Here, again, there are signs of underperformance in the euro area, particularly in the non-tradable sectors.4 Recent research suggests that this misallocation of capital and labour is trending upwards in many euro area countries.5 In conclusion, therefore, the euro area’s poor productivity appears a result of poor diffusion of technology from the frontier to other firms, and from an inefficient allocation of capital and labour to relatively low productivity firms.
Such factors are fortunately more receptive to structural reforms than innovation, which is harder to institute. There are two main areas that need to be addressed. First, barriers to knowledge diffusion need to be brought down. This includes fostering a competitive business environment that encourages the adoption of the best management techniques and organisational structures.