Regulation, Competition and the Productivity Puzzle in Europe’s Service-Based Economy

The OECD and Vrije Universiteit Amsterdam study finds that strict and fragmented product market regulation in EU services weakens productivity growth by blocking competition, limiting foreign productivity spillovers, and slowing the movement of workers toward more productive firms. It concludes that lowering entry barriers and deepening the Single Market for services are essential to revive business dynamism and long-term economic growth in Europe.

Produced by economists at the OECD Economics Department, with academic input from Vrije Universiteit Amsterdam, this paper looks at a central weakness of the European economy: slow productivity growth in services. Services account for the bulk of EU jobs and economic output, yet they have not delivered the productivity gains seen in manufacturing or in the United States. Despite digital technologies, growing ICT sectors, and decades of EU integration, many service industries remain fragmented along national lines. The authors argue that restrictive product market regulation, rules that limit competition, entry, or expansion, is a major reason why Europe’s services sector underperforms.

A widening gap between productive and lagging firms

Using firm-level data for more than four million companies across 21 EU countries from 2000 to 2021, the study shows that productivity differences between firms have grown wider over time. Highly productive “frontier” firms are pulling further ahead, while the share of low-productivity firms has increased, especially after the global financial crisis. This means that gains from innovation are not spreading efficiently across the economy. Although knowledge-intensive services such as ICT and professional services have grown, they have not been able to compensate for the long-term decline of manufacturing, which traditionally delivered strong productivity growth.

How regulation blocks productivity spillovers

To identify the impact of regulation more clearly, the authors use an innovative approach. They examine productivity spillovers from US multinational companies to their EU subsidiaries. Productivity improvements in US parent firms, such as better technologies or management practices, are treated as external shocks. If EU markets work well, these gains should spread to local firms. The study finds that this does happen, but only where regulation is relatively light. In countries and service sectors with stricter product market regulation, the productivity spillovers are much weaker and can even disappear entirely. High regulation in sectors such as professional services, retail, transport, and network industries often blocks these gains.

Entry barriers are the biggest problem

Not all regulations are equally harmful. The paper finds that barriers to entry are the most damaging. Complex licensing systems, heavy administrative requirements, and restrictions on service provision reduce competition and weaken firms’ incentives to improve. These rules make it harder for new, innovative firms to enter the market and for existing firms to expand. By contrast, rules related to trade and foreign investment play a smaller role. Importantly, the negative effects of regulation apply to both large and medium-sized firms, showing that even established companies struggle to benefit fully from global productivity gains in highly regulated environments.

Slower labour reallocation and weaker dynamism

The paper also looks at how workers move between firms. In a healthy economy, more productive firms grow faster and hire more workers, while less productive firms shrink. This reallocation is essential for overall productivity growth. The authors find that this mechanism has weakened significantly in the EU. In the early 2000s, a rise in firm productivity led to strong job growth. By the late 2010s, this link had become much weaker. Stricter product market regulation plays a key role in this decline. Administrative burdens and regulatory complexity make it costly for productive firms to expand, slowing hiring and keeping workers stuck in less efficient firms. While labour market rules also matter, product market regulation has a clear and independent effect.

What this means for EU policy

Taken together, the evidence paints a consistent picture. Europe’s services sector is held back not by a lack of technology, but by rules that limit competition and flexibility. Fragmented national regulations weaken productivity growth, reduce the spread of innovation, and slow the movement of labour to its most productive uses. The authors conclude that pro-competition reforms, especially those that lower entry barriers and simplify administrative procedures, could deliver significant productivity gains. Strengthening the Single Market for services is therefore not just a regulatory goal, but a central requirement for improving Europe’s long-term economic performance.