from28to34percent).WenotethatthenegativeturnaroundinK/Hgrowth
wasentirelyduetofastergrowthinE/N,andthattheturnaroundincapitalpercapita
growthwaslessthanonetenthoftheturnaroundinemploymentpercapita.Thusa
surprisingfindingisthattheMediterraneancountriessharedwiththeNordiccountries
adisappointingperformanceofcapitalgrowth,whileboththeAngloSaxonand
Continentalgroupsdisplayapositiveresponseofcapitalpercapitatomorerapid
growthinemploymentpercapita.

ThetimeseriesdynamicsofcapitalinvestmentintheindividualEUcountry
groupsisbeyondthescopeofthispaper.Wemerelynoteafactinthedata,thatthe

growthrateofcapitalinvestmentwasrelativelyweakintheNordicandMediterranean
countries.Thisinturnhelpstoexplainwhytheemploymentproductivitytradeoff,
whichwouldbeassumedtobetemporary,seemstohavepersistedatleastthrough
2003.SomethingheldbackinvestmentinEuropethatwouldotherwisebeexpectedto
respondtotheupsurgeofemploymentgrowth.

3. DEMOGRAPHIC VARIATION IN THE TURNAROUND OF EMPLOYMENT

PER CAPITA
InthissectionwelookmorecloselyattheturnaroundinthegrowthofEuropean
employmentpercapita.Weprovideananalysisofthedemographiccomponentsofthe
post1995increaseinEUemploymentgrowthbydecomposingemploymentintotwelve
agesexgroups.Didthepost1995turnaroundconsistofincreasesacrosstheboardin
eachagesexgrouporbecausethecompositionofemploymentshiftedtowardagesex
groupswhichalreadyhadrelativelyhighemploymentperperson?Wecananswer
thesequestionswithasimpleshiftshareanalysisof198595and19952005E/Ngrowth
ratesfortheEUandourfourEUcountrygroups.FollowingStiroh(2002),wecalculate
employmentandshareeffectsas,

employment _ effect = 0.5(enti enti n )( sti + s ti n )

share _ effect = 0.5(enti + enti n )( sti s ti n ),

(1)

whereeniistheemploymenttopopulationratioforgroupi,siisthepopulationshareof
groupi,andiindexesagesexgroups.Bydefinition,theemploymentandshareeffects
sumtothetotalchangeinemploymentbetweentimeperiodstnandtforagiven
country.Theemploymenteffectgivesthecontributionofthechangeinagroups
employmenttothetotalchangeinemployment.Theshareeffectcalculatestheeffectof
anincreaseinthegroupspopulationshare.Sincethesumofthesharechangesmustbe
zero,theshareeffectswillaccountformovementsamonggroupswithrelativelyhigh
andlowE/Nratios,e.g.,movementstolowparticipationgroupsliketeenagersorthe
elderlyfromprimeageadults,orviceversa.

Figure4plotsemploymentandshareeffectsforourfourcountrygroups.
Employmenteffectsareshowninblackandshareeffectsareshowningrey.Thetop
twopanelsdisplayresultsfortheNordicandAngloSaxoncountrygroups.Theblack
baremploymenteffectsaregenerallysmall,althoughtherewasasubstantialincreasein
maleandfemaleemploymentinbothgroupsinthe5564agegroup.AllAngloSaxon
femalegroupsfromages64downto25hadsubstantialemploymenteffects.

TheNordicandAngloSaxongroupsalsoshareanotablezigzagintheshare
effects,withpositiveshareeffectsforbothmenandwomeninthe5564agegroupsand

negativeshareeffectsinthe2534agegroups.Thisislikelytheresultoftheagingofthe
population.Itisalsotheresultofpost1995reformswhichreducedincentivesto
withdrawanddiscouragedtheearlyretirementofthoseinthe5564agegroups
(OECD,2006,p.133).Itturnsoutthattheshareeffectsallcancelout,andtheirsumis
only0.01.Intuitively,thisisbecausethegroupsacrosswhichthepopulationhasbeen
shiftingallhavesimilaremploymentrates. 9

ThebottomleftquadrantofFigure4showsthatemploymenteffectsinthe
ContinentalcountrieswerelessimportantthanintheNordicandAngloSaxon
countries.Butthereweresubstantialshareeffects,particularlyforthe2534agegroup.

Thebottomrightpaneloffigure4plotsdatafortheMediterraneancountries.
Again,thereisthesameeffectofagingontheshareeffects,buttheemploymenteffects
aresubstantiallylarger.91percentofthe6.6percentagepointincreaseinthe
employmentrateintheMediterraneancountriesisexplainedbyemploymenteffects,
andtheremainderbyshareeffects.Sincewomenstartedtheperiodwithmuchlower
employmentthanmen,wewouldexpectmostoftheincreasetobeconcentratedamong
women.Asitturnsout,70percentofthetotalMediterraneanemploymentincreasecan
beexplainedbyemploymenteffectsforwomen.Moreover,thisincreaseisnotjust
concentratedamongtheyoung;itisspreadacrossallagegroupsexcept65+,andis
focusedontheprimeworkingyears.

Thepatternoffemaleemploymentexplainingemploymentchangesextends
acrossthreeofourfourcountrygroups.InadditiontotheMediterraneancountries,
femaleemploymenteffectsexplain68and59percentofthetotalemploymentincreases
intheNordicandAngloSaxoncountries,respectively.IntheContinentalcountries,
femaleemploymentcontributeda1.3percentincreaseinaggregateemployment,but
shareeffectsandmaleemploymentcanceledoutessentiallyallofthat.Intheend,
Figure4summarizestwoimportantfindingsofthispaper.First,weconfirmtheresult
thattheEuropeanworkforceisaging,butaginghasnotyetsubstantiallyreduced
employmentinpartbecauseincentivesforearlyretirementhavebeenreduced.

ThesecondresultisthatthemajorityofemploymentchangesinEurope
following1995canbeexplainedbyincreasesinprimeagefemaleemployment.The
shiftshareanalysishelpsusnarrowdownwhichvariablesarelikelytobethemost
important,andthesearethevariablesaffectingwomenintheirprimeworkingyears. 10

Thereisnoreasonthatshareeffectshavetosumtonearzero.Forexample,ifacountrys
employmentratesbyagestayedconstantbutthecountrysuddenlywentfrombeingcomposed
mainlyofprimeageworkerstomainlyretirees,theassociateddeclineinemploymentwouldbe
entirelyexplainedbyshareeffects.
10Forinstance,bothAllardandLindert(2006)andBassaniniandDuval(2006)studytheeffectsof
retirementbenefits.Ourshiftshareanalysisshowsthatchangesinemploymentratesofthose
9

Thedistinctlydifferentbehaviorofthefemalefromthemaleemploymentratiosin
Figure4leadsusnowtodevelopregressionequationsexplainingE/Nthatdistinguish
betweenmenandwomen.

4. THE BEHAVIOR OF THE POLICY AND INSTITUTIONAL

VARIABLES

Thebasicquestionaddressedinthispaperiswhetherchangesinpolicyand
institutionalvariablesinEurope,includingculturalattitudesregardingfemalelabor
forceparticipation,contributedtothepost1995upsurgeinEuropeanemployment
growth.Inthissectionwefirstexaminethetimeseriesbehaviorofthepolicyand
institutionalvariablesandthenexaminethebackgroundofthesechanges.

4.1 Changes in the Policy and Institutional Variables

Figure5showsthetimeseriesbehaviorforthesixpolicy/institutionalvariables
forourfourcountrygroups.Thefirstoftheseisthetaxwedge,definedasthetotal
percentagerateofpersonalincomeandpayrolltaxation.Thisvariableexhibitsasharp
turnaroundatexactly1995forallthegroupsexceptthecontinentalcountries.The
largestdeclinewasintheAngloSaxoncountries,wheretaxesfellfrom26percentof
incomein1995toonly17percentby2002.ThedeclinesinMediterraneanandNordic
taxrateswere3and6percentagepoints,respectively.

TheOECDindexofemploymentprotectionlegislation(EPL)alsoexhibitsa
sharpturnaroundatthesametime;itwasrelativelyflatuntiltheearly1990sandthen
exhibitedasubstantialdeclineintheNordicandMediterraneancountries.Theindexof
productmarketregulation(PMR)declinedthroughalmosttheentireperiod,thoughthe
declinebeganatvaryingtimesinthedifferentcountrygroups.Uniondensityshows
similarbehaviorbydecliningsteadilyovertheentireperiodplottedinFigure4except
fortheMediterraneancountries.

Unemploymentbenefitsasmeasuredbytheaveragereplacementrate(ARR)
displaystheoppositetrendasdotheothervariables.Ifanything,ARRroseduringour
sample.Overallthebehaviorofthesepolicy/institutionalvariablesdoesnotsupporta
simplestorythatthesevariablesturnedaroundintandemafter1995andprovidethe
mainexplanationoftheemploymentandproductivityturnaroundsillustratedin
Figures1and2above.Themostpromisingvariablesforthisinterpretationarethetax
wedge,EPL,andtoalesserextentPMR.

aroundretirementagewerenotlargeenoughtoexplainsubstantialamountsofvariationin
aggregateemployment.

10

ItisimportanttonotethatthecountrygroupaveragesdisplayedinFigure5
representanexpositionaldevicethathasnobearingonoursubsequentregression
analysis.Ourregressionsattemptingtoexplainthebehaviorofgrowthinemployment
percapitaandinlaborproductivityarebasedondatafor14individualcountriesfor
eachyear,notthefourcountrygroups.

4.2 Background of the Changes

Whydidpoliciesmoveinthe1970sand1980sinthedirectionthatreduced
employmentpercapita?Thereisaconsensusviewthatthisoccurredbecausepolicies
adoptedtofightunemploymenthadadverseeffectsonemploymentpercapita(see
Nickelletal.2005).Todealwiththeindividualhardshipcausedbyhigher
unemployment,governmentsincreasedthegenerosityanddurationofunemployment
benefits.Tolimittheincreaseinunemploymentitself,theyattemptedtoregulatelayoffs
throughemploymentprotectionlegislation(EPL).Tospreadtheavailablejobsacross
thepopulation,theyresortedtolegislationfavoringearlyretirementandshorterhours
ofwork,socalledworksharing(Alesina,Glaeser,andSacerdote,2006).

AsshowninFigure5,thepolicyandinstitutionalvariablesturnedaroundat
differenttimesindifferentcountries,withtheclearestpost1995turnaroundinthetax
wedgeinthreeofthefourEUcountrygroups.Acatalystforthepost1995turnaround
wasthe1994OECDJobsStrategy.ThislandmarkagendahadamajorinfluenceonEU
policymakerstoshifttheirfocusfromalleviatingtheimpactofhighunemploymentto
reforminglabormarketswiththeaimofraisingemploymentpercapita.Fiveoftheten
keyrecommendationsofthe1994OECDJobsStrategyinvolvedturningaroundseveral
ofthekeypolicyvariablesthatenterintoouranalysisofthegrowthratesof
employmentpercapitaandproductivity.TheseincludedreformingEPL,PMR,and
ARR(seeOECD,2006,p.24).

TheLisbonAgendaof2000reinforcedthechangeinemphasistowardraisingthe
ratioofemploymentpercapita,especiallyforfemales,byreducingtheunemployment
rateandparticularlybyraisingthelaborforceparticipationrate.Quantitativetargets
weresetfortheemploymentpopulationratioofwomenin2005and2010(Pissarideset
al.2005).

Severalpolicieswerechangedthatarenotincludedinourregressionanalysis.
Unemploymentbenefitswerereformednotonlybyreducingtheunemployment
benefitsratio(ARR),butalsobyreducingthedurationofbenefits.Anotherchangethat
isdifficulttoquantifyisthestrictnesswithwhicheligibilityforunemploymentbenefits
wasadministered,socalledgatekeepingmechanisms(OECD,2006,p.62,75).

Overall,itwouldappearthattheturnaroundinthepolicyandinstitutional
variableswasaverygradualprocess,reactingatfirsttohighunemploymentby

11

adoptingmeasuresthatmadelabormoreexpensive,butthenrecognizingaftersomelag
thebenefitsofmakinglaborcheaper.Giventhelonglagsevidentinthisprocess,and
theverydifferenttimingoftheturnaroundinthepolicyandinstitutionalvariables,we
arenotconcernedthatthesevariablesaresystematicallyendogenoustothetimeseries
behaviorofemploymentpercapitaoroflaborproductivity.

5. THE RESPONSE OF EMPLOYMENT PER CAPITA TO POLICY

AND INSTITUTIONAL CHANGES
ThepointofdepartureforourstudyoftheEUemploymentturnaroundisa
substantialliteraturethatdebatesthesourcesofthepostwardeclineintheratioofEUto
UShourspercapita48percent(inlogs)from1960to1995.Thereiswidespread
agreementthatEuropemadelabormoreexpensive,atleastbefore1995,butlessonthe
ultimatecauses.Thereismuchlessworkonunderstandinghowmuchofthepost1995
turnaroundinH/Ncanbelinkedtoareversaloftheunderlyingpolicyandinstitutional
variables.

5.1 The Previous Literature on Changes in Hours per Capita and

Employment per Capita
Prescott(1994)isthebestknownadvocateoftheviewthatthesharpdeclinein
Europeanhourspercapitaisentirelyduetohighlabortaxes.Prescottestablisheshis
resultwiththeoryandcalibrationmethods,andapaperthatinterpretshisresultsby
Alesina,Glaeser,andSacerdote(2006)calculatesthatPrescottselasticityofhoursper
capitatoachangeinthetaxwedgeis0.92.TheAlesinaetal.paperarguesthat,because
maleshaveasmalllaborelasticity,thetaxelasticitymaybeonlyashighas0.40to0.45.

Severalpapers,includingDavisandHenrekson(2004),attempttoreplacethe
assumedtaxelasticityofPrescottwithelasticitiesestimatedfromthedata.Theyfinda
taxelasticityof0.22,buttheirresultsarequalifiedbyusingdataonlyforfouryears
between1977and1995.ApapercloselyrelatedtooursisAllardandLindert(2006).
Theiraimistosortthroughalloftheexogenouspolicyvariablesthatmighthave
reducedEuropeanhoursandemployment,but,surprisingly,theydonotnoticethe
post1995turnaroundinhoursorinemploymentpercapita.IntheendtheAllard
Lindertanalysisisunidimensional.TheypluckcandidatestoexplainlowerEuropean
hoursgrowthorproductivitygrowth,withnorecognitionthattheremaybeanegative
tradeoffbetweenthem.Theyalsofailtorecognizethattheremaybeatwoway
causationbetweenproductivityandemploymentchanges. 11

11

AmongotherprevioussourcesestimatingregressionstoexplainchangesinEuropeanlabor
inputareBeaudryandCollard(2001),BlanchardandWolfers(2000),andPissaridesetal.(2005).
LjungqvistandSargent(2006)havejoinedthedebatewithPrescottbyemphasizingthe

12

5.2 Regression Equations Explaining Employment per Capita

ThemostrecentandconvincingpaperinthisliteratureisfromBassaniniand
DuvaloftheOECD(2006),hereafterBD,whoexplainmovementsintheunemployment
rateandpercapitaemploymentinavarietyofeconometricspecifications.We
incorporatetheirdatadevelopedattheOECDbutprovideadifferentsetofregression
equationsthatareusedbothtoobtaincoefficientsontheeffectsofalternativepolicyand
institutionalvariables.UnlikeBDandpreviousauthors,weusetheestimated
coefficientstoestimatecounterfactualsimulations.Didthepost1995upsurgein
employmentpercapitarespondtochangesinoursetofvariables,orwastherean
unexplainedcomponent?

SinceweareaskingdifferentquestionsthanBD,weuseasomewhatdifferent
specificationthantheirs.WhereasBDstudiedthedeterminantsofchangesin
employmentpercapitain20OECDcountries,includingtheUS,Canada,andJapan,our
sampleconsistsoftheEU15minusLuxembourg.Wealsoweightourregressionsby
populationinordertoprovidethemostappropriateresultsfordiscussingtheEU,in
contrasttotheirunweightedregressionsthatgivethesameimportancetoLuxembourg
andtheUnitedStates.ThelargercountriesbetterrepresenttheEUasawholeand
shouldbetreatedassuchintheregressions. 12 Furthermore,intheinterestofobtaining
resultsthatapplyattheaggregatelevel,werunregressionsusingthetotalemployment
rate,notjustbrokendownbyageandgender.

Last,weruntheregressionsingrowthrates,ratherthanlevels,becausewehave
foundthattheresidualsinthelevelsregressionsseemtofollowarandomwalk. 13 Our
basicmodelpositsthatthelevelofemploymentisdrivenbythelevelsofthepolicy
variablesandtheoutputgap.Wethentakethefirstdifferenceoftheentireequationso
thattheactualregressionisofthegrowthrateoftheemploymentrate(E/N)onthe
growthratesofthepolicyvariablesandthechangeintheoutputgap. 14

Inadditiontotheimportantchangefromlevelstologarithmicgrowthrates,
thereareseveralothertechnicaldetailsinourregressionsthatdifferfromBDandmake
disincentiveroleofthewelfarestatethatispaidforbythetaxwedge.Acomprehensivelistof
suchstudiesispresentedinOECD(2006,p.93),butthislistappliesonlytostudiesinwhichthe
dependentvariableistheunemploymentrate,notE/N.
12
Tables4and5belowdisplayresultscomparingidenticalspecificationswithandwithout
populationweights.
13ThisfactlikelyexplainsBassaniniandDuvalsfindingofR2sequalto1.0.
14Thefinalregressionsareactuallyrunwithtwoyearchangesofthepolicyvariablesexpressed
asanannualrate.Thisallowstheireffectstohaveuptoaoneyearlag.Thecoefficientsreported
allcorrespondtothelongrunrelationshipbetweenthelevelsofthevariablesandthelevelofthe
employmentrate.

13

themmoreappropriateforthequestionsthatweaskinthispaper.Ourbaselineresults
differfromthoseofBDbyincludingmalesandfemalesfromages1564ratherthan
their2554,byeliminatingsplits(pre,post1992)incountryeffectsforGermany,Finland,
andSweden,andbyfurtherfillinginsomemissingdataintheirdatasetsothatour
resultscover19792003ratherthantheir19822003. 15

5.3 Employment Regressions Based on OECD Employment Data

Table3presentsourregressionresultsfortotalemploymentpercapitaforboth
sexesandthenseparatelyformenandwomen.Thedatabeginin1979andsothe
variables,expressedintheformofratesofchange,beginin1980andextendthrough
2003.TheobservationsareacrossallyearsandalltheEU15countriesexcluding
Luxembourg.Thuswehavemorethan300observations.Ourdeviceofsummarizing
thefourEUcountrygroupsinpart2ofthispaperhasnoimpactontheregression
analysis.Theobservationsthatweexaminehereareforindividualcountries,yearby
year,andthecountryaggregatesarenotincludedinanyway.

Theexplanatoryvariablesarearrangedingroups.Thefirstfourrows,
correspondingtothefirstfourframesofFigure5,exhibitthefourpolicyvariables,that
is,thetaxwedge(TW),employmentprotectionlegislation(EPL),productmarket
regulation(PMR),andtheaveragereplacementrateofunemploymentinsurance(ARR).
Thenexttwoexplanatoryvariablesarebetterdescribedasinstitutionalratherthan
policy,namelyuniondensityandadummyvariableforhighcorporatism.Thefirst
sixrowsofexplanatoryvariableswouldbeexpectedtohavenegativecoefficients,as
theyrepresentfactorsthatmakelabormoreexpensiveandthustoreduceE/N.Thenext
explanatoryvariableisthechangeintheoutputgap,ameasureoftheinfluenceon
employmentofthebusinesscycle.Finally,wealsoincludeadummyvariableequalto
1.0after1995and0.0before1995,todetectchangesinthetrendthatarenotexplained
bythepolicyandinstitutionalvariables. 16

ThemostimportantfindingfromTable3isthatallofthepolicy/institutional
variableslistedonthefirstsixlineshavesignificanteffectswiththeexpectednegative
signwiththeexceptionoftheEPLandPMRregulatoryvariables.Thechangeinthe
outputgaphastheexpectedpositivecoefficientatahighlevelofsignificance,andthe
post1995timedummyhasasignificantpositivecoefficientrepresentingaseparate
causeoffastergrowthrateofE/NinEuropeformen,women,andthecombinedboth

Detailsareinthedataappendix.
Tocallattentionagaintoimportantdifferencesbetweenourresearchandthatinoneofthe
morerecentlypublishedpaperonthistopic(Ohanian,Raffo,andRogerson,2007),weincludeall
policy/institutionalvariablestogetherwhereastheyintroducethemonlyasonebyone
alternativesratherthantogether,theydonotincludeanyvariableliketheoutputgaptocontrol
forthebusinesscycle,andtheydonotconsiderthepossibleissueofatimeshifteffectafter1995.

15
16

14

sexresultsthatgoesbeyondtheexplanationavailablefromthequantitativepolicy
variables.

Thenegativecoefficientsforthechangeinthetaxwedgearehighlysignificant.
Ourbaselinecoefficientforbothsexesof0.28islowerthanthatfavoredbyAlesinaetal.
(2006)intherangeof0.40to0.45buthigherthanthe0.22coefficientobtainedby
DavisHenreksononthebasisofamuchsmallerdatasetthanours.Fortheresults
dividedbysex,ourtaxwedgecoefficientformenof0.21isnottoofarbelowtheBD
coefficientof0.30,andourfemaletaxwedgecoefficientof0.37nottoofarbelowtheB
Dcoefficientof0.50.Giventhedifferentsamples,timeperiods,andourshiftfrom
levelstoratesofchange,differencesofthismagnitudearetobeexpected.The
importantpointtorecognizeisthatchangesinthetaxwedgearehighlysignificant
determinantsofchangesinemploymentpercapita.

Howmuchofthechangeafter1995dotheseemploymentregressionsactually
explain?Thisisperhapsthefirstpapertoaskthatquestion.Wehaveasetof
explanatoryvariablesandregressioncoefficientsfortheentire19802003period.Figure
6takestheregressionresultsfromTable3andconvertsthosechangesinthedependent
andexplanatoryvariablesintolevels.

Wecanusethese19802003regressioncoefficientstodecomposethepost1995
behaviorofemploymentpercapitabasedonthreeassumptionswhichcorrespondtothe
threelinesinFigure6,inwhichthetopframereportsresultsformalesandthebottom
framereportstheresultsforfemales.Thepredictedlineplotsthepredictionofthe
econometricequationsassumingtheactualvaluesofthepolicy/institutionalvariables
andtheactualvaluesofthetimedummycoefficients.TheFixedPolicylinesetsthe
sixpolicy/institutionalvariablesattheir1995valuesandcalculateshowmuchdifference
wouldhavebeenmadetoemploymentifthosesixvariableshadmaintainedtheiractual
post1995valuesratherthantheirfixedcounterfactual1995value.Thentheno
dummylinecalculatesanalternativeresultswhicheliminatetheeffectofthetime
dummyontheresults.

TheregressionsarerunwiththegrowthrateofE/Nasthedependentvariable.It
isquitepossibleforthisgrowthratetobenegative,asitwasformenasshowninthetop
frameofFigure6.ThegraphsinthetopandbottomframesofFigure6convertthese
growthratesintolevels.Forbothmalesandfemales,thegrowthrateofemployment
wouldhavebeenmuchlowerwithoutthehelpofthetimedummies.

5.4 Interpretation of the Time Effects

ThissectionprovidesaninterpretationofthetimeeffectsestimatedinTable3.
WhymightthegrowthrateofE/Nhaveturnedaroundafter1995forreasonsnotrelated
tooursixpolicyandinstitutionalvariables?The1994OECDJobsStrategyandthe2000

15

LisbonAgenda(discussedaboveinsection4.2)focustheirreformeffortsonaprimary
goalofboostingtheratioofemploymentpermemberoftheworkingpopulation(E/N),
particularlyforwomen.In1978thefemaleE/Nratiorangedbetween54percentin
Swedenand25percentinSpain,withanEU15averageof35percent.By2003thisratio
hadremainedthesameforSwedenat54percentbuthadrisenforSpainto36percent
andfortheEU15to43percent.ThequantitativegoalsoftheLisbonreformswerevery
ambitious,toraisetheEUaverageto57percentby2005and60percentby2010
(Pissaridesetal.2005,pp.910).WeobserveinFigures4and6asubstantialincreasein
employmentpercapitaforwomen,particularlyintheMediterraneancountries.What
causedtheongoingconvergenceinemploymentpercapitaforwomencomparedto
men,andforMediterraneanwomeninparticular?

OurbasicregressionresultsinthethirdcolumnofTable3implythattherewasa
substantialshiftovertimecapturedinthelargelypositivecountryfixedeffectsfor
femalesplustheaddedimpactofthepost1995timeeffect.ForSpanishfemales,there
wasacountryspecificpositivegrowthrateoffemaleemploymentpercapitaof1.62
percentbetween1980and1995period,risingby0.66percentto2.28percent
subsequently.Weneedtodeterminethecausesofthissubstantialshiftintheactual
employmentrateofSpanishwomenfrom25percentin1978to36percentin2003,atotal
increaseof44percent,oranannualloggrowthrateof1.46percent.

Basicexplanationsforthemovementofwomenintothelaborforcebeginwith
theliteratureontheUnitedStateswherefemaleparticipationsurgedbetween1965and
1985(assummarizedinPissaridesetal.2005,pp.2628).Theinventionanddiffusionof
consumerdurablesfreedupthetimeofwomenpreviouslydevotedtohousehold
drudgery,andthearrivalofcontraceptivesprovidedachanceforwomentogaincontrol
overthetimingofpregnanciesandworkeffort.ThiseffecthasbeenchristenedbyGalor
andWeil(1995)asfemalebiasedtechnologicalchange.

Persistenceandsocialnormsareoftendiscussedinthisliterature.Once
mothersenteredthelaborforce,itbecamemoreacceptablefordaughtersandtheir
sisterstoenter.Authorssuggestthattherewassimultaneouslyanewacceptanceof
marketemploymentbypotentialfemaleemployees,andachangebyemployersintheir
willingnesstoacceptthatnewemployeeswouldbefemales.

Previousresearch(includingBertolaetal.2002andDavisandHenrekson2004)
notestherelativelysmallsizeoftheretailandservicesectorsinEuropecomparedtothe
UnitedStates,andthisformerlydeprivedwomenofopportunitiesforflexibleandpart
timeemploymentinthesesectors.Reductionofproductmarketregulationsmayhave
playedsomeroleinallowingwomentoenterthelaborforce,butthatcannotexplainthe
positivepost1995dummiesinourregressionssincePMRisincludedasaregressor.

16


AnimportantrecentinnovationinEuropeanlabormarketsistemporaryjob
contracts.Theseallowemployeestobehiredwithoutthepreviousoverhangof
regulationsagainstfiring.Thesenewtypesofcontractsmayexplaintheroleofthe
positivetimedummyvariablesintheregressionsofTable3,buttheyarepartofthe
definitionoftheEPLvariableandindeedthereductionofregulationspreventing
temporaryemploymentcontractsisthesinglebiggestfactorthatcausedtheOECDs
EPLindextodeclineafter1995((OECD,2006,p.95).Thegrowthoftemporarycontracts
wasveryimportantincontributingtothegrowthofE/NinSpain(ParamioandZoffo,
2005).

Inaddition,increasedimmigrationtocountrieslikeSpain(asexaminedbyHeinz
andWardWarmedinger2005)maybeanexogenouseventhelpingtoexplainwhythe
timedummyinTable4ispositive.Bentolilaetal.(2007)documentthatthepercentage
offoreignbornintheSpanishpopulationincreasedfromamereonepercentin1991to
11percentin2006.Thesepotentialnewmembersofthelaborforcemayhavebeen
pulledintoSpainbyemploymentopportunitiesandcouldhavecontributedtothepost
1995increaseinthegrowthrateofemploymentinSpain.
5.5 Employment Regressions Based on GGDC Employment Data

Wenowturntotheprimaryobjectiveofthispaper,whichistorelatethepost
1995mutualpositiveturnaroundinthegrowthratesofemploymentpercapita(E/N)
andthenegativeturnaroundininthegrowthrateoflaborproductivity(Y/H).Because
theprimarydatarelevanttoourstudyofproductivitycomesfromtheGroningenCenter
(GGDC)ratherthantheOECDuponwhichwehavepreviouslyreliedforthe
decompositionofE/Nbysex,wenowpresentregressionsexplainingchangesin
employmentidenticaltothoseofTable3butnowusingadifferentdatasourceforthe
dependentvariable(theloggrowthrateofemploymentpercapita).Allthedataonthe
explanatoryvariablesareidenticalthroughoutthepaper.

Theseregressionswillbeusedasafirststagefortheproductivityregressions
thatarethecenterpieceofouranalysis.Ourgoalistofindgoodinstrumentsfor
employment,i.e.variablesthatexplainemploymentaswellaspossiblebutthathaveno
independenteffectonproductivity.

Table4reportsresultsfromtheemploymentregressions.Duetolackofdata,
thesereferonlytobothsexescombined,incontrasttotheresultsinTable3forthetwo
sexesseparately.AsinTable3,theobservationsareacrossallyearsfrom1979to2003
andEU15countries,withexceptionsnotedinthedataappendix.Column1reports
resultsforasimpleregressionwithcountryfixedeffects.Thecoefficientsonthetax
wedge,PMR,ARR,uniondensity,andtheoutputgapareallsignificantandhavethe
correctsigns,i.e.higherlevelsoftaxesandregulationlowertheemploymentrate.We
findnoeffectsfromEPL.Thisresultholdsthroughallofourspecifications.Theoutput

17

gaphasbyfarthemostexplanatorypowerforemployment,withatstatisticofnearly
11.Nextmostpowerfularethetaxwedgeanduniondensity.Thesetwovariableswill
beourmostpowerfulinstrumentsintheproductivityregressions.

Column2ofTable4addsadummyequalto1following1995and0otherwiseto
accountforapossibleexogenousshiftinthegrowthoftheemploymentrate.The
coefficientonthisdummyishighlysignificantandindicatesthataverageemployment
growthacrossEuroperosebynearlyafullpercentagepointfollowing1995(the
accompanyingboxdiscussespossiblereasonsforthisshiftinemploymentgrowthafter
1995).Theothercoefficientsremainlargelyunchanged.Theonlynotabledifferences
arethatthecoefficientsonARRanduniondensityrisesomewhat.

Columns3and4presenttwoimportantrobustnesstestsforthemodel. 17 In
column3wedropthepopulationweights.Theresultsarenearlyidenticaltocolumn2.
Allofthechangesinthecoefficientsarelessthanonestandarderror.EPLbecomes
marginallysignificant,butthisresultisuniquetocolumn3.Incolumn4weadd
dummiesforeachyearsothatthemodelisfullysaturated,i.e.thereisadummyfor
eachcountryandeachyear.Ourresultsremainessentiallyunchanged.Thecoefficient
onthetaxwedgedeclinessomewhat,toonly0.15,andthecoefficientoncorporatism
declinesto1.59,beingsignificantatonlythe10%level.Weviewtheinclusionofthe
yearbyyeartimedummiesasarobustnesscheck,notapartofourbasicresults,andit
isencouragingthatthisrobustnesscheckmakesverylittledifferencetoourbasicresults.

Column2isourpreferredspecificationandwillbeusedasthefirststagefor
instrumentalvariablesregressionsexplainingtheannualgrowthrateoflabor
productivityinsection6.Wehaveanumberofcandidateinstruments:uniondensity,
ARR,highcorporatism,thetaxwedge,andthepost1995dummy.Theprimetestfor
whethertheseinstrumentsarevalidiswhethertheyhaveanindependenteffecton
productivity,whichwewillexaminebelow.Wewillalsofurtherdiscusstheintuition
behindouridentification.Thepost1995dummyinparticularissomewhatquestionable
andwillnotbeusedinourprimaryregressions.

Intheappendixweincludeatableofextrarobustnesstests.WhenSpainortheMediterranean
countriesareexcluded,wefindthatthecoefficientonthepost1995dummyfallsfrom0.9to0.7.
WhentheUSisincludedwithitsownpost1995dummy,thecoefficientonthatvariableis0.38,
indicatinganunexplaineddeclineinUSemploymentgrowth,primarilyduetoasubstantial
declineintheUSlaborforceparticipationrateofyouththathasbeenwidelynotedand
discussed.

17

18

6. THE IMPACT OF POLICY AND EMPLOYMENT ON

PRODUCTIVITY

Wenowcombinealltheaspectsofgrowthinemploymentpercapitaandin
outputperhourintheEuropeaneconomysincethelate1970sinordertoestimatethe
effectofemploymentgrowthonproductivitygrowth.Asbefore,wefocusonthe
turnaroundafter1995.

Beforepresentingtheempiricalresults,itisworthstoppingtounderstandwhy
theremightbeacausalrelationshipbetweenproductivityandemployment.Standard
modelsofproductionpositthatlaborproductivityisanincreasingfunctionofthe
quantityofcapitalsuppliedperworker. 18 Ifthecapitalstockisfixedintheshortrun,
thatis,ifanyresponseofinvestmenttochangesinlabormarketconditionstakestime,
measuredasseveralyears.Whenemploymentrises,thecapitaltolaborratiofalls,
drivinglaborproductivitydown.

Ifinvestmentrespondsquicklyandpositivelytochangesinemployment,then
thetradeoffbetweenemploymentandproductivitywillbequantitativelysmall.
Alternatively,ifcapitalrespondsslowlyornotatall,thenthetradeoffwillbelonglived.
Ingeneral,theorytellsustoexpectaresponseofinvestment,butthisisunlikelytooccur
withsufficientspeedtoobscuretheshortrunproductivityemploymenttradeoff.

Ifemploymentincreasesbutthenewworkersareonaveragelessskilledthan
thosewhowerealreadyworking,thenwewillalsofindanegativerelationshipbetween
employmentandproductivity.Theremainderofsection6isdevotedtoquantifyingthis
tradeoff.Ifitexists,ithasimportantimplicationsforpolicychoices.
6.1 Reduced Form Regressions

Weattemptinthissubsectiontounitetwoseparatebutrelatedstrandsof
literature.ThefirstistheworkdiscussedinSection5.1and5.2thatanalyzesthe
determinantsofemployment.Thesecondliteratureistheonethatexaminesthe
relationshipbetweenproductivityandemployment.Layard,NickellandJackman
(2005)intheirfirsttwochaptersprovidemicroeconomicfoundationsfortheclassiclabor
supplyanddemandframework.Subsequentresearchersusedvariousmethodsto
quantifytheshortrunemploymentproductivitytradeoff; 19 theywereessentially

WecanconsideraconstantreturnstoscaleproductionfunctionF(K,L).Constantreturns
impliesthatwecanwriteFinitssocalledintensiveformF(K,L)=LF(K/L,1)=Lf(K/L).We
thencanwritelaborproductivityasY/L=f(K/L),wherefisanincreasingandconcavefunction.
19BourlesandCette,2005,arethestateoftheartinthisliterature,butseealsoBeaudryand
Collard,2002;Beaudry,Collard,andGreen,2005;andMcGuckinandvanArk,2005,among
others.
18

19

tracingthelabordemandcurve.Inthisandthefollowingsections,wemergethesetwo
strandsofresearch,attemptingfullytoquantifytheeffectsofpolicychoiceson
productivityandemployment,andtobegintoidentifythemechanismsthroughwhich
thesechoicesact.Asindicatedbeforeintheintroduction,ouranalysisisstaticand
shortrun.Itdoesnottracethroughthefulldynamicresponseofproductivityto
employment,becausewecannotfindthatsofarEuropehasbeguntoexperiencethe
dynamicresponsepredictedbytheory.

Thestructuralmodelintheprevioussectionprovidedtworeasonswhyan
increaseinemploymentcancreateashortrunnegativerelationshipbetween
employmentandproductivitythatis,adownwardslopingshortrunlabordemand
curve.Whenemploymentrises,thecapitaltolaborrationecessarilyfallssince
investmentcannotrespondinstantaneously.Secondly,whenemploymentrisesthenew
workerstendtobelessskilledandlessexperienced.Followinganincreasein
employment,ittakestimeforthecapitalstocktogrowenoughsothatthecapitalto
laborratioreturnstoitsinitiallevelandforaverageexperiencetorise.

Followingtheworkofpastauthors,webeginwithasimpleregressionof
productivitygrowthongrowthinemploymentpercapita,theresultsofwhichare
reportedinTable5. 20 Asinsection5,themodelunderlyingthisregressionisonein
whichthelevelofproductivityisaffectedbythelevelsofemploymentandthepolicy
variables.Wetakefirstdifferencesbeforerunningtheregression.

Ofthepolicyvariables,EPLandARRbothhavesignificanteffectson
productivityaftercontrollingforemployment,whichrulesthemoutasvalid
instruments.Bothoftheircoefficientsarepositive,aresultthatisrobustacrossallofour
specifications.Thisresultissurprisingbecauseweusuallythinkofgovernment
regulationasinterferingwiththemarketandloweringproductivity.Theresultthat
unemploymentinsurancecouldraiseproductivityisnotoriginaltothispaper,however.
AcemogluandShimer(1999,2000)developamodelofemploymentwithmatchingin
whichhigherunemploymentbenefitsgivefirmsincentivestocreatebettermatchesand
hencehigherproductivity.Similarly,EPL,bymakingemployeremployeerelationships
lastlonger,couldincreasejobspecifichumancapital. 21

Pastauthors,mostnotablyMcGuckinandvanArk(2005),havetestedwhether
thereisalongruneffectofemploymentonproductivity.Thatis,theyregressmulti
yearaveragesofproductivitygrowthonthesameaveragesofemploymentgrowth.An
alternativetothismethodistoregressproductivityonboththecurrentandlagged
valuesofemploymentgrowth.Ifthelongrunimpactofemploymentonthelevelof
productivityiszero,thentheinitialnegativecoefficientsofemploymentshouldbe
Asintheemploymentregressionsabove,thesampleistheEU15excludingLuxembourgfor
19802003andobservationsareweightedbypopulationexceptasnotedotherwise.
21BarbaraPetrongoloinitiallypointedthisouttous.
20

20

followedbyoffsettingpositivecoefficientsonthelagsofemploymentgrowth.Whenwe
addlaggedvaluesofemploymenttotheproductivityregressions,theresultsareentirely
unchanged.Inotherwords,wefindthattheshortruneffectofemploymentseemstobe
permanent.22 ThisresultisconsistentwithourfindinginFigure3andTable2above
thatgrowthincapitalslowedinEuropewhilegrowthofemploymentwasincreasing.

Wesuggestthreespeculativeexplanationsforaminimalresponseofinvestment
toemploymentgrowth.First,newinexperiencedentrantstothelaborforcecouldbe
employedinretail,trade,andserviceestablishmentsthatwerepreviouslyunderutilized.
IfPMRpreviouslyrequiredthatshopsclosedineveningsandonSundays,andPMR
wasloosenedtoallowlongerhours,thensomeofthenewemployeesmighthavebeen
employedwiththesamecapitalstockthatexistedbefore.Wethinkthisisanimportant
reasonwhycapitalinvestmentdidnotrespondtotheincreaseofemployment,
especiallyinthetradeandservicesectors.

Thesecondexplanationreliesonthefactthatmarginalworkerstendtobethe
leastskilledandhavetheleastincome.Workerswithlowincomeslikelyhaverelatively
highmarginalpropensitiestoconsumeoutofincome.Inthiscase,theincomethatgoes
tothenewentrantstothelaborforcemaynotdriveupsavingorinvestment.

Athirdmorespeculativeexplanationforthefailureofinvestmenttorespondto
higherEUE/NconcernsthecrossborderaspectofcapitalinvestmentwithinEurope.If
theSpanishE/Nincreasesbecauseofaninflowofpreviouslyathomefemalesandof
immigrantsfromMorocco,doesthattriggeraninflowofinvestmenttoSpainfromother
countries?Itispossiblethatthisprovidesanincentivetodomesticandforeign
investmentfirmstoinvestmoreintheSpanishretailandservicesectors,butthis
responsetimemaybeverylong,atleastlongerthanthetimehorizonofthispaper.

6.2 Identifying Causation by Using Instrumental Variables

Uptothispointtheseregressionsdonotidentifycausationfromemployment
growthtoproductivitygrowth,becausetheoppositedirectionofcausationcouldcreate
thesamenegativeproductivityemploymentcorrelation.Thatis,theregressionwould
notbeidentifyingtheslopeoftheshortrunlabordemandcurve. 23 Forexample,a

WealsoranregressionssimilartothoseofvanArkandMcGuckinwithmovingaveragesof
employmentgrowth,andourresultsremainedunchanged.
23Theoreticalwork,e.g.AcemogluandShimer(1999,2000)andLagos(2006),usingmatching
modelshasshownthattheremaybemorecomplexinteractionsthanthesimplesupplydemand
frameworkcandescribe.IntheAcemogluShimermodel,unemploymentbenefitsimpact
workersdecisionswhetherornottoacceptjoboffers.Becauseworkersarelessmotivatedto
acceptajobofferwhenbenefitsrise,firmsessentiallychooseadifferentproductionfunctionthat
hashigheroutputperhourworked.Policyonlydirectlyaffectsemploymentrates.Becauselabor
22

21

classictechnologyshock,suchastheinternetrevolution,couldraiseworkerefficiency
andproductivityandleadtoadeclineinthedemandforworkers. 24 Itwouldchange
bothproductivityandemploymentgrowth,andthereforeconventionalOLSestimates
wouldbeinconsistent.

Ontheotherhand,theclassicalRealBusinessCycle(RBC)technologyshockthat
causesaneconomicexpansion,simultaneouslyraisingemploymentandproductivity,
wouldgointheoppositedirectionasourresultsandhencedoesnotpresentan
identificationproblem.Paststudiesoftheemploymentproductivitytradeoffhaveused
variousinstrumentalvariablesmethods,buttheyhavenotincludedasrichamodelof
employmentdynamicsaswehavedevelopedpreviouslyinthispaper.Wetherefore
takeadvantageofthepowerofthismodeltopredictemployment.

Column2ofTable5reportsresultsfromatwostageleastsquares(2SLS)
regressionusingthetaxwedgeastheinstrument.Thekeyidentifyingassumptionsare
thatthetaxwedgehasnodirectimpactonproductivityandthattheeffectoftaxeson
productivityismediatedbyemployment.Sincetaxessimplyaffectthelaborsupply
decision,weseenoreasonwhytheyshoulddirectlyaffectlaborproductivity.
Moreover,sincethetaxwedgeonlydriveslaborsupplydecisions,presumablyany
effectsonproductivitymustbedrivenbyemployment.

Table4showsthatthetaxwedgeisagoodpredictorofemploymentchanges,
andtable5showsthatishasnoeffectonproductivityaftercontrollingfor
employment. 25 Wefindahighlysignificantnegativecoefficientonemploymentgrowth
butnowsomewhatsmaller,0.65incolumn2ascomparedto0.84incolumn1.The
standarderror,however,issubstantiallylarger,at0.20.Ourestimatedemployment
productivitytradeoffisnearlyidenticaltothatestimatedbyBourlesandCette(2005),
eventhoughtheyalsousedaslightlydifferentsampleintermsofcountriesandyears
includedandasubstantiallydifferentsetofinstruments.

Itisworthaskingwhetherthetaxwedgemightbesomehowcausedby
productivity,andifso,whattheresultswouldbe.Therearetwoopposingwaysthat
taxesmightbedrivenbyproductivity.First,governmentsmightraisetaxeswhenthe
budgetisindeficit,andlowerthemwhenthereisasurplus.Inthatcase,wewould
expecttoseetaxesfallwhenlaborproductivityishigh,andviceversa.Thiswould
induceanegativecorrelationbetweentaxesandproductivity.Sinceemploymentis
negativelyrelatedtotaxrates,thiswouldimplyapositiverelationshipbetween
supplyfalls,productivityrises.Thisisaninterestingalternativemechanismfortheproductivity
employmenttradeoffthatwedonotfurtherexplorehere.
24See,e.g.Basu,FernaldandKimball(2006).
25Our2SLSregressionsalsopasstheSargantestforinstrumentvalidity.Wecanneverthenull
hypothesisthatourinstrumentsarevalidevenatthe20percentlevel.Theregressionsusing
alternativesetsofexogenousinstrumentsalsopassthistest.

22

employmentandproductivity.Ataxpolicyrespondingtofiscalbalanceswouldrun
againstourresultsandhencedoesnotpresentanidentificationproblem.

Inorderfortaxestobeaninvalidinstrument,theywouldneedtobepositively
correlatedwithproductivity.SupposegovernmentsfollowaKeynesianpolicywhereby
theyraisetaxratesduringbooms,whenproductivityishigh,andlowertaxesduring
recessionswhenproductivityislow.Inthatcase,taxeswouldbepositivelycorrelated
withproductivity.Sinceemploymentisnegativelycorrelatedwiththetaxwedge,this
wouldmeanthatweshouldfindaspuriousnegativecorrelationbetweenproductivity
andemployment.

Itisnotpossibleinourmodelstatisticallytodifferentiatebetweenthesetwo
storiesabouttaxes.Wethereforepresentasetofalternativeidentificationstrategiesin
theappendix.Wedropthetaxwedgeanduseonlythehighcorporatismdummyand
uniondensityasinstrumentsandfindresultsnearlyidenticaltothoseobtainedusing
thetaxwedge.Theappendixalsoexploresusingalternativelagstructures,dropping
theoutputgapfromtherighthandsideoftheregression,andchangingthesampleof
countries.Insomespecifications,thecoefficientonemploymentisnolongerstatistically
significant,butitisneverlessnegativethan0.24,andthepointestimateisalmost
alwaysmorenegativethan0.40.

Movingbacktoourmainresults,thesizeofthecoefficientwefindon
employmentissurprisinglylarge.Acoefficientof0.64onemploymentgrowthislarger
thanasimpleCobbDouglasproductionfunctionwouldpredict.Thatmodelwouldtell
usthatweshouldexpectthecoefficientonemploymenttobeequaltothecapitalshare
ofincomeintheeconomy.Wefindavalueof0.64thatisroughlytwicethetypicalone
thirdshareofcapital.Thisisevidenceinsupportofthepropositionthatwhen
employmentrises,thenewworkerstendtohavelowerhumancapital,whichcouldbe
embodiedineducation,acquiredskills,orsimplyexperience.

Column3addsthepost1995dummyasaninstrument.Identificationwiththe
dummyvariablecomesfromregressingtheaverageunexplainedproductivitychange
after1995ontheaverageunexplainedemploymentchange.Inotherwords,weare
takingtheentireemploymentresidualasbeingexogenous.Amotivationforthis
methodwouldbethatmostofthechangefollowing1995wasdrivenbysocialfactors
encouragingfemaleemploymentsuchasthosediscussedaboveinsection5.4,orby
policyvariablesnotincludedintheregressions,ratherthanreversecausationfrom
productivitytoemployment.Themainadvantageofmakingthisassumptionisthatwe
cutthestandarderrorontheemploymentcoefficientinhalf,from0.20to0.10.Thepoint
estimaterisessomewhatto0.74.Thismodel,asallofourothers,passesthe(admittedly
weak)Sargantestforinstrumentvalidity.Moreover,itisnotablethatinnoneofthe
regressionsintable5ortheappendixdowefindasignificantcoefficientonthepost

23

1995dummyinthesecondstage.Thatsaid,intheinterestofconservatism,the
remainderoftheresultsareidenticaltothoseincolumn2.

Incolumns4to6,wetakeeveryvariablethatwassignificantintheemployment
regressionsbutnottheproductivityregressionsandusethemasinstruments.Theset
includesthetaxwedge,uniondensity,andhighcorporatism.Thisinstrumentsetgives
usidentificationaspowerfulasincolumn4,butwithouttheconcernsaboutreverse
causation.Inthiscase,thecoefficientonemploymentisstill0.65,withastandarderror
of0.11.

Last,columns5and6addtworobustnesstestsasintable4.Incolumn5,we
dropthepopulationweights.ThiscausesthecoefficientonPMRtobecome
substantiallylarger,andmarginallysignificant,andthecoefficientonEPLtoshrink
somewhat.Thecoefficientonemploymentgrowth,however,remainsunchanged.In
column6,weaddyeardummies.Thiscouldbemotivatedbythepossibilitythatthere
arecommontechnologyshocksthataffectlaborproductivityineverycountryinagiven
year.Inthiscase,wefindasomewhatlargerstandarderrorontheemployment
coefficient.ThecoefficientonEPLalsodeclinessomewhat,from1.77to1.19.Lookingat
table5asawhole,whatwearefindingisthatthenegativerelationshipbetween
employmentandproductivityisrobusttoavarietyofdifferentidentificationschemes
andpanelmodels.Weneverfindacoefficientlessnegativethan0.60.Thepositive
effectsofEPLandPMRarealsorobustacrossallthespecifications.

OurresultsaresomewhatintensionwiththosefoundbyNikolettiandScarpetta
(2003)andAllardandLindert(2006).NikolettiandScarpettafindanegative
relationshipbetweenPMRandTFPattheindustrylevel.AllardandLindert,inmacro
regressionssimilartoours,reportthreespecificresults.TheyfindthatEPLandPMR
bothhavenegativeimpactsonproductivity,andtaxwedgeshavenoneteffect.Our
regressionsfindnearzerocoefficientsonallfivevariablesexceptforPMRandEPL,
whichhavepositivecoefficients.Thefactthatweincludeabroadsetofcontrolsinour
regressionshelpstoexplainourdifferentresults.Moreover,sinceweonlyuseshortlags
ofthepolicyvariables,itispossiblethatAllardandLindertaretakingaccountofmuch
longertermbehavior(i.e.overthespanofdecades)thaninourresults.

6.3 Post-1995 Simulations

Table6reportsturnaroundsinproductivityandemploymentgrowthforthefour
countrygroups.Recallthatalltheseresultsarebasedonregressionsforthe14EU
countries,andthecountrygroupaveragesemergeforexpositionalpurposesonlyafter
theregressionsarerun.Foreachgroup,wereportpreandpost1995growthratesfor
theactualdata,predictedvaluesfromtheregressions,andacounterfactualsimulation
inwhichthepolicyvariablesarefixedattheir1995levels.

24

Itiseasiesttounderstandthemeaningofthissimulationbytakinganexample.
LetusbeginwiththedataforlaborproductivityintheMediterraneancountries.For
19801995,theregressionpredictsannualLPgrowthof2.12percent.Hadpolicybeen
fixedatits1995levelfortheentireperiodthough,productivitygrowthwouldhavebeen
asomewhatslower1.82percent.Soduringthatspan,policyeffectsraisedproductivity
growthby0.30percentperyear.Inthepost1995sample,however,withfixedpolicy,
productivitywouldhavebeen0.28percenthigher.Thechangefollowing1995inthe
policyeffectcolumnisthentheeffectonproductivityofthechangeinpolicy.Forthe
Mediterraneancountries,thiscomesouttobe0.58percent.Thisisnearlyhalfthe
predicteddeclineinproductivitygrowth.

InallthecountrygroupsexcepttheAngloSaxons,weestimatethatpolicyand
institutionalchangesafter1995loweredproductivitygrowth.Aswejustsaw,forthe
Mediterraneancountries,weestimatethatpolicychoicesloweredproductivitygrowth
by0.58percentperyear.FortheContinentalcountries,theeffectwas0.15percent,
whileintheNordiccountries,theeffectwas0.47percent.FortheAngloSaxon
countries,weestimatethatpolicychangesactuallyraisedproductivitygrowthby0.13
percent.Thisisbecausepre1995,theyweretheonlycountrygroupwithpoliciesthat
substantiallyloweredproductivitygrowth.

Lookingattheresultsofthesimulationsforemployment,wefindbyfarthe
largesteffectintheNordicandMediterraneancountriespolicychoicesraisedgrowth
intheemploymentrateby0.46percentperyearineachgroup.IntheContinentaland
AngloSaxoncountries,policyactuallyloweredemploymentgrowthby0.04and0.07
percent,respectively.Thisisconsistentwiththeresultthatpolicyalsohadrelatively
smalleffectsonproductivityinthesegroups.

Thebottomthreerowsoftable6reporttheresultsforthefullEU15.For
productivity,ofthetotalnegativeturnaroundof0.89percent,thepolicyvariablesdrive
0.29percent,about1/3.Foremployment,ofthe1.31percentagepointincreasein
growth,only0.26percentagepoints,or1/5ofthetotal,isexplainedbythepolicy
variables.

Ingeneral,theemploymentregressionsdonotexplainmuchofthepost1995
changeinemploymentthepost1995dummyisforcedtoexplainthemajorityofthe
change.Theaverageaccelerationinemploymentgrowthacrossthefourgroupsis1.33
percent.Sincethepost1995dummyisestimatedtobeapproximately0.9,thereisnot
muchleftforthepolicyvariablestoexplain. 26

Thechangesintheoutputgapcanalsoexplainsomeofthehigherrateofemploymentgrowth
following1995.

26

25

Figure7plotspredictionsfortheEU15thatareanalogoustotable6.Thetop
panelshowsthepredictedleveloflaborproductivity,withalineartrendtakenoutto
makeiteasiertounderstand.Thelineartrendistheaveragegrowthratepriorto1995,
sothatthedeclineinthelinesfollowing1995showshowmuchproductivityfellbelow
whereitwouldhavebeenifhadgrownatitspre1995rate.Thelevelsofproductivity
areallsetto100in1994.Thepost1995turnaroundisimmediatelyapparentinthe
declineintheproductivitylinesdisplayedfollowing1995.Forthecounterfactual
simulation,policyhadroughlynoeffectpriorto1995,butsubsequently,itloweredthe
levelofproductivityaccountingfora2.5percentdeclineinthelevelby2003about
1/3ofthetotal.

Thethirdlineinfigure7showswhathappensiftheeffectsofthepost1995
dummyonemploymentareturnedoff.Thatis,westillallowthedummytoaffect
productivitydirectly,butwesimulateemploymentfollowingitspre1995growthrate.
Inorderforthisexercisetocarryanymeaning,wemustassumethatproductivity
changesdidnotdrivethepost1995accelerationinemployment;i.e.,thiswouldbevalid
iftheemploymentaccelerationweredrivenbysocialfactors.Wethenfindthatthere
wouldhavebeennodeclineatallinthelevelofproductivity.Infact,productivity
wouldhaverisenaboveitspre1995trend.

Thisisakeyfinding.IftheemploymentshiftinEuropewasexogenous,it
explains100percentofthedeclineinEuropeanproductivitygrowthsince1995.This
resultisthesameasthefindingthatthepost1995dummyintheproductivity
regressionsisnotstatisticallysignificantaftercontrollingforemploymentandpolicy,
thereisnosignificantchangeinEuropeanproductivitygrowthfollowing1995. 27
However,wecanexplainonly1/3ofthetotaldeclineinproductivityusingthepolicy
andinstitutionalvariables.

Thequestionthenbecomeswhethertheunexplainedshiftinemploymentwas
drivenbychangesinproductivityorwhetheritwasexogenous.Thefactthatthepost
1995dummyisinsignificantintheproductivityregressions,alongwiththefactthatthe
regressionsusingthepost1995dummypasstheSargantestforinstrumentvalidity,is
evidenceinfavorofthepropositionthatemploymentwasnotdrivenbyproductivity.
Furthermore,insection5.4above,wediscusssocialfactors,separatefromproductivity,
thatcouldhavedriventheunexplainedriseinemployment.Intheend,wehaveno
statisticalevidencethattheriseinemploymentgrowthwasdrivenbyproductivity,and
webelievethattherearesocialfactorsorthogonaltoproductivitythatexplainrecent
employmentbehavior.Sothereisasolidcasetobemadethatinfact,wecanexplain
100%ofthedeclineinEuropeanproductivity,asacombinationoflabormarket
liberalizationandsocialchanges.
Whenemploymentisdroppedfromtheregression,thepost1995dummyissignificantwitha
coefficientof0.70.AsimilarregressionfortheUSgivesamirrorimagepositivecoefficientof
0.70.

27

26


ThebottompanelofFigure7showsemploymentresults.Inthiscasenotrendis
takenout.Theeffectsofpolicyonemploymentareestimatedtobesmallerthanfor
productivity.Theemploymentrateispredictedtohaverisenby10percentfollowing
1994,butonly2.3percent,or1/5,isdrivenbythepolicyvariables.Thecounterfactual
simulationdoesnotbegintodivergenoticeablyuntil1998.Byconstruction,
employmentgrowthisflatwhenwedropthepost1995dummy.So4/5oftherisein
employmentfollowing1995isdrivenbythisunexplainedresidual.
6.4 The Combined Effects of Policy and Institutions on Productivity
Growth in Europe

Inordertogetabetterviewoftheeffectsofthepolicyvariablesonemployment
andproductivity,weneedtocombinetheeffectsthatactthroughbothstagesofour
2SLSestimation.Inparticular,thepolicyvariablesallhaveeffectsonemployment,
whichwillaffectproductivity,andsomealsohaveindependenteffectsonproductivity
growth.Table7reportsresultsfromthisexercise.Foreachvariable,wecalculatethe
effectofaunitstandarddeviationshock,wherethestandarddeviationsaremeasureson
post2000data(exceptforthehighcorporatismdummy,forwhichwesimplylookat
whathappenswhenitisturnedon).

Column1reportsthesizeoftheshocks.Column2displaystheeffecton
employmentandcolumn3theeffectonproductivity.Incolumn4,wecalculatean
implicitimpactonoutputpercapitawhereweassumethatthevariableshavenoeffect
onhoursworkedperemployee.StandarderrorscalculatedusingtheDeltamethodare
reportedinparentheses.Ofthesixvariablesstudied,threehavepositiveneteffectson
outputpercapitaandthreehavenegativeeffects.However,thestandarderrorson
theseestimatesarefairlylargeonlythreeofthecoefficientsforoutputpercapitaare
morethantwostandarderrorsawayfromzero.

ThethreevariableswithapositiveneteffectonoutputpercapitaarePMR,ARR
andEPL.Thisresultiscausedbythefactthattheyallhaveindependentpositiveeffects
onproductivitythathelpovercomethenegativeeffectonoutputfromlower
employment.Eveninthecaseofnoindependenteffects,theestimatedelasticityof
outputwithrespecttoemploymentisonly0.31,soitdoesnottakeabigeffectto
overcomethis.TheeffectofPMRonproductivityhasaverylargestandarderror,sowe
donotputmuchweightonit.ForEPLandARR,ontheotherhand,theeffectson
productivityarehighlysignificant.ThepositiveeffectonoutputpercapitaofEPLhasa
coefficientmorethantwostandarderrorsawayfromzero,andthepositiveeffectofthe
ARRonoutputpercapitaisclosetotwiceitsstandarderror.

Forthetaxwedge,weestimatethatanincreaseof9percentagepoints(wherethe
averagelevelis30.8percent)lowerstheemploymentrateby2.67percent,butonly

27

lowersoutputby0.83percent.Thisisarelativelysmallcosttoapolicythatchooses
higherratherthanlowertaxes.Moreover,thestandarderroronthisestimateissmall
only0.4percent.

Thelastofthethreevariablesthathasastatisticallysignificanteffectonoutput
percapitaisuniondensity.ThestandarddeviationofuniondensityacrossEuropeis
23.32percentagepoints.Anincreaseofthismagnitudeinuniondensityispredictedto
lowertheemploymentrateby7.93percent.Itraisesproductivity,however,by5.07
percent.Itsneteffectonoutputpercapitaisthenonly2.85percent.Thisisstillalarge
change,andthestandarderrorisonly1.07percentagepoints.Lookingbackatthetime
seriesplotofthepolicyvariablesinFigure5,weseethatchangesinuniondensitynear
themagnitudeof20percentagepointshaveindeedoccurredwithinthetimeperiodof
ourdata.IntheAngloSaxoncountries,uniondensitydeclinedby20percentagepoints
between1978and1998.IntheMediterraneanandContinentalcountries,therewere
smallerdeclinesofabout6percentagepointsbetween1993and2003.

Throughoutthepaperwehaveexploredtheinterplaybetweenchangesinthe
growthratesofemploymentandproductivity.Certainqualitativefeaturesarerobust.
First,theeffectsofthesixpolicyandinstitutionalvariablesonproductivityare
uniformlypositive.Thisisduetothefactthattheycanworkbothdirectlyandthrough
decreasingemployment.Second,uniondensityhasarobustlynegativeeffectonoutput
percapita,andEPLseffectisrobustlypositive.Moreimportantly,wefindthismethod
ausefulframeworkinwhichtounderstandtheeffectsofpolicyonsomeofthemajor
variablesofconcerninthemacroeconomy.

Thefindingthatthesixpolicyandinstitutionalvariablesalldriveproductivity
upis,onceagain,surprising.Itisworthtakingastepbacktoconsiderexactlywhatthis
resultmeans.First,notethatwedonotfindthatthevariablesallhavedirecteffectson
productivityonlyEPLandARRhavesignificantcoefficientsinthesecondstage
regressions.Moreover,oneexplanationforthesetwopositivecoefficientsisthatweare
seeingresidualeffectsofthesevariablesonemploymentthatarenotcapturedbythe
firststageregression.

Thesecondsurprisingresultisthatwefindnobouncebackresponseof
productivitytoemployment.Thatis,thelagsofemploymentgrowthdonothave
positivecoefficients,indicatingthattheshortrunnegativecorrelationbetween
employmentandproductivityisactuallyapermanenteffect.Whilethisresultis
surprising,wearenotawareofotherresearcherswhohaverobustlyfoundabounce
back.OnlyMcGuckinandvanArk(2005)findthattherelationshipbetween5year
growthratesofproductivityandemploymentisnotsignificantlydifferentfromzero,
buttheydonotincludeasextensiveasetofcontrolsaswedo.

28

Macroeconomictheorytellsusthatweshouldexpectabounceback.Buttheory
doesnotalwaysaccordwiththefacts.GoingbeyondthedatainTable2ontheaverage
post1995growthratesofcapitalpercapita(K/N),wefindauniformpatternacrossall
fourEuropeancountrygroupsthatgrowthinK/Ndeclined,insomecasesprecipitously,
in200005ascomparedto19952000.Thisdisappointingperformanceofcapitalgrowth
liesbehindoursurprisingresultthattheemploymentproductivitytradeoffwas
permanent,atleastasfarasourdataextend,ratherthantemporary.

7. CONCLUSIONS AND POLICY IMPLICATIONS

Thesinglemostnotablechangeafter1995inEuropehasbeenheterogeneity.
Priorto1995,Europeancountriesfollowedrelativelysimilarpaths.Theyhadhigh
growthratesofproductivity,andwereconvergingtotheproductivityleveloftheUS.
Atthesametime,theywereexperiencinghighlevelsofunemploymentandlittle
employmentgrowth..

Following1995,Europeancountriesalsodivergedfromeachother.Insome,we
observeimpressiveemploymentgrowth,bothduetopolicyandtoculturalfactors
includingimmigrationandagreateracceptanceofwomenenteringtheworkforce;in
othercountries,employmentgrewmoreslowly.Thispaperstudiesthenegative
correlationbetweengrowthinlaborproductivityandemploymentpercapita,country
bycountryandyearbyyear.Welinkchangesinpolicyandinstitutionalvariablesto
bothchangesingrowthratesoflaborproductivityandofemploymentpercapita.We
usestatisticalmethodstocontrolforreversefeedbackfromproductivitytoemployment,
andwefinddualeffectsofpolicyonlaborproductivityandemployment.Ourbaseline
resultsinTable6suggestthat,atleastintheshortrun,lowertaxesandlooser
regulationsraiseemploymentgrowthandreduceproductivitygrowth.Wehave
identifiedthisnegativecorrelationinreducedformregressionsthatallowbothdirect
andindirecteffectsofchangesinthepolicyandinstitutionalvariablesonproductivity
growth.
Thepost1995heterogeneityacrossEuropeprovidesafertilesettinginwhichto
studytheeffectsofvariouspolicychanges,andthisheterogeneityhelpsustofind
significanteffectsofpolicyandinstitutionalvariablesnotonlyonemploymentper
capitaandonproductivity,butalsoonoutputpercapita.WefindthatbyreducingEPL,
PMR,unemploymentbenefits,andaveragetaxrates,countriescauseproductivity
growthtodecline,partlyorcompletelyoffsettingthebenefitofhigheremployment.
Ultimately,theeffectsofthesepolicychangesonoutputpercapitaareambiguous.
Somefactors,suchasunions,seemtohaveastrongnegativeeffectonoutputpercapita.
Ontheotherhand,EPLandunemploymentbenefitshaveapositiveeffectonoutputper
capita.PMRandthetaxwedge,asfaraswecantell,haveroughlynoeffects.Itis

29

certainlytruethattheseresultscanbefragile,andtherearewideconfidenceintervals
aroundsomebutnotallofourestimates.
Surprisingly,wefindthateveryonepercentagepointincreaseinthetaxwedge
onlylowersoutputpercapitaby0.1percent.Sincethecoefficientontaxesinthe
employmentregressionsisestimatedtobeapproximately0.3,thetradeoffbetweenless
workandonlyslightlylessincomeshouldnotberejectedoutofhandintheperspective
ofthevaluablesocialservicesthatthesetaxescanfinance.
Moregenerally,themostimportantinnovationofourapproachtothesepolicy
questionsistochangethecurrentfocusofEuropeanpolicydiscussions.Europeansin
theLisbonAgendaplacedmajoremphasisonraisingemploymentpercapita,especially
offemales,butnowlamentthattheirproductivityandTFPgrowthhasbeenslowerthan
theUSsince1995.Ouranalysissuggeststhatsomeofthepolicyreformsthatareatthe
topoftheEuropeanreformagendamayraiseemploymentpercapitabutmayalso
reduceproductivity,leavingasinoursimulationsperhapsnegligibleeffectsonoutput
percapita. 28
Thereasonwefindthatthesepoliciesworkisthatwhenemploymentgrowthrises,
laborproductivitygrowthdeclines.Ifworkerswerehomogeneous,wewouldexpect
theelasticityofproductivitytoemploymenttoequal,atmost,tocapitalsshareof
income,about1/3.Wefindanelasticityofatleast0.5.Thisimpliesafurthereffectfrom
thefactthatmarginalworkerstendtobetheleastskilledandexperienced.Thisisin
accordwithourfindingthatmostoftheadditionalworkershavebeenfemaleswithlittle
previousworkexperience,andthattherecentriseofemploymentalsoinsomecountries
suchasSpainconsiststoasubstantialdegreeofimmigrants.
OneinterpretationofourresultsisthathademploymentnotriseninEurope
following1995,laborproductivitygrowthwouldnothaveslowed.IntheUSthough,
aftercontrollingforemploymentandpolicy,therewasstillanunexplainedrisein
productivitygrowth.ThisisreflectedintheaccelerationofUSTFPrelativetotheEU.
Inotherwords,evenifemploymenthadnotriseninEurope,productivitygrowthwould
stillhaveslowedrelativetotheUS.SincewedonotmodelTFPinthispaper,wecannot
explainthedivergenceinTFPtrends.

Lawsthatprotectincumbentsandlimitentrancetomarketstendtoinhibit
adoptionofnewtechnologies.Whiletwoofourpolicyvariables(EPLandARR)seemto
gointhedirectionofraisingincomepercapita,theeffectsofregulationontechnological
changemustalsobetakenintoaccountandthisadditionalchannelisoutsideofthe
28

Thepolicytradeoffemphasizedhereisnotuniquetoourpaper.PichelmannandRoeger(2008)
havethesamepointofdepartureasthispaperaboutthepolicytradeoff.Theyminimizeits
empiricalimportancebasedonasimplethreeequalVARmodelthatdoesnotaddressanyofthe
issuesofsimultaneityandendogeneityuponwhichwefocushere.

30

scopeofouranalysis.Intheend,apolicyshouldbejudgedbasedontwoeffects:astatic
effectandadynamiceffect.Whenapolicyreformisfirstenacted,itwillhavean
immediateimpactinraisingemploymentwhilereducingproductivity.Thisistheshort
runstaticeffectthatisthesubjectofthispaper.Inthelongrun,therearetwoimportant
dynamiceffects.Thefirstisthatinvestmentmayriseafteremploymentrises.The
secondisthatwhenpolicyreformsraisetheincentivesforadoptionofnewtechnologies,
aneconomymayadoptnewtechnologiesfasterandmoveclosertothetechnological
frontier.

Thispaperhasbeenonlyaboutthestaticeffect.Moreover,welookedforthe
firstofthetwodynamiceffectstheresponseofinvestmenttoemploymentchanges
andwereunabletofindit.Inparticular,thegrowthofcapitalpercapitaslowedrather
thanincreasedbetween2000and2005.However,theseconddynamiceffectiscriticalto
thelongrunprosperityofEurope.Creationandadoptionofnewtechnologyisthe
enginethatdriveslongrungrowth.Theeffectsofunemploymentbenefitsareprobably
drivenbytheirstaticcomponent.Ontheotherhand,wefindthatproductmarket
regulationhasfewstaticeffects,anditislikelymainlyadynamicpolicy.Inthelong
run,liberalizationthatencouragescompetitionwillbeagoodthing.Thispapershows
thatliberalizationcanhaveshortruncosts,butwhenthelongrunbenefitsarelarge,
thosecostsshouldnotdissuadepolicymakersfrommakingtherightdecision.

31

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35

APPENDIX A.

ROBUSTNESS TESTS

TablesA1andA2providerobustnesstestsfortheemploymentandproductivity
regressions,respectively.ThefirsttwocolumnsoftableA1removeSpainandthenthe
Mediterraneancountriesfromthesample.Thepost1995dummyfallsfromitsestimate
ofapproximately0.9inthemaintext,toroughly0.7However,thechangeisnot
statisticallysignificant.Incolumn3weaddtheUStothesampleandfindsimilar
resultsasinthemaintext.TheUShasanegativepost1995dummyof0.38,andthe
coefficientonPMRbecomessignificant.Sinceweusepopulationweights,theresultsin
column3arelargelydrivenbytheUS.Last,column5lagsalloftheexplanatory
variablesby1yearinordertoavoidanypossiblesimultaneity.Theresultsdonot
changenotably.

TableA2presentsrobustnesstestsfortheproductivityregressions.Column1
removestheMediterraneancountriesfromthesample.Thecoefficientonemployment
isnowonlysignificantatthe5percentlevel,ratherthanthe1percentlevel,becausethe
standarderrorislarger.EPLalsolosesitssignificantcoefficient.Incolumn2,wetry
droppingtheoutputgap,sinceitcouldcausesimultaneitybiasinourresults.The
coefficientonemploymentrisesto0.46.Thisislikelyduetothefactthattheregression
isnowpickingupsomeoftheshortruncorrelationbetweenemploymentand
productivity.

Incolumns3and4,welagalloftheexplanatoryvariablesbyoneyearexceptfor
theoutputgap.Usingonlythetaxwedgeasaninstrument,thecoefficienton
employmentisnolongersignificant,asitsstandarderrorisrelativelylarge.The95
percentconfidenceintervalextendsfrom0.75to0.25.Column4addsuniondensity
andhighcorporatismasdummies.Thisbringsthestandarderrordownandmakesthe
coefficientsignificantatthe1percentlevel.Column5showsthatexcludingthetax
wedgefromtheregressiondoesnotaffecttheresults.

Columns6and7addtheUStotheanalysis.Asbefore,sinceweusepopulation
weights,theUSdatadominatesthesample.Incolumn6,thepointestimateon
employmentisinlinewithothercolumns,butthestandarderrorhasrisento0.31.In
column7,usingafullsetofinstruments,employmentisonceagainsignificantatthe1
percentlevel.

Lookingacrossthecolumns,thepositivecoefficientsonEPLandARRareclearly
veryrobusttoavarietyofspecifications.Thepointestimateonthepost1995dummyis
usuallynegative,butitisneverstatisticallysignificantateventhe10percentlevel.In
theUS,ontheotherhand,thepost1995dummyhasacoefficientof0.45,whichis
significantatthe1percentlevel.Sowhileitseemsthattherewasnoexogenousnegative
shocktoEuropeanproductivitygrowth,therewassomesortofpositiveshockforthe
US.

36

APPENDIX B. DATA SOURCES BY ORDER OF APPEARANCE

Section2.2
Source:GGDCTotalEconomyDatabase,Jan.2007.http://www.ggdc.net/index
dseries.html:

Output(19702006):LinearaverageofGKandEKSmeasuresofGDP.
Dataadjustments:ValuesforGermanyratiolinkedtoW.Germany(GKonly)in1989.
USAmeasuresarefromBEANIPATable1.1.6(lastupdatedJuly27,2007).USA
measuresforTable2arefromGGDCasdefinedaboveforthesakeofuniformitywhen
comparinglevels.

Hours(19702006):Totalannualhoursworked.
Dataadjustments:ValuesforGermanyratiolinkedtoW.Germanyin1989.USA
measuresarethelatestBLSnumbersreleasedAugust7,2007providedbyPhyllisOtto
viaemail.

Population(19702006):Midyearpopulation.
Dataadjustments:ValuesforGermanyratiolinkedtoW.Germanyin1989

Employment(19702006):Personsengaged.
Dataadjustments:ValuesforGermanyratiolinkedtoW.Germanyin1989

Source:EUKLEMSDatabase,Mar.2007.http://www.euklems.net:

GrossOutput(19792004):Priceindexes,1995=100.BasicFiles,tabGO_P.
Dataadjustments:Duetomissingdata,GreeceGO_Pvaluesweresetequaltotab
VA_P(ValueAddedPriceIndex)valuesfrom19791994.Alsoduetomissingdata,
GO_PvaluesforLuxembourgindustries21t22and34t35weresetequaltoindustryD
from19791994.

1997PurchasingPowerParity(PPP)Index:Nationalcurrencyper1997GermanEuro.

NominalCapitalCompensation(19792004):BasicFiles,tabCAP.
Dataadjustments:NegativeCAPobservationswerereplacedbymultiplyingVAbyTotal
EconomyCAPdividedbyTotalEconomyVAinthatyear.
Notes:NominalamountsconvertedtoGermanEurosby1997industryPPPsusingthe
formula:
CAPin1997GermanEuros=CAPinnationalcurrency/[((GO_P/1997GO_P)/
(GermanGO_P/1997GermanGO_P))*1997PPP].

RealGrowthinCapital(19802004):BasicFiles,tabCAP_QI.

37

Dataadjustments:NoCAP_QIdataisavailableforGreece,Netherlands,andPortugal.
Thesecountriesarethereforedroppedfromallcalculationsinvolvingcapital.No
significantdifferencearisesinnoncapitalmeasuresfromtheexclusionofthesethree
countries,andthuswecontinuetousetheentireEU15whenpossible.NoCAP_QI
dataisavailablebefore1993forSweden.Therefore,Swedenwasdroppedfromall
calculationsinvolvingcapitalpriorto1993.
Notes:Realgrowthofaggregatedandsubaggregatedindustriesandcountries
calculatedusingaweightedaverageofthecomponentsrealgrowthrates.The
weightedaverageiscalculatedusingthegeometricmeanacrosseachyearpairofthe
industryorcountrysnominalshareofcapitalcompensation.

Hours(19802004):Totalhoursworkedbypersonsengaged.BasicFiles,tabH_EMP.

NominalValueAdded(19792004):Grossvalueadded.BasicFiles,tabVA.
Notes:NominalamountsconvertedtoGermanEurosby1997industryPPPsusingthe
formula:
VAin1997GermanEuros=VAinnationalcurrency/[((GO_P/1997GO_P)/(German
GO_P/1997GermanGO_P))*1997PPP].

RealGrowthinValueAdded(19802004):BasicFiles,tabVA_QI.
Notes:Realgrowthofaggregatedandsubaggregatedindustriesandcountries
calculatedusingaweightedaverageofthecomponentsrealgrowthrates.The
weightedaverageiscalculatedusingthegeometricmeanacrosseachyearpairofthe
industryorcountrysnominalshareofgrossvalueadded.

CapitalsShareinTotalOutput(19802004):Geometricmeanacrosseachyearpairof
nominalcapitaldividedbynominalvalueadded.

CapitalDeepeningGrowth(19802004):(Realcapitalgrowthminusgrowthintotal
hoursworkedmultipliedbycapitalsshareintotaloutput.

TotalFactorProductivity(TFP)Growth(19802004):Outputperhourgrowthminus
capitaldeepeninggrowth.

Employment(19802004):Numberofpersonsengaged.BasicFiles,tabEMP.

EUKLEMSNotes:
Duetomissingdata:AllvaluesforIrelandindustry71t74setequaltoIreland
industryKbefore1995,allnominalvaluesforIrelandindustries60t63and64setequal
to0.5*IrelandindustryIbefore1995,allindexvaluesforIrelandindustries60t63and64
setequaltoIrelandindustryIbefore1995,andallindexvaluesforGermanyindustries
60t63and64setequaltoGermanyindustryIbefore1991.

38

Aggregatedtotaleconomyresultsmaynotmatchupperfectlytocomparable
estimatesintheEUKLEMSDatabasebecauseweusedtheirtotaleconomyPPPsto
converttotaleconomynumberstoacommoncurrency,whereasEUKLEMSonly
convertedbyindustryandthenaddeduptheconvertedindustrynumberstomakea
convertedtotaleconomytotal.Wediditthiswaytokeeptotaleconomygrowthrates
bycountryequaltotheestimatesgivenontheEUKLEMSwebsite.Convertingby
industryandthensummingtomakenewtotaleconomyvaluesdistortsthesegrowth
rates.

Section3.2.2
Source:OECDPopulationandLaborForceStatistics,Volume2006release02.
http://www.oecd.org:

EmploymentperCapita(19782003):Employmentdividedbypopulationformen,
women,andcombined.

Source:AllardLindertDatabase,Jan.2006.Seewebsitefortheirsourcesanddata
adjustments.http://www.econ.ucdavis.edu/faculty/fzlinder/OECD_1950
2001_annual1.xls:

LaborTaxWedge(19782001):Totaltaxwedgeincludingemployerssocialsecurity
contributions.

EPL(19782001):TheAllard(2003)measureofthestrictnessofemployeeprotection
laws.

Source:GGDCTotalEconomyDatabase,Jan.2007.http://www.ggdc.net/index
dseries.html:

OutputGap(19782003):Measureofthegapbetweenactualandpotentialoutputasa
percentageofpotentialoutput.PotentialoutputcreatedusingaHodrickPrescottfilter.
Forspecificcalculations,seeourStatadofile.

Source:BassaniniDuvalDataset,obtainedviaemailinApril2007.SeeBassaniniDuval
(2006)fortheirsourcesanddataadjustments.

LaborTaxWedge(19782003):Taxwedgebetweenthelaborcosttotheemployerand
thecorrespondingnettakehomepayoftheemployeeforasingleearnercouplewith
twochildrenearning100%ofAPWearnings.Thetaxwedgeexpressesthesumof
personalincometaxandallsocialsecuritycontributionsasapercentageoftotallabor
cost.

39

Dataadjustments:DataratiolinkedtoAllardLindertstaxwedgemeasureformissing
years.

EPL(19782003):OECDsummaryindicatorofthestringencyofemploymentprotection
legislation.
Dataadjustments:DataratiolinkedtoAllardLindertsEPLmeasurepriorto1982.

ARR(19782003):Averageunemploymentbenefitreplacementrateacrosstwoincome
situations(100%and67%ofAPWearnings),threefamilysituations(single,with
dependentspouse,withspouseinwork)andthreedifferentunemploymentdurations
(1styear,2ndand3rdyears,and4thand5thyearsofunemployment).

PMR(19782003):OECDsummaryindicatorofregulatoryimpedimentstoproduct
marketcompetitioninsevennonmanufacturingindustries:gas,electricity,post,
telecoms(mobileandfixedservices),passengerairtransport,railways(passengerand
freightservices)androadfreight.

UnionDensity(19782003):Tradeuniondensityrate.
Dataadjustments:Duetomissingdata,dataforFinland,Germany,andSwedenyears
1991and1992obtainedbylinearinterpolation.DataforGreeceyears2002and2003set
equaltoGreece2001.DataforSpainyears1978,1979,and1980setequaltoSpain1981.

OutputGap(19782003):OECDmeasureofthegapbetweenactualandpotential
outputasapercentageofpotentialoutput.
Dataadjustments:DataratiolinkedtooutputgapmeasurederivedfromtheGGDCTotal
EconomyDatabaseformissingyears.
Notes:OutputgapmeasuresareupdatedfromBassaniniandDuvalspaper.Theyused
outputgapmeasuresfromOECDEconomicOutlook76,December2004.TheOECD
outputgapmeasurewaschoseninfavoroftheoutputgapmeasurederivedfromthe
GGDCusinganHPtrendbecausetheOECDmeasurehasmoreplausiblegapsand
morestablegrowthratesofpotentialoutput.

DegreeofCorporatism(19782003):Indicatorofthedegreeofcentralization/co
ordinationofthewagebargainingprocesses,whichtakesavalueof1forhighdegreesof
centralizationandcoordinationandzerootherwise.

DemographicPredictions

PredictionsforfuturedemographictrendsweredownloadedfromtheUNs
WorldPopulationProspectsdatabaseathttp://esa.un.org/unpp/index.asp?panel=2.

AdditionalNotesontheProductivityRegressions

40

Theregressionsallpassthestandardspecificationtests.Inparticular,theSargan
testindicatesthatourinstrumentsarevalid,theWuHausmanntestrejectsthenullthat
employmentgrowthisnotendogenous,andtheCraggDonaldtestforidentification
rejectsthenullthatthemodelisunderidentifiedatthe.01percentlevel.

ThecoefficientswefindarenearlyidenticaltothosefoundbyBourlesandCette
(2005),butarelargerthanthosefoundbyMcGuckinandvanArk.Theirsampleis
differentfromoursinitstimeperiodandselectionofcountries.Moreover,inatleast
someoftheirregressions,theydonotcontrolforthebusinesscycle.Giventheshortrun
positivecorrelationbetweenoutput,productivityandemployment,wewouldexpect
theexclusionoftheoutputgaptobiastheestimatedcoefficientonemployment
upwards.Inunreportedexperiments,wefindthatitdoes.

Theothercontrolsweincludeontherighthandsideareslightlydifferentfrom
bothBourlesandCette(2005)andMcGuckinandvanArk(2005).Wetrytobeascareful
aspossibleinavoidingsimultaneitybias,whichleadsustousefewercontrolsthan
BourlesandCette.

StataCommands

Weusedextensivelytheivreg2andxtivreg2commandsinstata:
Baum,C.F.,Schaffer,M.E.,Stillman,S.,2006.ivreg2:Statamoduleforextended
instrumentalvariables/2SLS,GMMandAC/HAC,LIMLandkclassregression.
http://ideas.repec.org/c/boc/bocode/s425401.html

Schaffer,M.E.,Stillman,S.,2007.xtivreg2:StatamoduletoperformextendedIV/2SLS,
GMMandAC/HAC,LIMLandkclassregressionforpaneldatamodels.
http://ideas.repec.org/c/boc/bocode/s456501.html

OtherNotes:

AlltrendsweregeneratedusingHodrickPrescottfilterwithannualdata
smoothingparameterof6.25.Anextrayearwasaddedontosmooththeendofeach
trend.Thevaluegiventothisyearequaledtheaveragegrowthrateofpreviousfour
years.

Growthratesweregeneratedusingtheexponentialgrowthrateformula.

41

Figure1.TrendinOutputperHour,OutputperCapita,and
HoursperCapita,USandEU15,AnnualGrowthRates,1970
2006
6
5
EU15Y/H

Percent

USY/H

3
2
1
0
1970

1975

1980

1985

1990

1995

2000

2005

2000

2005

EU15Y/N

USY/N

Percent

2
1
0
1

EU15H/N

USH/N
3
1970

1975

1980

1985

1990

1995

Source: GGDCTotalEconomyDatabaseexceptBEA,BLSfortheUnitedStates,seedataappendix

Figure2.TrendinEmploymentperCapitaandHoursper
Employee,USandEU15,AnnualGrowthRates,19702006
2
1.5
USE/N

Percent

1
0.5
0
0.5
EU15E/N
1
1970

1975

1980

1985

1990

1995

2000

2005

1995

2000

2005

1
USH/E
0.5

Percent

0.5

1
EU15 H/E
1.5

2
1970

1975

1980

1985

1990

Source: GGDCTotalEconomyDatabaseexceptBLSfortheUnitedStates,seedataappendix

Figure3.TrendinCapitalInputperHourandTotalFactor
Productivity,USandEU15,AnnualGrowthRates,19802004
7
6

Percent

5
4
3
2

EU15K/H

USK/H
0
1980

1985

1990

1995

2000

2.5
2

EU15TFP
1.5

Percent

1
0.5
0
0.5

USTFP
1
1.5
2
1980

1985

1990

Source: EUKLEMSDatabase,seedataappendix

1995

2000

Figure4:EmploymentandShareeffectsfortheTurnaroundinEmploymentperCapitaGrowth,19952005versus19851995
Nordic

Men

AngloSaxon

65+

65+

5564

5564

4554

4554

EmploymentEffect

3544

Women

3544

2534

2534

1524

1524

65+

65+

5564

5564

4554

4554

ShareEffect

3544

3544

2534

2534

1524

1524

Continental

0.02

0.015

0.01

65+

65+

5564

5564

4554

4554

3544

3544

2534

2534

1524

1524

65+

65+

5564

5564

4554

4554

3544

3544

2534

2534

1524

1524

0.005

Source: Authorscalculations

Mediterranean

0.005

0.01

0.015

0.02

0.025

0.02

0.015

0.01

0.005

0.005

0.01

0.015

0.02

Figure5.PolicyandInstitutionalVariables,19802003
TaxWedge

EmploymentProtectionLegislation

45

Nordic

40

Mediterranean

3.5

Continental

35
Continental

2.5

Mediterranean

30

Nordic
1.5

25
AngloSaxon

AngloSaxon

20
0.5

15

1980

1985

1990

1995

1980

2000

1985

1990

1995

2000

UnemploymentBenefits(ARR)

ProductMarketRegulations
50

Continental

45

Continental

40
Mediterranean

35

Nordic

30

25

Nordic

20
15

2
AngloSaxon

AngloSaxon

10
Mediterranean

1
5
0

0
1980

1985

1990

1995

2000

1980

1985

1990

1995

2000

HighCorpratismDummy

UnionDensity
1

90

0.9

80
Nordic

70

0.8
0.7

60
AngloSaxon

50

Nordic
Mediterranean

0.6
0.5

40
Mediterranean

0.4
Continental

30

0.3

20

0.2

Continental

10

0.1

AngloSaxon

0
1980

1985

1990

Source: Authorscalculations

1995

2000

1980

1985

1990

1995

2000

Figure6:EU15MaleandFemaleEmploymentperCapita
Simulations,19802003
Men
70
68
66
64

Predicte

62
60

Fixed

58
56

NoPost1995

54
52
50
1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

Women
47

45
Predicte
43
Fixed

41

NoPost1995

39

37

35
1981

1983

1985

Source: AuthorsCalculations

1987

1989

1991

1993

1995

1997

1999

2001

2003

Figure7:Actual,Predicted,andFixedPolicyLaborProductivityand
Employment
LaborProductivity

104

NoPost1995
EmploymentDummy

102

100

98

Counterfactual
96

Predicted

94

92

90

88
1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

Employment

112

Predicted

110
108

Counterfactual
106
104
102
100

NoPost1995Dummy
98
96
94
1980

1982

1984

1986

Source: AuthorsCalculations

1988

1990

1992

1994

1996

1998

2000

2002

Table1
GrowthinOutputperHour,HoursperCapita,andOutputperCapita,
CountriesandCountryGroups,selectedintervals,19702006
LabourProductivity
GrowthRates
19701995
19952006 Difference
UnitedStates
EU15
EU15xMed
Nordic
Denmark
Finland
Sweden
AngloSaxon
Ireland
UnitedKingdom
Continental
Austria
Belgium
France
Germany
Luxembourg
Netherlands
Portugal
Mediterranean
Greece
Italy
Spain
StandardDeviation

1.42
2.89
2.81
2.41
2.74
3.29
1.72
2.73
4.03
2.68
2.88
3.12
2.85
3.05
2.91
2.50
2.30
2.85
3.15
2.36
2.71
4.19
0.63

2.13
1.41
1.87
2.09
1.15
2.48
2.49
2.18
4.16
2.04
1.75
2.28
1.42
1.85
1.67
1.92
1.54
1.70
0.24
2.53
0.44
0.24
1.00

HoursperCapita
GrowthRates
19701995
19952006 Difference

0.71
1.49
0.94
0.32
1.59
0.80
0.76
0.55
0.13
0.64
1.14
0.85
1.43
1.19
1.23
0.58
0.76
1.15
2.91
0.17
2.28
4.43

0.55
0.82
0.84

0.77
0.85
1.27
0.41
0.72
0.66
0.72
0.89
0.66
0.68
1.15
0.96
0.29
0.54
0.16
0.75
0.33
0.43
1.35
0.46

0.04
0.59
0.07
0.56
0.67
0.97
0.26
0.46
2.01
0.37
0.13
0.18
0.50
0.16
0.33
1.28
0.47
0.05
1.92
1.13
0.74
3.69
1.02

Source :GGDCTotalEconomyDatabaseexceptBEAfortheUnitedStates,seedataappendix

OutputperCapita
GrowthRates
19701995
19952006 Difference

0.58
1.41
0.92
1.33
1.52
2.24
0.68
1.18
2.67
1.09
0.76
0.48
1.17
0.99
0.63
0.99
1.01
0.11
2.67
1.46
1.16
5.04

1.97
2.07
1.97

1.64
1.89
2.02
1.31
2.01
3.37
1.96
1.99
2.46
2.17
1.90
1.94
2.78
1.76
3.01
2.40
2.03
2.29
2.84
0.55

2.09
2.00
1.94
2.66
1.82
3.45
2.75
2.64
6.17
2.41
1.62
2.09
1.92
1.70
1.34
3.20
2.01
1.75
2.15
3.66
1.18
3.46
1.27

0.12
0.07
0.03
1.02
0.07
1.44
1.44
0.63
2.80
0.45
0.37
0.37
0.25
0.20
0.60
0.41
0.25
1.26
0.25
1.63
1.11
0.61

Table2
AnnualGrowthRatesandTurnaroundinGrowthRatesofLabourProductivity,LabourandCapitalRatios,
andTotalFactorProductivity,CountriesandCountryGroups,19802004

19801995GrowthRates
LabourProductivity(Y/H)
HoursperEmployee(H/E)
EmployentperCapita(E/N)
CapitalperHour(K/H)
CapitalDeepening
TotalFactorProductivity(TFP)
19952004GrowthRates
LabourProductivity(Y/H)
HoursperEmployee(H/E)
EmployentperCapita(E/N)
CapitalperHour(K/H)
CapitalDeepening
TotalFactorProductivity(TFP)
Difference,19952004minus19801995
LabourProductivity(Y/H)
HoursperEmployee(H/E)
EmployentperCapita(E/N)
CapitalperHour(K/H)
CapitalDeepening
TotalFactorProductivity(TFP)
MemoItems:
CapitalOutputRatio(K/Y)
CapitalperCapita(K/N)

UnitedStates

EU15

Nordic

AngloSaxon

Continental

Mediterranean

1.34
0.13
0.51
3.56
1.17
0.17

2.34
0.49
0.04
3.68
1.11
1.23

2.30
0.02
0.74
4.06
1.23
1.07

2.46
0.16
0.23
4.44
1.25
1.21

2.46
0.77
0.03
3.47
1.07
1.39

2.07
0.32
0.11
3.52
1.05
1.02

2.29
0.16
0.06
3.56
1.20
1.09

1.41
0.39
0.92
2.81
0.95
0.46

1.92
0.16
0.56
2.86
0.96
0.96

2.11
0.37
1.01
3.99
1.20
0.91

1.63
0.57
0.49
2.99
1.01
0.63

0.63
0.29
1.73
2.01
0.73
0.10

0.95
0.03
0.46
0.01
0.03
0.92

0.93
0.10
0.95
0.87
0.16
0.77

0.37
0.14
1.30
1.20
0.27
0.11

0.34
0.21
1.24
0.45
0.05
0.29

0.82
0.20
0.46
0.48
0.06
0.76

1.44
0.03
1.62
1.51
0.32
1.12

0.96
0.49

0.06
0.18

0.82
0.04

0.10
0.59

0.34
0.18

0.07
0.15

Source :EUKLEMSDatabase,seedataappendix

Table3
RegressionsofEmploymentperCapitaGrowth
onPolicyandInstitutionalVariables,19802003
Combined
TaxWedge
EmploymentProtectionLegislation
ProductMarketRegulation
AverageReplacementRate
UnionDensity
OutputGap
HighCorporatism
Post1995Dummy
Nordic
Denmark
Finland
Sweden
AngloSaxon
Ireland
UnitedKingdom
Continental
Austria
Belgium
France
Germany
Netherlands
Portugal
Mediterranean
Greece
Italy
Spain
R2
N
RMSE

0.28
0.25
0.55
0.17
0.47
0.51
2.76
0.95

***

***
***
***
**
***

Men
0.21
0.34
0.29
0.11
0.41
0.56
1.87
1.09

Women
**

**
***
***
*
***

0.37
0.14
0.75
0.27
0.56
0.46
4.20
0.66

***

***
***
***
***
***

0.41
0.43
0.88 *

0.64
0.69
1.12 **

0.23
0.23
0.56

0.33
1.02 ***

1.16
1.45 ***

1.38
0.41

0.30
0.16
0.57
1.78
0.66
0.68

0.87
0.76
1.16 ***
2.44 ***
0.30
1.32 ***

0.50
0.82
0.33
0.86 **
2.46 ***
0.33

0.80 *
1.06 ***
0.77 ***

1.09 **
0.55 *
1.62 ***

***
***
*
*

0.14
0.54 **
0.02
0.47
314
1.32

0.47
312
1.34

*Indicatessignificanceat10%level,**5%,***1%
Equalto1ifwithin19962003,otherwise0
Allregressionsweightedbypopulation
Source: Newspecificationsandanalysisbasedondataobtainedfrom
BassaniniDuval(2006)andtheOECD.SeeDataappendix.

0.37
312
1.65

Table4
FirstStageRegressionsofEmploymentperCapitaGrowthonPolicy
andInstitutionalVariables,19802003
(1)

(2)

(3)

(4)

TaxWedge

0.38 ***
(0.08)

0.28 ***
(0.07)

0.25 ***
(0.07)

0.15 **
(0.08)

EmploymentProtectionLegislation

0.20
(0.82)

0.86
(0.79)

1.57 *
(0.87)

0.27
(0.83)

ProductMarketRegulation

1.11 *
(0.57)

0.44
(0.55)

0.66
(0.62)

0.05
(0.67)

AverageReplacementRate

0.21 ***
(0.05)

0.18 ***
(0.05)

0.13 **
(0.05)

0.18 ***
(0.05)

UnionDensity

0.43 ***
(0.11)

0.46 ***
(0.10)

0.45 ***
(0.10)

0.41 ***
(0.11)

HighCorporatism

2.27 **
(1.04)

2.04 **
(0.98)

1.70 *
(0.86)

1.59 *
(0.96)

OutputGap

0.54 ***
(0.05)

0.52 ***
(0.05)

0.51 ***
(0.05)

0.38 ***
(0.06)

0.94 ***
(0.15)

0.86 ***
(0.17)

1.15 ***
(0.44)

Post1995Dummy

R2
N
RMSE

0.46
320
1.25

0.52
320
1.18

0.48
320
1.31

0.59
320
1.09

WeightedbyPopulation
YearDummiesIncluded

Yes
No

Yes
No

No
No

Yes
Yes

*Indicatessignificanceat10%level,**5%,***1%.Timeandfixedeffectscoefficientsnotreported.
Equalto1ifwithin19962003,otherwise0
Allregressionsincludecountryfixedeffects
Source: AuthorsCalculations

Table5
SecondStageRegressionsofProductivityGrowthonEmploymentperCapita
GrowthandPolicyandInstitutionalVariables,19802003
(1)
EmploymentRate

0.84 ***
(0.04)

TaxWedge

0.04
(0.06)

EmploymentProtectionLegislation

(2)

(3)

(4)

(5)

(6)

0.64 ***
(0.20)

0.74 ***
(0.10)

0.64 ***
(0.12)

0.63 ***
(0.14)

0.62 ***
(0.16)

1.82 ***
(0.62)

1.66 ***
(0.65)

1.77 ***
(0.60)

1.62 **
(0.63)

1.07
(0.81)

1.19 *
(0.64)

ProductMarketRegulation

0.48
(0.43)

0.56
(0.45)

0.54
(0.44)

0.58
(0.44)

0.98 *
(0.56)

0.8
(0.52)

AverageReplacementRate

0.10 ***
(0.04)

0.14 ***
(0.05)

0.12 ***
(0.04)

0.13 ***
(0.05)

0.13 **
(0.05)

0.14 ***
(0.05)

UnionDensity

0.06
(0.08)

0.03
(0.12)

0.02
(0.09)

HighCorporatism

0.94
(0.77)

0.49
(0.94)

0.73
(0.82)

OutputGap

0.78 ***
(0.04)

0.68 ***
(0.11)

0.73 ***
(0.07)

0.67 ***
(0.08)

0.74 ***
(0.09)

0.76 ***
(0.08)

0.06
(0.13)

0.14
(0.24)

0.14
(0.18)

0.15
(0.21)

0.65
320
0.92

0.63
320
0.95

0.64
320
0.93

0.62
320
0.95

0.52
320
1.18

0.69
320
0.86

Yes
No
Taxwedge

Yes
No
Taxwedge
Post1995TE

Yes
No
Taxwedge
HighCorp.
UnionDens.

No
No
Taxwedge
HighCorp.
UnionDens.

Yes
Yes
Taxwedge
HighCorp.
UnionDens.

Post1995Dummy

R2
N
RMSE
WeightedbyPopulation
YearDummiesIncluded
ExogenousInstrument(s)

Yes
No
None

*Indicatessignificanceat10%level,**5%,***1%.Yearandcountrydummycoefficientsnotreported.
Equalto1ifwithin19962003,otherwise0
Allregressionsincludecountryfixedeffects
Source: AuthorsCalculations

Table6
Actual,Predicted,andCounterfactualSimulationsofProductivityandEmploymentGrowth
LaborProductivity
Predicted FixedPolicy PolicyEffect
2.12
1.82
0.30
0.90
1.18
0.28
1.23
0.65
0.58

Mediterranean

Pre95
Post95
Change

Actual
2.53
0.52
2.01

Continental

Pre95
Post95
Change

2.26
1.76
0.50

2.38
1.57
0.81

2.41
1.75
0.66

0.03
0.18
0.15

0.04
0.76
0.80

0.12
0.92
1.04

0.28
0.80
1.08

0.16
0.12
0.04

Nordic

Pre95
Post95
Change

2.00
1.92
0.08

2.33
1.38
0.95

2.27
1.80
0.47

0.06
0.41
0.47

0.61
0.70
1.31

0.80
1.02
1.82

0.64
0.73
1.36

0.17
0.29
0.46

AngloSaxon

Pre95
Post95
Change

2.52
2.23
0.29

2.56
2.13
0.43

3.14
2.57
0.57

0.57
0.44
0.13

0.23
0.83
1.06

0.25
0.86
1.12

0.92
0.26
1.18

0.67
0.60
0.07

EU15

Pre95
Post95
Change

2.32
1.44
0.88

2.33
1.44
0.89

2.39
1.73
0.66

0.06
0.29
0.23

0.15
1.16
1.31

0.15
1.16
1.31

0.28
0.91
1.19

0.13
0.25
0.12

Source: AuthorsCalculations

Actual
0.27
1.87
2.14

EmploymentperCapita
Predicted FixedPolicy PolicyEffect
0.06
0.35
0.29
1.63
1.46
0.17
1.57
1.11
0.46

Table7
EffectsofUnitStandardDeviationPolicyShocksonEmployment
Productivity,andOutputperCapita
ShockSize

Employment

Productivity

OutputPerCapita

TaxWedge

9.21

2.67 ***
(0.64)

1.71 ***
(0.53)

Employment
ProtectionLegislation

0.87

0.74 **
(0.36)

0.23
(0.37)

0.97 ***
(0.31)

ProductMarketRegulation

0.9

0.14
(0.24)

0.35
(0.25)

0.21
(0.22)

AverageReplacementRate

11.31

0.90 ***
(0.34)

1.37 ***
(0.31)

0.47 *
(0.25)

UnionDensity

23.32

7.93 ***
(1.17)

5.07 ***
(1.23)

2.85 ***
(1.07)

1.02 **
(0.48)

0.65 **
(0.33)

0.37 *
(0.21)

HighCorpratism

Note:Standarderrors(Deltamethod)inparentheses
Source: AuthorsCalculations

0.96 **
(0.4)

TableA1
FirstStageRegressionsofEmploymentonPolicyVariables,19802003

TaxWedge

1
0.25 ***
(0.06)

2
0.25 ***
(0.07)

3
0.2 ***
(0.07)

4
0.14 *
(0.07)

Employment
ProtectionLegislation

0.88
(0.75)

1.38
(0.86)

0.90
(0.30)

1.03
(0.79)

ProductMarket
Regulation

0.24
(0.49)

0.34
(0.51)

0.99 **
(0.48)

0.84
(0.56)

Unemployment
Benefits(ARR)

0.08 *
(0.05)

0.01
(0.06)

0.19 ***
(0.05)

0.21 ***
(0.05)

UnionDensity

0.29 ***
(0.10)

0.35 ***
(0.11)

0.49 ***
(0.10)

0.44 ***
(0.10)

HighCorpratismDummy

2.95 ***
(0.83)

2.32 *
(1.22)

2.18 **
(1.02)

2.04 **
(0.97)

OutputGap

0.46 ***
(0.04)

0.55 ***
(0.04)

0.54 ***
(0.03)

0.64 ***
(0.05)

Post1995Dummy

0.66 ***
(0.14)

0.75 ***
(0.14)

0.93 ***
(0.16)

0.91 ***
(0.16)

Post95Dummy(U.S.)

0.38 **
(0.17)

R2
RMSE
N
Notes

0.48
1.02
296
SpainExcluded

0.53
0.99
251

0.58
0.96
344

MediterraneanCountries

U.S.included,witha

Excluded

separatepost95dummy

0.53
1.15
306
Allexplanatory
variablesexcept
outputgaplagged
byoneyear

Allregressionsincludepopulationweightsandfixedcountrydummies
Source:AuthorsCalculations

TableA2
SecondStageRegressionsofProductivityonEmploymentandPolicyVariables
1
0.56 **
(0.26)

EmploymentRate

2
0.46 **
(0.22)

3
0.24
(0.23)

4
0.43 ***
(0.13)

0.64 ***
(0.16)

5
0.39
(0.31)

6
0.51 ***
(0.15)

0.01
(0.04)

TaxWedge
Employment
ProtectionLegislation

1.05
(0.94)

1.88 **
(0.92)

2.43 ***
(0.90)

2.72 ***
(0.86)

1.6 **
(0.64)

1.49 *
(0.82)

1.56 **
(0.76)

ProductMarket
Regulation

0.27
(0.50)

0.56
(0.63)

0.93
(0.68)

0.65
(0.63)

0.59
(0.44)

0.47
(0.50)

0.4
(0.44)

Unemployment
Benefits(ARR)

0.25 ***
(0.06)

0.15 **
(0.07)

0.17 **
(0.07)

0.14 **
(0.06)

0.13 **
(0.05)

0.16 **
(0.08)

0.14 **
(0.05)

UnionDensity

0.05
(0.14)

0.16
(0.18)

0.14
(0.18)

OutputGap

0.65 ***
(0.15)

HighCorpratismDummy

1.23
(1.37)

0.57
(1.30)

1.37
(1.31)

Post1995Dummy

0.06
(0.27)

0.20
(0.28)

0.36
(0.33)

0.08
(0.17)

0.28 ***
(0.07)

0.31 ***
(0.06)

0.13
(0.24)

0.67 ***
(0.10)

0.49 ***
(0.17)

0.25
(0.21)

0.24
(1.24)

0.13
(0.19)

0.41
(0.36)

0.28
(0.21)

0.46 ***
(0.17)

0.44 ***
(0.15)

Post95Dummy(U.S.)

R2
RMSE
N
ExogenousInstruments

Notes

0.51
0.97
251
TaxWedge

0.27
1.3
329
TaxWedge

0.31
1.28
305
TaxWedge

0.30
1.28
305
TaxWedge
HighCorp.
Unions

0.63
0.95
320
HighCorp.
Unions

0.56
0.88
344
TaxWedge
HighCorp.
Unions

MediterraneanCountries

OutputGap

Allexplanatory

Allexplanatory

Taxwedgenot

U.S.included,

U.S.included,

Excluded

Excluded

variablesexcept

variablesexcept

usedasan

withaseparate

withaseparate

outputgaplagged

outputgaplagged

exogenous

post95dummy

post95dummy

byoneyear

byoneyear

instrument

Allregressionsincludepopulationweights.Inallcases,theSarganstatisticcannotrejectthenullofinstrumentvalidityatthe20%level
Source:AuthorsCalculations

0.51
0.93
344
TaxWedge

0.56 ***
(0.09)