The EU’s fixation on productivity growth
In recent years, productivity growth has been elevated to a central policy objective within the European Union, embraced by both economists and policymakers. This trend has been reinforced by Mario Draghi’s influential report on the future of European competitiveness. Draghi emphasises the urgent need for faster productivity growth in the face of unfavourable demographic trends, so that Europe can sustain its social model while strengthening its position in technology and climate policy.
Since its release, the report has significantly shaped EU policy. Yet amid this growing sense of urgency, a more fundamental question risks being overlooked: productivity of what, and to what end? Productivity growth is often treated as an objective in itself, despite the fact that it measures only a narrow dimension of economic performance. Higher productivity does not automatically translate into broader social progress or ecological sustainability.
In this insight, we argue that productivity should remain a means to an end. That end, in our view, should be human wellbeing within planetary boundaries. Productivity increases can help, but are far from a silver bullet to get Europe there.
What is productivity?
Productivity, in economic terms, usually refers to how efficiently inputs (labour and capital) are used to produce outputs (goods and services). The most common measure is labour productivity, often expressed as output per hour worked. Another frequently used measure is total factor productivity (TFP), which captures the portion of output not explained by the amount of measured inputs, usually labour and capital.
In other words, productivity measures how much commercial value is generated per unit of measured input. If productivity grows, more goods or services can be produced with the same amount of labour and capital. As such, productivity growth is often seen as a key driver or even the holy grail of economic growth, higher wages, and improved living standards.
However, as said TFP generally only focuses on labour and capital as inputs. This means analyses based on TFP overlook the depletion of natural resources and environmental and social externalities that are not (properly) priced in markets, such as pollution, biodiversity loss, or unpaid care work.
More fundamentally, higher productivity may contribute to higher GDP, but this does not automatically translate into greater wellbeing. Mainstream economics generally uses GDP as a proxy for success, based on the assumptions that rational consumers earn and spend money to maximise utility (wellbeing), and that a society’s wellbeing is the simple sum of all individual’s wellbeing. However, GDP was never intended to be a wellbeing indicator.
The main shortcomings of GDP in capturing wellbeing are that the measurement excludes all non-monetised forms of value (such as a nice walk in the sun), while it includes and commensurates all legal monetised value (including both watermelon and watermelon-flavoured vapes, for example), disregards ecological damage and is blind to the distribution of consumption, too.
The pitfalls of international productivity comparisons
International comparisons of productivity are often used to identify best practices. Countries with stronger productivity growth (with often a focus on the internationally competitive sectors) are presented as models to learn from. But such comparisons fall short for several reasons:
1. There is no universal recipe for productivity
Differences in productivity between countries do not arise solely from policy and business choices such as investment in R&D or capital deepening. On the contrary, economic development is shaped by numerous factors: from a country’s history and culture, to its geography and natural resources, to the quality of its institutions and education. These factors interact in complex ways and evolve over long periods of time, creating path dependencies.
On top of that, the way a country is embedded in the evolving global economy, such as which parts of which value chains it currently occupies, affects how productivity might be gained or lost. As a result, economic structures are not easily replicable. Policies that are effective in one context may yield very different outcomes elsewhere, even when implemented with similar intent.
2. Social policy trade-offs are often overlooked in comparisons
Even if one assumes that elements of another country’s economic model can be replicated, productivity outcomes are typically the result of broader policy choices that involve trade-offs. International comparisons tend to highlight outcomes while paying less attention to what may have been given up to achieve them. For example, higher productivity growth has been associated with more limited job security, lower taxes have been found to boost growth, and generous (early) retirement provisions make highly skilled workers leave the labour force earlier; too early from a productivity perspective.
These differences in how countries structure their market, public and welfare domains, sometimes called Varieties of Capitalism, affects a range of social outcomes. Countries with stronger welfare states might, for example, see a more equal income distribution. These varieties of capitalism are also related to countries’ growth models and, by extension, productivity development. Analysing how productivity might be increased without paying attention to these other relevant socioeconomic dimensions will always fall short.
Comparing the US and EU: What do different types of productivity measures tell us?
A recent study on the productivity gap between the European Union and the United States illustrates the importance of how exactly productivity is measured. Over the past three decades, the EU’s hourly labour productivity has fallen behind the US across several metrics. Measured in real purchasing power parity (PPP) terms, the gap increased from around 27% in the late 1990s to roughly 38% by 2024. In plain nominal terms, the divergence is even larger. However, when measured in nominal PPP terms, the gap has remained broadly stable since around 2010.
This divergence across indicators highlights that different productivity measures capture fundamentally different economic realities. Real PPP-adjusted productivity, which is for instance used in the Draghi report, reflects change in an economy’s productive capacity, i.e. what it can produce. Nominal productivity on the other hand is best used when measuring a country’s international economic power, as it shows its purchasing capacity on global markets. And nominal PPP-adjusted productivity seems to be the best proxy for living standards, taking into account cost differences between countries.
One possible explanation for the stable productivity gap since 2010 in nominal PPP-adjusted terms is that productivity gains in the US have not (fully) translated into lower prices for domestic consumers, therefore not improving living standards compared to Europe. Another is that households in Europe and elsewhere have benefited from these productivity gains to a similar extent, which seems likely as digital goods and services, which have been the main driver of US productivity growth in recent years, are easily diffused globally.
3. Not all productivity (growth) is equally desirable, because ecological factors are excluded
A narrow focus on productivity levels can obscure important qualitative differences between sectors. High-productivity activities may also be energy-intensive, environmentally burdensome, or strategically vulnerable. Strengthening such sectors may improve aggregate productivity statistics, but not necessarily long-term economic resilience or sustainability.
By focusing on productivity growth, a more fundamental question is ignored: which types of economic activity should be prioritised, and how should trade-offs between productivity, sustainability, and strategic autonomy be managed?
As an example, we can have a look at the rapid rise of Artificial Intelligence (AI). There are high expectations for productivity increases coming from AI, but what is often overlooked in the cost-benefit analysis is that AI data centres are very capital- and energy-intensive, and require a lot of water for cooling.
This omission is partly due to the narrow definition used for productivity generally. Productivity analyses usually focus on labour productivity or total factor productivity, a combination of how much labour and capital are involved in the production process. What is lacking or underrepresented in these measures are the use of energy and material. Sometimes the financial cost of energy does get included, but not the full social cost.
Including these factors in productivity calculations actually shows that genuine productivity increases – where an economy produces more commercial value with the same inputs across labour, capital, energy and material – were historically much lower than an increase in productivity as is conventionally measured. Therefore, an orientation towards labour or total factor productivity without including energy and material use can never turn Europe into the ‘beacon of climate responsibility’ that the Draghi Report claims we should be.
4. Europeans should think as a union, not as 27 countries
Productivity comparisons are typically made at the national level, implicitly assuming that each country should aim to maximise its productivity. In integrated economic areas such as the European Union, however, this perspective can be misleading. As emphasised by Mario Draghi, economic strength at the European level depends not on uniformity across countries, but on effective specialisation and coordination. Differences in productivity between countries could therefore be due to a functional division of tasks rather than wasteful inefficiencies.
This perspective shifts the focus from imitation to cooperation, and from national benchmarking to collective outcomes. To assess whether a country in Europe should aim to become more productive, we should assess whether its industrial structure fits in a futureproof Europe first. Based on that, we can then compare whether these sectors are as productive as they could be.
Furthermore, to embed the ‘One Europe’ idea in our macroeconomy and break the race to outcompete each other as countries, we need fiscal integration, at least for the eurozone. The monetary union has closed the possibilities for differences in productivity (growth) to be equalised through the exchange rate. This currently leaves only internal devaluation (a relative lowering of wages and prices, which is socially only feasible in recession) as a way to rebalance productivity differences.
If we accept productivity differences between countries due to strategic specialisation, which would be sensible, then a permanent fiscal capacity that channels tax contributions from the more to the less productive countries is the social solution.
That said, the assumption highlighted by amongst others Draghi that productivity growth helps to pay for our welfare states is not always valid. That only works if we see tax base increases, i.e. if we see more labour income as a result of productivity gains. Looking at for instance AI, this is questionable, as AI could well mean that labour gets replaced with AI, so we start to work less. The benefits of the efficiency gains flow to the shareholders, and the tax base for capital is lower.
5. Productively destroying the planet we all depend on?
Lastly and perhaps most fundamentally, increasing productivity only makes sense if we use the gains to work less, not to produce more. Economic growth is a major ecological problem, and getting our economy back within planetary boundaries requires a downscaling of production and consumption.
By definition, if labour productivity increases and working time remains constant, total production will increase. So, increasing labour productivity can actually deepen ecological overshoot, unless we find ways to equitably reduce working time. It might be possible and desirable to increase productivity and reduce average working times, but this will probably require a reform of labour markets and social security systems first.
Moving beyond productivity as an end in itself
We just listed five reasons not to focus on productivity exclusively for economic strategy. That does not mean productivity is useless. Producing goods and services with fewer inputs, through smart innovation, has indeed been a big driver behind the increase in living standards of the past two centuries. Yet, we need to start by recognising that economies are complex phenomena, shaped by the interaction of environment, history, culture and institutions in which they exist. This makes that simple recipes for productivity growth are hard to transpose across countries. We also believe that Europe should think as a union, which might include some ‘low’ productivity countries.
More fundamentally, before chasing productivity growth, we need to discuss what productivity we need. Crafting an economy that enables a high quality of life for all within planetary boundaries requires a lot more than productivity increases in the conventional sense. The productive side of the economy is always linked to the social side. Increasing production by sacrificing welfare states is unlikely to help wellbeing. On the ecological side, a proper interpretation of productivity would include energy and material use. That automatically calls into question what many current productivity comparisons tell us. Finally, productivity only helps wellbeing if we find a way to reduce working time, rather than producing more with our productivity gains.
Overall, we should keep in mind a crucial question when discussion productivity: productivity of what, and to what end?
