In this paper, I use a four-sector general equilibrium model with labour market rigidities to seek fresh insights into how and to what extent sectoral productivity growth drives sectoral reallocation and the relative labour productivity gap between Europe and the U.S. Using the Groningen Growth and Development Centre 10-sector database, I calibrate the model to the U.S. economy in an attempt to identify the forces at work during the pre-1995 period of convergence and what effectively went wrong during the subsequent period. I also perform a series of counterfactual experiments that seek to quantify the pace of sectoral productivity growth that Europe needs to sustain to be able to close the productivity gap with the U.S. and what kind of alteration in the sector reallocation this would entail.
Why do I take this approach? First, I focus narrowly, albeit more deeply, on the relative Europe-U.S. productivity gap because the recent development of the European productivity performance offers an intriguing counterpoint that continues to exercise the minds of researchers and policy makers. This divergence is even more puzzling in light of the similarities in the economic fundamentals—both economies experienced a remarkable upsurge in the late 1990s while unemployment and inflation remained unusually low. Second, in searching for clues, I adopt an approach that brings together different strands of the literature, with the notion of structural change as a common theme.