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September 5, 2005

Report attacks Europe’s poor record in information technology

Policies that inhibit the productive use of information and communications technology are at the heart of Europe's relative economic decline over the past decade, according to a hard-hitting new report submitted to the European Union.

By CBR Staff Writer

After 50 years of catching up with the US, European productivity growth has slowed and is now falling behind, says the report by London, UK-based Indepen Consultants Ltd. The puzzle given that ICT is more or less available to all globally, is why Europe as a whole has invested less in ICT and gained still less in terms of productivity and growth relative to other economies which have made more effective use of ICT.

In contrast, it says that during the previous 50 years Europe demonstrated a capacity for rapid economic and social advancement. Policies that once worked are no longer working, it argues.

The report says that between 1996 and 2000, ICT contributed almost three times as much to annual growth in US labor productivity than was the case in Europe. As a share of overall productivity growth, ICT contributed 42% in the 15 core EU states and 80% in the US.

Within the EU, the Central and Eastern European accession countries have had substantially higher productivity growth than the core EU countries since 1995, and are expected to continue to grow at roughly double the rate of the core 15 states the next five years, partly driven by investment in ICT.

Indepen says that higher productivity growth in the US that is attributable to ICT was achieved even though the ICT sector itself comprises a similar share of GDP to that in Europe. However, the share of ICT investment as a share of overall private investment was approximately 50% higher in the US than in Europe. Business invests more in ICT in the US, and it gains a larger productivity payoff per unit of investment.

ICT is having a disproportionate impact in terms of investment and productivity growth relative to the size of the sector, particularly in the US. This reflects the fact that ICT is diffusing throughout the economy, and offers high returns where the policy environment allows complementary investments in organizational change to be implemented successfully.

The report sees historical parallels with other general-purpose technologies such as steam (and rail) and electricity, where wide-ranging impacts on the economy and society resulted even though the sectors themselves did not form a large part of the economy.

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Within Europe, it says that productivity performance converged in the first half of the 1990s and diverged in the second half. A study by the European Commission showed the slowdown in productivity for Europe as a whole in the mid-1990s resulted from the performance of the four large European countries: France, Germany, Italy, and Spain.

The report says ICT is not a bolt-on. The productive and profitable use of ICT requires changes in the organization, management, and the location of activities. In a passage that will chill the blood of the political establishment in countries such as Germany and France, it says change will involve the entry and exit of firms, the hiring and firing of labor, and the need for more general-purpose skills.

Using a term coined by the economist Joseph Schumpeter, it says the productive and profitable use of ICT requires creative destruction. Fundamental change is required to benefit fully from ICT, and greater investment in ICT capital and skills alone in the current European environment would deliver poor returns.

It says differences in the payoff within Europe and between Europe and other regions post-1995 points to a premium on economic flexibility. The US, with its more flexible economy, has invested more in ICT and gained more in terms of productivity per dollar invested in ICT than Europe. There is also a negative relationship between productivity growth in ICT-intensive using sectors and employment law rigidity.

It says European expectations and policy have been shaped by post-war productivity catch-up with the US at a time when creative destruction may have mattered much less to economic progress. European economies have not obviously suffered from significantly lower growth due to structural rigidities in the past.

However, it says that position changed abruptly in the mid-1990s. It says the challenge for policy makers is to ensure that regulation does not impede creative destruction and that there is a rapid response in terms of skills requirements. Barriers to the reallocation of labor, including undue restrictions on hiring and firing and impediments to labor mobility, should be lowered. Barriers to the creation and destruction of firms and to market integration should also be lowered in order to allow innovation and creative destruction to flourish and to enable economies of scale to be exploited in relation to ICT use.

The report, commission by the UK’s Department for Trade and Industry, is part of the debate surrounding the EU’s i2010: European Information Society 2010 initiative, designed to foster growth and jobs in the information society and media industries.

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