Technology use and employment protection

A question that is often asked with regard to productivity across countries is Why is the U.S. more productive than the E.U.? Studies have suggested that much of the difference can be explained by the wider use of information and communication technologies in the U.S. But this just raises the obvious question Why does the U.S. use these technologies more? A new column at VoxEU.org provides new evidence suggesting the answer may lie in differences in employment protection legislation.

The column, Employment protection and technology choice by Eric Bartelsman Joris de Wind and Pieter Gautier notes that until the mid-1990s, E.U. productivity had been converging towards U.S. productivity. But since then, U.S. productivity growth has accelerated and the U.S.-E.U. gap has widened. Robert Gordon is one economist who has noted this fact:

[...] since 1995 Europe has experienced a productivity growth slowdown while the United States has experienced a marked acceleration. As a result, just in the past eight years, Europe has already lost about one-fifth of its previous 1950-95 gain in output per hour relative to the United States. Starting from 71 percent of the U. S. level of productivity in 1870, Europe fell back to 44 percent in 1950, caught up to 94 percent in 1995, and has now fallen back to 85 percent. (Gordon 2007: 176).

One factor that has been put forward to explain this productivity difference is the production and use of information and communication technologies (ICT). Such activity is much lower in the E.U. than in the U.S.

Bartelsman, de Wind and Gautier continue,

Why has the adoption of the new ICT been much slower in the EU? Recent research in Brynjolfsson et al. (2008) and our latest paper (Bartelsman et al. 2010) provides evidence that the adoption of these new technologies is associated with an increase in the variance of firm productivity. For example, implementation of advanced business software like SAP and Oracle requires a new organisational structure and the outcome is inherently uncertain. The variance of firm productivity is therefore relatively large in sectors that intensively use ICT.

For a given firm, adopting a technology with risky outcomes is attractive because the benefits can be scaled up if the outcome is good, while firms can fire workers or exit if things go poorly. Essentially, the ability to close a production unit is a real option that bounds the downward risk.

But what is the role of labour market policy? Bartelsman, de Wind and Gautier explain that one major policy difference between Europe and the U.S. is that employment protection legislation is much stricter in Europe. They

[...] show that the employment share of risky (ICT-intensive) sectors is indeed smaller in the EU than in the US, and that, within Europe, high-protection countries have relatively smaller ICT-intensive sectors than low-protection countries. We then find that countries with strict legislation are relatively less productive.

Bartelsman, de Wind and Gautier go on to say,

In order to explore the mechanism and to establish how much of the US-EU productivity divergence can be explained by stricter employment legislation, we develop a two-sector matching model with endogenous technology choice, i.e. firms can choose between a safe sector with stable productivity and a risky sector with productivity subject to sizable shocks. In the absence of employment protection legislation, the risky sector is relatively attractive because firms have the option to fire workers which bounds the downward risk. Introducing legislation makes it less attractive to use risky technologies, so this establishes the negative relationship between employment protection and the size of the risky sector. Legislation also results in more labour hoarding, i.e. the productivity threshold below which a worker is fired is lower if legislation is stricter. Further, the size of the effect increases as the variance of the shocks in the risky sector increases. This explains why productivity growth is lower in high-protection countries in particular when new technologies with a high variance in profitability become available.

So no matter what your views of the origins of employment protection legislation, the research findings Bartelsman, de Wind and Gautier put forward clearly show that the economic costs of employment protection increase with change, over time, in the type of technological opportunities available, but the benefits are unaffected.

If these research results are right then I can't help but think that they have serious implication for New Zealand, and if we really want to have a "knowledge economy", and catchup with Australia, then we should not ignore such findings.

• Bartelsman, Eric J, Pieter A Gautier, and Joris de Wind (2010), “Employment Protection, Technology Choice, and Worker Allocation”, CEPR Discussion Paper 7806.
• Brynjolfsson, E, A McAfee, M Sorell, and F Zhu (2008), “Scale without mass: business process replication and industry dynamics”, Harvard Business School Working Paper, 07–016.
• Gordon, R. J. (2007). ‘Why was Europe Left at the Station When America’s Productivity Locomotive Departed?’ In Mary Gregory, Wiemer Salverda, and Ronald Schettkat (eds.), Services and Employment: Explaining the U.S.-European Gap, Princeton: Princeton University Press.