What drives TFP long-run dynamics in five large European economies?

The aim of this paper is to study the long-run cointegrating relationship of TFP in a panel of five large European economies, namely France, Germany, Italy, Spain, and UK. We test whether TFP is determined by the so-called “capital misallocation effects, scale effects, and labor market effects”. By considering aggregate data, over the period 1983–2017, we employ dynamic panel cointegration techniques to identify the long-run component of TFP. We get two main results. First, the interest rate, the real compensation and the real exchange rate have a positive impact on TFP. Then, the incidence of temporary employment (a proxy of labor market flexibility) has a negative effect on TFP. Moreover, for robustness, we run a panel VECM to check for causalities among the variables. Notably, this further excercise confirms the existence of a strong and positive long-run relationship between TFP and prices. We conclude that coordinated policies on the issue of interest rate, exchange rate, labour cost and regulation, may allow to reassemble the productivity slowdown puzzle and strengthen the European economic structure.