Total Factor Productivity in the EU - Direct and Indirect Impact of Labor Market Institutions

Total factor productivity is an essential determinant of long-run growth. Given the dissatisfactory evolution of TFP in member states of the EU, determination of key factors of productivity growth is essential for better economic performance of member states. The goal of the paper is to quantify direct and indirect impact of labor market institutions and knowledge on total factor productivity growth in member states of the European Union with emphasis on their interactions. By means of least square dummy variables panel data regression, the impact of R&D, human capital and five institutions on total factor productivity growth is estimated. Empirical analysis is conducted on dataset covering observations for 28 member states over 1998-2016. Regression results approve the theoretically expected productivity enhancing effect of knowledge and indicate significantly negative impact of labor market institutions on TFP growth. Besides direct effects, labor market institutions negatively influence productivity growth via their impact on human capital and R&D. Therefore, policy measures that support knowledge accumulation and reform current institutional set up on labor markets are essential for boosting productivity growth in the EU.