We apply the tradable-nontradable framework to evaluate the lack of convergence in labour productivity among EU Member States. Our results show that increases in overall productivity are primarily due to the tradable and not the nontradable sectors of production. The low productivity growth in peripheral EU countries before the crisis was accompanied by a sharp increase in the production of nontradables (i.e., nontradable goods and services) relative to other EU countries. We identify differences in the legal systems and the quality of public institutions, among others, as factors relevant for explaining the observed productivity growth differentials. Our findings have implications for the European Commission's macroeconomic imbalance procedures since the tradable-nontradable approach allows identifying patterns of real divergence on a disaggregated level.

While all EU economies witnessed a sharp decline in output during the financial crisis, the peripheral EU countries were particularly hard hit. This is surprising, given their sound macroeconomic performance prior to the crisis. It became obvious that imbalances had been building up underneath a seemingly tranquil macroeconomic surface. We argue that the underlying mechanisms are mirrored by productivity developments in a tradable-non-tradable framework. Countries that were severely affected not only exhibited low productivity growth in tradables (e.g., manufacturing), but also experienced a sharp increase in the production of non-tradables (e.g., real estate) before the crisis.