Capital intensity and growth in the European Union

Abstract

This paper concludes that more rapid growth can return to the Europe Union (EU) in the future only if member countries can return the efficiency to that they had in converting gross capital formation into the growth of GDP during the 2000–2007. A few countries, such as Germany, have done that and are now growing even faster than before the 2008/2009 recession. It is a mistake, however, to think of efficiency purely in terms of automation. Investment in new machines (which increase the capital/labor ratio) may even lead to slower growth because in most EU countries the output elasticity with respect to labor is higher than the elasticity with respect to capital. Italy will start growing again if its firms start hiring and stop thinking in terms of substituting more capital for labor. If firms avoid hiring because of rigidities in the labor laws which were implemented under previous governments, these must be reviewed and revised.