Productivity growth in the euro area

We explain total factor productivity (TFP) growth in the euro area, using a constant elasticity of substitution (CES) production function which allows for technical progress to increase the efficiency of both labour and capital. Our results suggest that the elasticity of substitution (i.e. the elasticity of the demand for labour and capital with respect to their relative price) lies in the 0.6-0.7 range and that – until the late 1990s – technical progress increased labour efficiency at an approximately constant rate, while that of capital tended to decelerate. However, thereafter we find a structural break in TFP growth which we attribute to “directed technical change” in favour of capital. This may shed light on the puzzling deceleration in average labour productivity as well as TFP growth that took place from the late 1990s until recently. JEL Classification: E2