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Labour productivity growth in good old Germany: is Germany falling further behind?

The development of aggregate productivity growth — here proxied by hourly labour productivity — is one of the important indicators for sustainable economic growth for each country.

According to the new growth theory, the medium term productivity increase is seen as a variable which mainly depends on human capital and innovation capacity. It reflects the medium-term growth perspectives of a country.

For quite a long time, Germany in that respect was well known as country with relatively high productivity growth. But this picture changed: Germany’s medium term productivity growth (measured at 5-year averages) fell from 1.9 per cent in 1995 to 2000 to 1.4 per cent for the period 2001-2006. This is slightly better than the overall performance of the Euro area in that respect. However, compared to the growth rates in the US, UK, Nordic countries and Japan, the performance of Germany is quite weak.

The German productivity slowdown is, however, not only pronounced in an international perspective but also in historical perspective. Productivity growth was at rates of 2.5 per cent on average over 1985-1990 and on 2.9 per cent over 1990-1995. Of course, the re-unification in itself boosted the growth rates. The decline from 2.5 to 1.4 per cent over 15 years, however, is alarming.

There is a second feature that is interesting about the German productivity figures. Whereas the average or trend growth rate seems to be lower now than 15 years ago, the variance is still very high.There was an extraordinary increase in productivity growth around 2000 — going hand in hand with the German boom and a further strong increase in 2006. Even if the business cycle volatility in Germany seems to be lower now — as it is the case for most industrialized countries — than 15 or 20 years ago, the productivity volatility is high.

To shed light on this issue, we used a state space model to decompose the German productivity growth rate into a trend and a business cycle component. We made use of an approach outlined by Robert Gordon.[1] This approach makes use of the well known stylized business cycle fact, that producvtivity growth is leading the business cycle and decomposes the productivity growth into trend, business cycle and idiosyncratic components. Formally, we estimate:

where y stands for productivity, x for output gap and the time-varying part (alpha) measures trend productivity growth. Such a model has two advantages: First, we can decompose productivity growth in different components and compare the variance decompositions over. Second, we have a decomposition technique based on a well established stylized business cycle fact.

We found two interesting results:

1) From the variance decomposition we can infer, that over the whole sample (1960-2008) business cycle effects and shifts in the trend productivity rate both together explain about half of all variance. Considering the period from the early 1990s onwards gives a different picture. The importance of business cycle fluctuations for the variance of the trend rate increased by a factor of 2, whereas the importance of trend variations decreased by 40 per cent.

2) The trend productivity decline seems to have come to an end at the very end of the sample, however, the uncertainty is very high.

Obviously, the expected positive effects of IT investment as documented for the US[2], did not work in the same strengths for Germany.[3] We can put it differently: the fact, that the German economy has a extraordinary export performance and competitiveness was mainly driven by massive wage restraints but is not due to productivity gains. The picture below is a little bit older but nevertheless intuitive. The bold pink magenta line is Germany….

Such a policy can be only a second-best solution. Low internal demand and a stagnating economy for a large part of the recent decade is to some extent the other side of the “wage restraint” coin in the face of low productivity growth.

Future prospects for Germany are not that bleak but policy action is needed: a sustainable recovery of German productivity increase in the medium term needs

a) a policy supportive for human capital formatoin and innovation,

b) a policy conducive for new and expanding sectors (new technologies),

c) a macroeconomic environment supportive for growth.

Remark: The paper was cross-posted at http://macroeconomicsandotherthings.blogspot.com/. Pictures are available there.

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