The role of wages in triggering innovation and productivity: A dynamic exploration for European economies

Abstract

This paper addresses the issue of sluggish productivity growth in advanced countries and investigates its underlying causes, focusing on the direct impact of real wages. Analyzing data from 14 European countries spanning 1995 to 2018, we employ Local Projections to estimate the Sylos Labini productivity equation. Advancing our understanding of established literature, we dynamically explore the wage-productivity nexus, testing the hypothesis that higher wages enhance productivity independently of aggregate demand. Our findings indicate that wages exert a persistent and direct positive effect on productivity, both at the aggregate and sectoral levels. This effect remains stable over time, even with large changes, and is more pronounced during periods of low or negative wage growth. Moreover, higher wages prove to stimulate innovation more effectively in core countries. These findings suggest that demand-side expansionary policies would be more effective in enhancing labor productivity and long-term growth when combined with policies promoting wage growth.