No. 35

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Drivers of productivity growth in European regions

08 June 2017

Studies

RiTo No. 35, 2017

  • Kadri Männasoo

    Professor, Director of School of Business and Governance, Department of Economics and Finance, Tallinn University of Technology

  • Heili Hein

    Heili Hein

    Early Stage Researcher, PhD student, Tallinn University of Technology

  • Raul Ruubel

    Doctoral Candidate at Tallinn University of Technology

The objective of this analysis is to investigate research and development (R&D) and human capital as drivers of productivity growth in European regions. Productivity levels across countries and regions vary to a large degree and the discrepancies tend to persist over time. Moreover, differences in productivity account for a major part of per capita income disparities. Despite extensive economic and policy measures, substantial productivity gaps are still prevalent in the European Union (EU). The crucial challenge for researchers and policy-makers is to understand the causes of productivity gaps and to determine ways to escape low productivity.

The connection between productivity and R&D and human capital has theoretical footings in the ample endogenous growth literature. However, research activities and human capital are also central to the concept of absorptive capacity. Per this concept, R&D has two purposes. First, research creates new knowledge and innovation, and second, it develops absorptive capacity, or the ability to identify, assimilate and exploit outside knowledge. Thus, the technological progress of a region depends both on its own innovative capabilities as well as on its capacity to exploit external knowledge. R&D and human capital are important for both capabilities, raising both the ability to create own innovations and to imitate the creations of others.

In current literature, productivity is often operationalized as the multi-factor productivity measure termed “total factor productivity” (TFP) – as opposed to utilizing a single-factor productivity measure such as labour productivity. The empirical framework of this paper is based on a Schumpeterian endogenous growth model that explains the effects of absorptive capacity on TFP growth. In addition to the dual effects of human capital and R&D, the model involves the effects of conditional convergence. This analysis complements the model by adding a spatial dimension via regional spillovers, and by including the regions’ pre-accession starting position, or the regions’ productivity gap in 2003. The model is estimated by using a generalized method of moments, making it possible to account for endogenous feedback effects.

The econometric analysis is conducted on a panel of 99 European NUTS1 regions from 31 countries over the period 2000–2013. 28 of these countries are EU members, and three countries (Iceland, Norway and Switzerland) belong to the European Free Trade Association (EFTA). Additionally, two subsamples are defined. The advanced Europe subgroup includes EU-15 countries plus the three EFTA countries, and the emerging Europe subsample contains the 13 new member states that joined the EU in 2004 or in later accession waves.

The analysis results indicate that advances in human capital quality have an overall positive effect upon productivity in European regions. Interestingly, this effect is weaker in the emerging Europe: as the productivity gap in emerging economies widens, the positive effect of human capital quality on productivity decreases. This could imply that regions lagging far below the productivity frontier possess underdeveloped economic structures that cannot fully exploit increases in workforce qualification. Likewise, R&D expenditures have a significant positive impact on productivity in advanced Europe, but prove insignificant in the emerging regions. In contrast to advanced Europe, growth in EU-13 largely stems from spatial spillovers and regional convergence and is notably dependent on the pre-accession starting position.

Overall, these results imply that productivity drivers in advanced and emerging economies of Europe diverge to a great extent. During the post-accession period of 2004–2013, productivity growth in the new member states has strongly relied on spillover effects from their more affluent neighbours. The gap-driven potential for productivity growth is decreasing over time, however, and the regions in the new member states need to gradually shift their growth drivers towards internal sources like human capital quality and research activities, while at the same time supporting the development of efficient market structures and a growth-promoting regulatory structure.

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