Capital Quality Improvement and the Sources of Economic Growth in the Euro Area

39 Pages Posted: 13 Apr 2005

See all articles by Plutarchos Sakellaris

Plutarchos Sakellaris

University of Maryland - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Focco Vijselaar

affiliation not provided to SSRN

Abstract

Europe's growth slowed in the 1990s, reinforcing the overall impression of a need to catch up with the US regarding standards of living. In reaction, EU leaders adopted the famous Lisbon Agenda in 2000. The Agenda is now under review, the aim being to determine why progress on its pro-growth goals has been unsatisfactory and what can be done about it. The first crucial step in this process is to understand the true sources of the European growth slowdown. Sources-of-growth calculations have always been imprecise, but evidence from the US suggests that 'quality upgrading' - especially in capital goods - has substantially worsened the precision problem since the 1990s. Unfortunately, quality adjusted sources-of-growth calculations, however, have not performed satisfactorily for Europe, so Europe's leaders are working with potentially misleading accounts of Europe's growth slowdown. Redressing this omission is the goal of this paper.

Failure to account properly for capital quality improvements leads to two mistakes. First, overall GDP is underestimated. Our calculations, for example, show that euro area GDP growth was underestimated on average by 0.7 percentage points annually in the late 1990s. However, similar quality-adjustment figures raise US growth figures in the same period by even more, so quality-adjusting suggests that the US-EU growth gap was even more pronounced than previously believed. Secondly, the sources-of-growth calculations used to prioritize Europe's pro-growth policies are skewed. Our calculations show that the contribution of the slowdown in disembodied technical progress to the overall slowdown is more pronounced after quality adjustment.

Our findings point to the need for adoption of microeconomic measures aimed at enhancing overall efficiency and boosting innovation activity. Such measures would aim at a better business environment, e.g. by easing regulatory and administrative burden and liberalizing energy and telecommunications markets.

Suggested Citation

Sakellaris, Plutarchos and Vijselaar, Focco, Capital Quality Improvement and the Sources of Economic Growth in the Euro Area. Economic Policy, Vol. 20, No. 42, pp. 267-306, April 2005. Available at SSRN: https://ssrn.com/abstract=701683

Plutarchos Sakellaris (Contact Author)

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Focco Vijselaar

affiliation not provided to SSRN

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