Beyond borders: how spillovers and commercial networks shape European productivity

Abstract Understanding the drivers of economy-wide productivity growth has long been of interest to academics and policy makers. In this paper, we contribute to the literature by conducting a comprehensive analysis of the impact of technical change and catch-up on economic development in European regions. In doing so, we differentiate the internal productivity growth of each sector from the external spillover effect across both regions and sectors. As our study is much more granular than previous studies, we provide fundamental information for regional and national agencies to design effective policy measures aiming to stimulate regions' economic growth. We model the spatial interdependencies among the European regions using inter-regional and inter-sectoral input-output tables from the EUREGIO database. Our empirical application shows that the trade-related spillover effects cannot be disregarded, and that neglecting them would hide part of the explanation behind changes in productivity across regions. We conduct various counterfactual analyses to demonstrate this augmented impact of the trade network. We also simulate the regional TFP improvements due to digitalization, as well as the propagation effects of the financial crisis and the downturn in the construction sector. These analyses reveal how more traditional approaches that overlook these indirect effects tend to underestimate the true impact of positive and negative shocks on regional productivity growth. Our findings could serve policymakers as the ground for building a categorization of regions based on their presence in trade networks.