A European industrial policy for services: the Single Market

Industrial policy is back on the European agenda. Inside the European Commission headquarters, policy makers are fiercely discussing the instruments, sectors, and ways of funding for a new European industrial policy. Many parts of the economy could potentially be targeted with the aim to raise a country’s competitiveness through industrial policy. In Europe’s case, it ranges from 5G to the new green deal.

Yet, the number one factor that has the strongest track record of supporting Europe’s economic prosperity and consequently should be the focal point of any industrial strategy is absent in this debate: the EU single market.

A common fallacy in every debate about industrial policy is the obsession with the manufacturing sector. Granted, manufacturing is a highly productive activity which supports relatively well-paid jobs for skilled and unskilled workers. The sector has historically produced many innovative ideas that spilled over to the rest of the economy. And, manufacturing goods are easy to trade. This in turn allows for further specialisation whilst rising productivity, which increases living standards in the long run.

However, it would be entirely wrong to stick to this manufacturing mania. These days most jobs are in services, not in manufacturing. More importantly, because of the tremendous growth of digital networks and technologies, many services have experienced an enormous boost in productivity, tradability and know-how. In a recent study, we show that services sectors such as information services, telecommunications, and business services are at least as productive as manufacturing.

Therefore, making a fuss about the risk of de-industrialisation has become increasingly futile. This is not only because services can be as productive and innovative as manufacturing. It is also because many manufacturing companies no longer produce goods but sell services instead. IBM used to be a computer maker but now mainly produces digital solutions. Moreover, services – many of them delivered digitally – are a critical input that shapes the competitiveness of Europe’s manufacturing sector.

But, changing EU policymakers’ fixation with manufacturing is only one part of the story. Our study also shows that in order to unleash the full potential of Europe’s services economy, firms need to embrace digital technologies such as software, electronic invoices and cloud computing. Increasing the rate of technology absorption is not an easy task, however. Adopting new technologies is costly, and to do it, companies need the right set of incentives and rewards.

And this is exactly where the EU single market has an important role to play. Companies will only adopt digital technologies if they are compelled by market forces. Unfortunately, regulations in the digital economy and services sectors themselves all too often prevent foreign firms and technologies from contesting domestic markets. If markets are protected, particularly the low performing firms will enjoy their comfortable place. And why would any firm invest in digital technologies and change their business models when governments allow them to stay in their comfort zone?

Indeed, our study finds that closed services markets and restrictive rules on technologies are associated with a lower take-up of digital technologies. Besides, our report also finds that in many services sectors only a handful of companies capture most of the revenue. In short, market structure in services are often distorted. For instance, the market for business services shows a few dominating firms with many smaller firms left behind. Our study finds that the benefits of investing in digital technologies in such skewed markets are entirely wiped out by the lack of market competition.

If European policymakers want to be serious about the discussion on industrial policy, they should consider putting back the EU single market in services at the core of that strategy. Moreover, any push for the diffusion of digital technologies into the wider European services economy will also help to boost manufacturing productivity, removing the need to pick winners and avoiding any difficult discussion on who needs more industrial policy funding.

This would be the best industrial strategy to help Europe’s economy – both manufacturing and service – to thrive again.

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This blog was originally published by Encompass on March 4 2020