This paper shows that the European productivity slowdown is attributable to the slower emergence of the knowledge economy in Europe compared to the United States. We consider various explanations which are not mutually exclusive: for example, lower growth contributions from investment in information and communication technology in Europe, the relatively small share of technology producing industries in Europe, and slower multifactor productivity growth (which can be viewed as a proxy for advances in technology and innovation). Underlying these explanations are issues related to the functioning of European labor markets and the high level of product market regulation in Europe. The paper emphasizes the key role of market service sectors in accounting for the productivity growth divergence between the two regions. We argue that improved productivity growth in European market services will be needed to avoid a further widening of the productivity gap.