While the average firm total factor productivity (TFP) growth has started to pick up in Europe after a long doldrum since the global financial crisis (GFC), we find that the recovery is not uniform. Firms operating in industries with higher level of economic sophistication have seen stronger TFP growth recovery from pre-crisis years than firms in other sectors. The recovery is stronger in emerging Europe than in advanced Europe. The strong TFP growth trend in high-tech industries (some examples include, pharmaceutics, computer, and electronics) is in line with recent studies emphasizing sizeable knowledge spillovers, particularly in emerging economies (World Economic Outlook, International Monetary Fund (IMF), April 2018). We also find that there is considerable heterogeneity even among firms within high-tech industries, suggesting that firms’ ability to benefit from knowledge spillovers differ widely even within these sectors. Particularly in emerging Europe, sizeable segments of firms still experience negative TFP growth, including in high-tech sectors. In addition, firm TFP levels have not changed much compared to pre-GFC averages. Wide within-sector TFP level and growth differentials seem to suggest that technology spillovers are not automatic. Can structural distortions, leading to resource misallocation, explain why some firms do not benefit from spillovers? Given that the relationship between competition and innovation varies with distance to frontier (Aghion and others, 2009), policies that reduce misallocation can strengthen the incentives to innovate across all firms and spread the benefits form knowledge spillovers more widely.
We shed light on key drivers of firm productivity and employment growth, emphasizing heterogeneity in economic segments, and efficiency in resource allocation, linking it to various proxies for structural gaps, such as strictness of product market regulation, competition, strictness of labor market regulation, size-based tax policies, and financial constraints.