Unwrapping Some Euro Area Growth Puzzles: Factor Substitution, Productivity and Unemployment

We estimate a long-run supply-side system incorporating a CES function with timevarying factor-augmenting technical progress for the euro area over the period 1970-2005. We find that the elasticity of substitution lies below unity at 0.7, that labour-augmenting technical progress is dominant in the long-run while capital-augmenting technical progress plays an important role in the interim. We also find evidence for a structural break in the pattern of biased technical progress at the end of the 1990s. Our results help to solve two puzzles in Europe's recent growth experience which differ extremely from the US experience. The first puzzle is related to the effects of the IT boom in the 1990s on productivity growth in Europe. The second puzzle concerns the changes in the "Okun's law" relationship, linking growth to the reduction of unemployment, which are observable in Europe since the late 1990s.