In other words, the laggard firms aren’t absorbing the new technology and incorporating it into their production processes to increase their efficiency, possibly due a lack of competitive pressures. But labour productivity growth not only depends on the efficiency gains of each firm in the economy. It also depends on the extent to which capital and labour are allocated to the most productive firms.
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.