Austerity and Productivity: Evidence from Euro Area Regions

Yao Chen, Ricardo Duque Gabriel, Mathias Klein and Ana Sofia Pessoa
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Yao Chen: Erasmus University Rotterdam
Ricardo Duque Gabriel: Federal Reserve Board
Mathias Klein: Sveriges Riksbank
Ana Sofia Pessoa: International Monetary Fund

No 26-083/VI, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We find that fiscal consolidations raise productivity significantly and persistently. In our data, a consolidation that lowers regional public spending by 1% on impact raises TFP by about 1% on impact and about 2% after two years, even as economic activity contracts. We document this using two innovations. First, we build a novel regional utilization-adjusted TFP series for Europe, covering 139 NUTS 2 regions in ten euro area countries over 1999– 2019, which corrects the Solow residual for cyclical variation in capital utilization and labor effort. Second, we isolate plausibly exogenous spending cuts with a Bartik-style instrument that interacts pre-accession regional spending shares with narratively identified national consolidation episodes. Productivity gains are larger than those observed in comparable downturns without consolidation and arise almost entirely within sectors and coincide with net exit of establishments, rather than reflecting reallocation across sectors.

JEL-codes: E32 E62 H53 (search for similar items in EconPapers)
Date: 2026-11-01
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