ES (02/2024) From laggard to leader? Closing the euro area’s technology gap

Question 1

[Europe’s lost IT revolution]

How did Europe’s productivity compare to that of the United States after World War II?

Answer 1

After World War II, the productivity in Europe, particularly in the four largest economies of the euro area, rapidly increased, closing the productivity gap with the United States from 25% in 1945 to 100% by 1995.

Question 2

[Europe’s lost IT revolution]

What changed in the productivity growth trend of the euro area compared to the United States after 1995?

Answer 2

Between 1995 and 2007, while annual growth in GDP per hour surged in the United States, it slowed and diverged in the euro area, leading to a productivity ratio of 0.8 relative to the United States by 2008, indicating a significant loss in productivity.

Question 3

[Europe’s lost IT revolution]

What are considered the main reasons for the euro area’s loss of competitiveness in recent decades?

Answer 3

The euro area’s loss of competitiveness is largely attributed to European firms’ failure to capitalize on the efficiency gains offered by information and communication technologies (ICT), impacting both capital stock and total factor productivity.

Question 4

[Europe’s lost IT revolution]

How did investments in ICT transform the economy of the United States compared to Europe?

Answer 4

Broad-based investments in ICT transformed the US economy, especially the services sector, by making ICT a general-purpose technology that radically changed business operations and customer service, leading to an average annual productivity growth of 3.2% between 1995 and 2005, compared to just 0.9% in Europe.

Question 5

[Europe’s lost IT revolution]

What is the current debate regarding the impact of recent technological innovations on productivity?

Answer 5

There is a debate over whether the most recent technological innovations are less revolutionary compared to past inventions like the railway, electricity, or the telephone, or whether the full benefits of technologies like AI have yet to be realized due to slow adoption rates.

Question 6

[Europe’s lost IT revolution]

Why have firms in the euro area struggled to benefit from the ICT revolution?

Answer 6

The struggle of euro area firms to benefit from the ICT revolution is attributed to slow technology diffusion within the economy, preventing firms from fully leveraging new technological advancements to enhance productivity.

Question 7

[The role of competition and capital markets]

How does the business environment in the United States differ from the euro area in terms of fostering investments in ICT?

Answer 7

The business environment in the United States is less regulated, making it easier or more necessary for firms to invest in Information and Communication Technologies (ICT), compared to the euro area, where product and labor markets often remain heavily regulated with high barriers to entry.

Question 8

[The role of competition and capital markets]

How productive are younger firms in the euro area compared to their older peers, and what contributes to this productivity?

Answer 8

Younger firms that survive in the euro area are on average almost three times as productive as their older peers. Much of this productivity gap is explained by young “superstar” firms, which increase their productivity by around 100% per year, invest significantly in intangible assets, and employ fewer, more specialized workers.

Question 9

[The role of competition and capital markets]

What trends have been observed in the manufacturing sector regarding firm demography and productivity?

Answer 9

In the manufacturing sector, a marked decline in productivity growth among high-tech frontier firms over the past decade coincided with a slowdown in business dynamism and an increase in the average age of these firms, which is now about 50% higher than before the global financial crisis.

Question 10

[The role of competition and capital markets]

How does firm size influence investments in ICT and what challenges do smaller firms face?

Answer 10

Firm size is crucial for driving investments in ICT as the fixed costs related to process reorganization disproportionately affect small and medium-sized enterprises, which may struggle with the financial burden of these investments.

Question 11

[The role of competition and capital markets]

What impact do administrative thresholds have on the growth of younger firms in the euro area

Answer 11

Administrative thresholds, such as labor laws that become applicable when a firm exceeds certain size limits (e.g., 50 employees in France), prevent younger firms from expanding and reaching a size where they can compete more effectively and benefit from economies of scale.

Question 12

[The role of competition and capital markets]

How does the employment distribution between large and small firms in the euro area compare with that in the United States?

Answer 12

In the United States, firms with more than 250 employees account for almost 60% of total employment, whereas in the euro area, the share ranges from 12% to 37%, indicating a less favorable environment for firm growth in the euro area.

Question 13

[The role of competition and capital markets]

What challenges do euro area firms face in scaling up, particularly regarding capital access? What does the productivity disparity between highly productive young firms and the general productivity at the country level indicate about the euro area economies?

Answer 13

• Euro area firms often encounter difficulties in scaling up due to a lack of external capital, with venture capital investments much lower than in the United States. This funding constraint frequently forces innovative companies to relocate to regions where capital markets are deeper and funding more accessible.
• The disparity indicates that while young firms can be highly productive, a significant portion of resources remains locked in less productive sectors of the economy, highlighting inefficiencies and the potential for productivity improvement if resources were reallocated more effectively.

Question 14

[The US management hypothesis]

What does the ‘US management hypothesis’ suggest about the role of management in ICT-related productivity?

Answer 14

The “US management hypothesis” suggests that IT adoption requires complementary organizational changes to fully realize productivity gains from digital technologies, indicating that management practices significantly influence the effectiveness of IT investments.

Question 15

[The US management hypothesis]

How do US multinationals operating in Europe compare to European firms in terms of productivity gains from IT?

Answer 15

US multinationals doing business in Europe achieve significantly higher productivity gains from IT than their European counterparts, despite operating under the same regulatory environments, largely due to superior people management practices.

Question 16

[The US management hypothesis]

According to research by ECB staff, what percentage of firms in the euro area effectively use digital technologies to enhance productivity?

Answer 16

Research by ECB staff indicates that only about 30% of firms in the euro area, those closest to the technology frontier, manage to use digital technologies in ways that effectively raise productivity over time.

Question 17

[The US management hypothesis]

What impact does investment in ICT have on the efficiency of most firms in the euro area?

Answer 17

For most firms in the euro area, investment in ICT has no significant impact on their efficiency, suggesting that additional factors such as management practices and organizational changes are crucial for realizing the benefits of such investments.

Question 18

[The US management hypothesis]

How does the level of education in many euro area countries affect firms’ ability to benefit from digital technologies?

Answer 18

In many euro area countries, a significant share of adults, sometimes more than a third, have not completed upper secondary education. This educational gap contributes to why many firms have not been able to capitalize on the ICT revolution, as effective use of digital technologies often requires a substantial base of human and managerial capital.

Question 19

[Why Europe urgently needs to tackle its competitiveness crisis]

Why has closing the technology gap in the euro area become more urgent recently? How do current electricity prices in the EU compare to those in the United States and China, and what impact is this having?

Answer 19

• The urgency to close the technology gap in the euro area has increased due to Russia’s war against Ukraine, which has significantly raised energy costs, affecting the price competitiveness of euro area firms.
• Currently, electricity prices in the EU’s industrial sector are almost three times as high as in the United States and more than twice as high as in China, leading to a decline in the production of high energy-intensive goods and weakening the euro area’s stronghold in traditional industries.

Question 20

[Why Europe urgently needs to tackle its competitiveness crisis]

What long-term trend in energy pricing is expected, and what is the recommended response to maintain competitiveness?

Answer 20

Energy from fossil fuels is expected to become increasingly expensive as carbon prices rise, suggesting that the only sustainable way to regain competitiveness is to reduce dependency on fossil fuels by accelerating the green transition.

Question 21

[Why Europe urgently needs to tackle its competitiveness crisis]

What challenge does the green transition pose to productivity in the euro area?

Answer 21

The green transition poses a challenge to productivity because high carbon-intensive sectors, which have been more productive on average, are being phased out in favor of greener but initially less productive sectors, likely leading to a short-term reduction in aggregate productivity.

Question 22

[Demographic headwinds require higher productivity growth]

What demographic trends are projected for the euro area by 2070 according to Eurostat?

Answer 22

By 2070, the old-age dependency ratio, which compares the number of people aged 65 or above to those aged 20 to 64, is expected to increase from 37% in 2022 to 60% in the euro area, indicating a significant demographic change towards an older population.

Question 23

[Demographic headwinds require higher productivity growth]

How have work preferences changed in the euro area since the 1970s, and what is its impact on productivity needs?

Answer 23

Since the 1970s, there has been a secular downward trend in the average hours worked per employee, mostly due to a decline in the number of hours employees desire to work. This shift necessitates an increase in output per hour worked to maintain the sustainability of the social system amid an aging population.

Question 24

[Slow technology diffusion risks raising market concentration]

What is the impact of slow technology diffusion on market dynamics in the euro area?

Answer 24

Slow technology diffusion, where productivity gains from digitalization are confined to a few highly innovative and productive firms, has led to increased market concentration and a widening productivity gap between leading and lagging firms, particularly in the services sector.

Question 25

[Productivity growth supports monetary policy] How does productivity growth influence the conduct of monetary policy in the euro area?

Answer 25

Productivity growth is a key determinant of medium-term inflation and real interest rates, directly affecting how monetary policy is conducted. It influences the overall economic environment, impacting inflation rates and the necessary adjustments in monetary policy.

Question 26

[Productivity growth supports monetary policy] What impact does persistently low or negative productivity growth have on inflation?

Answer 26

Persistently low or negative productivity growth exacerbates _the effect of strong growth in nominal wages on unit labor costs for firms_, increasing the likelihood that firms will pass higher wage costs onto consumers. This could delay the return of inflation to the target of 2%.

Question 27

[Productivity growth supports monetary policy] How do measures that enhance productivity growth support monetary policy objectives?

Answer 27

Measures that boost productivity growth support monetary policy by helping to achieve and maintain price stability. Enhanced productivity reduces unit labor costs and helps stabilize prices, thereby aiding in the effective implementation of monetary policy.

Question 28

[Productivity growth supports monetary policy] What are the potential benefits of higher productivity growth for future monetary policy space?

Answer 28

Higher productivity growth increases the marginal product of capital and raises the neutral real interest rate (r *), the rate at which monetary policy is neither expansionary nor restrictive. An increased r * would lessen the need for unconventional monetary policy measures, which often have significant side effects.

Question 29

[Productivity growth supports monetary policy] What is the estimated impact of a one percentage point increase in trend productivity growth on the neutral real interest rate (r*)?

Answer 29

New estimates suggest that a one percentage point increase in trend productivity growth can raise the neutral real interest rate (r*) by 0.6 percentage points, thereby potentially reducing the reliance on unconventional policy measures in response to future economic shocks.

Question 30

[How to boost productivity?] What are the two primary factors that influence aggregate productivity growth in the euro area, according to the analysis?

Answer 30

Aggregate productivity growth in the euro area is influenced by how technologies are utilized and advanced at the firm level, known as the management hypothesis, and how resources are allocated across firms, which relates to the broader business environment.

Question 31

[How to boost productivity?] What is the estimated productivity gain for the manufacturing sector in Italy if frontier firms could scale to global benchmarks

Answer 31

It is estimated that aggregate productivity in the Italian manufacturing sector would be around 15% higher if national frontier firms were as large as the global frontier benchmark, indicating significant potential for productivity improvements through better resource allocation.

Question 32

[Increased competition raises diffusion of skills] Why is a regulatory framework that encourages competition crucial for the euro area?

Answer 32

A regulatory framework that encourages competition is crucial because it can significantly enhance the adoption and diffusion of digital technologies. Research has shown that strict market regulations and rigid labor markets have historically inhibited digital technology adoption in the euro area.

Question 33

[Increased competition raises diffusion of skills] What evidence supports the need for stronger competition in today's digital economy?

Answer 33

Research indicates that stronger competition is linked to significant improvements in managerial ability, which is vital for capitalizing on digital technologies. In today’s digital era, competition is far more critical than in the past due to the rapid pace of technological change.

Question 34

[Increased competition raises diffusion of skills] What changes are suggested to facilitate the Schumpeterian process of creative destruction in the euro area?

Answer 34

To bolster the process of creative destruction, it's suggested that the cost of firm entry and expansion, as well as the cost of closing a failing business, be reduced. For instance, reducing the time it takes for creditors to recover debts after a company defaults (currently taking twice as long in the euro area as in the U.S.) could encourage more dynamic business activities.

Question 35

[Strengthening the Single Market and fostering integration] What is the current state of integration in the European market services sector, and why is it considered disappointing?

Answer 35

Integration in the European market services sector is disappointing because it remains limited, with intra-EU trade in services accounting for only about 15% of GDP, compared to over 50% for goods. This limited integration reflects ongoing regulatory and administrative barriers that restrict cross-border trade in services.

Question 36

[Strengthening the Single Market and fostering integration] What benefits could be realized from more integrated and deeper capital markets in the euro area?

Answer 36

More integrated and deeper capital markets in the euro area could significantly boost the diffusion of technology, with research suggesting that increased access to capital could reduce the distance from the technological frontier by 5 to 7%.

Question 37

[Strengthening the Single Market and fostering integration] What further steps are suggested to complete the banking union?

Answer 37

Completing the banking union involves steps like ratifying the amendment of the Treaty establishing the European Stability Mechanism and creating a European deposit insurance scheme (EDIS), which are essential to sever the sovereign-bank nexus and enhance the stability of the banking sector.

Question 38

[Raising public investment] What has been the trend in public investment in the euro area compared to the United States?

Answer 38

Public investment has been weak in the euro area for a long time, particularly after the sovereign debt crisis, resulting in a visible gap in public investment levels compared to the United States.

Question 39

[Raising public investment] What new framework has the ECB welcomed, and what does it aim to balance?

Answer 39

The ECB has welcomed the recent agreement on a new economic governance framework in the European Parliament and the Council, which aims to balance the need for debt sustainability with incentives for investments and structural reforms.

Question 40

[Raising public investment] What role does the Next Generation EU (NGEU) program play in addressing the euro area's competitiveness crisis?

Answer 40

The NGEU program plays a significant role in overcoming the euro area’s competitiveness crisis by allocating most of its funding to public investment in crucial areas like education and training, thereby boosting productivity growth.

Question 41

[Raising public investment] What are the potential risks of rushing the implementation of investment projects under NGEU?

Answer 41

Rushing the implementation could lead to supply bottlenecks, unwarranted demand-driven inflationary pressures, and the risk of prioritizing "easy-to-fulfill" projects that favor government consumption over long-term investment.

Question 42

[Raising public investment] How has NGEU contributed to the euro area's institutional architecture?

Answer 42

NGEU has addressed three important gaps: - it established a central fiscal tool for stabilization, - enhanced coordination in economic policymaking at the European level, - and increased the liquidity of EU bonds, thus deepening capital markets and progressing towards creating a European safe asset.