In some key areas Europe is ahead of the United States in the application of digital technologies, but it lags far behind the US in overall productivity. Robert Atkinson, outlines the reforms needed to make digital Europe work better
For many years after World War II, productivity grew faster in Europe than in the United States. But in 1995 the Americans moved ahead and US productivity accelerated from an average of 1.6% per year to 2.7% by 2005. Europe's declined from 2.3% per year to 1.4%. So can Europe regain its old momentum? The key will be the more widespread use of information and communication technologies (ICT). Europe will have to put digital transformation at the centre of its economic policies for trade, technology, competition, the labour market and regulation.
Higher productivity is central to economic growth. The US productivity boost after 1995 increased America's gross domestic product (GDP) by more than $1,900bn, and ICT is credited virtually all of the growth in labour productivity between 1995 and 2002.
If the EU-15 nations had been able to maintain their old productivity, their combined GDPs would be more than €1,100bn greater today. If EU productivity could grow over the next 25 years at its old rate of 2.3% per year, the economy would be 25% larger than its current growth rate promises. Boosting productivity would also help address two of the major challenges facing Europe − creating more wealth to meet the costs of its ageing population, and the investment needed to deal with global warming.
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In some areas Europe is ahead of the US in the use of ICT, including broadband, banking, smart cards and health care. Denmark, Finland, Iceland, the Netherlands and Sweden are among the world leaders in broadband. Europe leads in the use of ICT for road congestion pricing, and the Netherlands and Denmark have made significant advances in e-health. An overwhelmingly large share of banking transactions in EU newcomers like Estonia is done on the internet.
But overall, Europe has not gained the same level of benefits from ICT achieved by the United States. In sectors that use ICT intensively like banking and retailing, productivity growth in the EU-15 has changed little since the early 1990s, while American stores and banks have seen a sharp acceleration in their productivity. Here we have a puzzle. Europe, like the United States, has experienced the ICT revolution and ICT investment by companies in France, Finland, Germany, Italy, Switzerland and the United Kingdom, have had a significant effect on productivity.
Why then has Europe not benefited as much as the United States? There appear to be two key reasons. First, European companies as a whole, particularly in the service sector, generally invest less in ICT than their American counterparts. Among 19 of the OECD nations, the United States ranked second in investment in hardware, software and telecommunications as a share of fixed capital investment, with rates 50% or more above other nations. Finland came first, but that doesn't alter the overall picture for Europe.
Second, compared to American companies, EU ones appear to make less "re-engineering" changes and fewer of the organisational ones needed to get the maximum benefit from ICT investments. It's not entirely clear why this process appears to be less developed in Europe, but some evidence suggests that it may be related to different managerial practices and regulatory and cultural constraints.
Policymakers must send clear signals that all organisations, whether business, non-profit or government, need to take full advantage of the ICT revolution to increase productivity growth. This means placing relatively less emphasis on creating and supporting robust global competitors, particularly in the high-tech sector, and more on boosting ICT usage in all sectors, including those that are less traded globally, such as government, and distribution, retailing and financial services. It is through productivity growth in these and other sectors, rather than by marginally increasing employment in a few high-tech firms, that Europe will realise the greatest gains in productivity and income.
A number of significant corrections to existing policies are now needed. These should start with a re-thinking of the misguided decision by the European Union to re-classify a number of information technology (IT) imports so that they are no longer covered by the World Trade Organization's Information Technology Agreement (ITA). Even though the ITA affords zero-tariff status to most high-tech products, the EU is imposing duties at the border as high as 14% on a growing number of IT products, including multi-function printers, set-top boxes and liquid crystal display (LCD) computer monitors. Worse yet, the EU is looking to move additional products out of ITA coverage, including PDAs with additional functionalities. It justifies its action because these products have undergone some kind of innovation.
Even if these tariffs give European manufacturers some modest benefit, they make ICT goods more expensive and thereby further reduce relative ICT investment. It has been estimated that for every 1% drop in price in IT products, there is a 1.5% increase in demand, so for Europe to impose high tariffs on a host of ICT-based products is a path to lower, not higher, productivity.
Regulations that limit the use of ICT have to be reduced. Well-intentioned EU policymakers all too often consider laws and regulations that would slow digital transformation. Moves to over-regulate internet privacy limit the emergence of dynamic business models that offer considerable benefits to consumers. Efforts to regulate radio frequency identification technology (RFID) under the guise of privacy protection slow the deployment of a technology that promises dramatic productivity improvements, particularly in two of the sectors where Europe lags behind: wholesale and retail distribution. Proposals to regulate internet telephony and internet video content (the EU's Television without Frontiers Directive) in ways akin to the current legislation of circuit-switched telephony and over-the-air TV would have similarly deleterious effects on their deployment.
Forty years ago, American economist John Kendrick studied the main drivers of growth and wrote: "Technological changes upon which productivity gains rest are bound to have a more or less disruptive influence on individuals and institutions." It is no different today. To gain the full benefits of the digital revolution means that nations must accept and even embrace the kinds of transformation and restructuring enabled by IT. It is only through this that the full economic benefits will be realised. Yet, too many firms, civic groups and policymakers in Europe appear to want the benefits of the ICT revolution without the disruption.
Catching up with the US in productivity growth will require at least a greater acceptance of change. Among other things, this means dismantling laws and regulations protecting powerful entities against competition from emerging new on-line competitors. It means making sure that labour market rules do not thwart companies intent on restructuring. And it means ensuring that companies, especially those serving their customers on-line, have access to all the European market. Europe's product markets are still not fully integrated, making it harder for EU businesses to use IT to gain the economies of scale that their US competitors enjoy.
Europe has lagged behind the United States in its transition towards a fully digital economy and society, but it possesses numerous advantages that could yet help it to leap-frog ahead. Its stronger social safety net of universal health care and benefits for displaced workers, for instance, should enable Europe to more easily accept the dynamism and accompanying churning implicit in restructuring. Its willingness for governments to play a partnership role in economic policies allows Europe to experiment with policies to spur digital transformation in various sectors. The next phase of digital transformation will by necessity require public-private partnerships, especially in areas where government is already involved like health care, education, transportation, housing and construction, and financial services. In contrast to the United States, where there is often less support for these kinds of public-private partnerships, Europe is not as burdened by such pre-dispositions. This is perhaps one reason why a number of European nations lead the United States in broadband and health IT.
The emerging digital economy has produced enormous economic and social benefits, but the best is yet to come. Now it is up to EU policymakers is to ensure that the policies and programmes they put in place spur digital transformation, so that Europe's citizens can benefit fully.
