Europe and the Issue of Competitiveness

1. Europe and the Issue of Competitiveness Europe in International Economy School of Public Policy

2. Industrial and competitiveness policy • ICP: • Is designed to improve a country’seconomicperformance; • Not to specify and enforce particularoutcomes but to alter market processes by attacking the rigidities which impede the force of market selection; • A framework in which private sector flexibility is encouraged and adjustment to shocks is facilitated; • Vs. attempt to lead the private sector through a planningprocedure – some form of picking winners – predictingemergence of sunrise sectors; • Today’s ICP: also providing industry with appropriate resources such as an educated and trained labor force, an appropriate research base and infrastructure;

3. Industrial and competitiveness policy in European Context • 1940s – 1960s: orthodoxy was that government could and should correctmarketfailures – microeconomic intervention in specific sectors was normal; • 1970s European ICP aimed to create super-firms to compete with the US giants; • 1980s: respect for marketforces increased; • Since 1990s: • Commission view that should promoteadaptation to industrial change in open and competitivemarket; • Commission and academia treat firms and sectorspecificpolicies with suspicion, but approves of horizontal/generalpolicies to supportmarket activity in general; • Firm-specific and sector-specific industrial policy undertaken by member statesconstrained by EU rules on state aid; • Microeconomic industrial policy is often contradictory – governmentstend to simultaneouslysupportsunrise and sunset industries; opportunity cost is high; • Instruments: traditional industrial policy – subsidies, tax breaks, protection from competition; today also regulation and deregulation, reorientation of public services (education) subsidization of infrastructure and research;

4. Theory • Market failurein general: • Uncompetitive markets, externalities, informational or distributional problems; • Under-supply of scientific and industrial knowledge – public-goodsaspect of information; • Infant industries: • Economy of scale argument – infant operating below optimum size – will never achieve the low cost associated with the large-scale production of established firms; • First mover advantage; • Picking the winner – not easy even for entrepreneurs investing their own money (government investing other people’s); • Strategic industrial policy: • 1980s trade theory turned to models of imperfect competition – explain intra-industry trade between AIC; • Explanation for oligopolistic rivalry + policy prescriptions; • CA is no longer a matter of traditional factor endowments – can be consciouslyshaped; • Attracting specific sectors to particularlocations feasible and profitable; • Selective or general?

5. Industrial agglomerations • Information and ideas circulateinformally within an agglomeration – speeding up the process of productdevelopment; • Technologyspillovers are concentrated locally; • Pull factors reduce costs for members of agglomeration – positive externalities based on mass production of specialized inputs (specialized labor, specialized services, shared costumers, shared infrastructure – universities, flow of information – including informal); • Agglomeration reduces cost by allowing firms to contract out all but their coreactivities – only efficient if the specialized suppliers can themselves operate on a large enough scale – offsetting market transaction costs; • Silicon Valley example; • While the agglomeration very large – most of the firms will be small (extremely specialized and operating on sufficient scale)– agglomeration can be substitute and complement of technical economies of scale; • ICP have to target not only large firms but also SMEs;

6. Research and development • Innovation is a good – its production is driven by profit but innovation have peculiar characteristics; • Firms will onlyinvestheavily in RD if they canappropriate for themselves the knowledge; • Innovations are non-rival – can be easily copied – littleincentive to innovate because other firms will use the expensively acquired knowledge – free rider problem; • Suggests policy which provide patent system and provides public funding of basicresearch; • Government can indirectly promote innovative industries by sponsoringRD in selected areas- less risky thanpicking the winners: • Still roomfor government failure – researchers are influencing the decision, there is correlation between researchexpenditure and researches’ incomes; • Technological loops, linkages, feedbacks, spillovers – help to translate scientific knowledge into commerciallyusefulinnovations: • Creation of new knowledge by one firm generate positive externalities for other firms (better and cheaper products + new scientific/non-patented information) as well as ensuring firm’s own survival through the patented knowledge (competitive advantage); • Countries in which the research is carried out acquire a comparative advantage in the form of human capital resource endowments that may persist for some time; • Pure science will remain economicallyinertunless society possesses a supply of entrepreneurs operating through markets– importance of the institutionalsetting; • Rule for support: the furtherawayfrom the marketplace and the moregeneral the type of research, the moreappropriate it is for publicfunding - promotion of pre-competitive RD;

7. General recommendation • ICP shouldnot target specificfirms or sectors, but aim at improving the generalfunctioning of markets; • Difference between offering incentives to specific investor to invest into country and to make the country more likely to attract investment; • It is not enough to demonstrate existence of market failure – governmentaction is costly and quickly becomespoliticized and selective; • Once hooked on industrial policy funds sectorgrows beyond their market-determined size and hence enjoying more political support • Industrial policies become path-dependent and self-perpetuating;

8. Oligopolistic Competition in High-tech Industrial policy of EU – subsidy 25

9. Weaknesses of Europe • RD spending continues to lag in Europe - limited cooperation between industry and academia; • Small, newly established firms that tend to pioneer new informational technologies – greater difficulties to cope with the complexity of European regulation; • Two weeks to start a new business in the US, moth in Italy and Spain; • Europe: immigration-unfriendly policies – less attractive for HT specialist form Asia; • Emphasis on vocational as opposed to university education makes labor force less attuned to radical new technologies; • Lower hiring and firing costs make it easier for US entrepreneurs to gamble on unproven technologies of great promise but uncertain commercial potential; • European financial system – well suited to mobilizing saving and deploying it for investment by incumbent firms - does not go to the start-ups and small firms that are the motors of output and productivity growth; • IT producing sector is where US excels – but only 6% GDP – cannot explain differences in productivity trends - US productivity advantage since 1990s centered in retail trade, wholesale trade, financial services – ICT using activities; • Europe faster productivity growth in telecommunications (privatization and uniform product standards); • Higher cost of computer hardware in Europe (localizing costs) – itself barrier;

10. Strengths of Europe • Europeans have vastly grater amounts of leisure time; • Higher level of earnings equality, more people with health insurance, infant mortality rates are lower, poverty rates are lower, rates of violent crime are lower; • Number of prisoners is only 87/100k vs. 685 in US; • Rigidities have not stood in the way of rapid export growth; • European exporters dominate in precision manufactures; • Moving into H-T and premium goods is potential source of insulation from high competition of Emerging Markets: • European firms continue to compete successfully in a wide range of HT products (pharmacy, high-speed trains) • Europe has not been subject to the kind of great financial scandals;

11. Example of reform • Netherlands 1980s – Wassenaar Agreement 1982 • Frozeminimum wages, eliminated the indexation of other wages to inflation; • Given inflationary climate – cut labor cost; • Limited the erosion of take-home pay – G cut social security and other labor taxes; • Reduced public-sector compensation by 3,5%; devaluation of the guilder 1982 – strong employment gains followed; • Part-time work rules were relaxed, facilitating women’s labor force participation (30-60% 1973-1995); • Reducing the disability benefits – partially disabled required to find job; • Increased participation broadened the tax base – unemployment from 10-5%; • Ireland 1987 similar program – an experiment in competitive corporatism; • General reform (national level) • Labor cost can be cut; wages can be brought into line with productivity; • Reducing tax distortion – decrease wedge between labor cost and take-home pay; • Investing in education and training – enhance occupational mobility; • Pursue structural reforms that encourage labor-force participation (broadening the tax base); • Reforms can then be complemented by demand-side stimulus – making structural reform easier to swallow; • Resulting shift toward a loosermonetary policy and a tighterfiscal policy – make for a more investment-friendly policy mix; • Scaling back the policies tends to favor unemployment at the expense of the employment; • Agreement to moderate the growth rate of wages encourage firms to create additional jobs while reducing the pay of those with the most seniority and job security; • Important in NED an IRL: corporatistmindset that value solidarity and encourage cooperativeresponse to crisis + small countries –interest groups around one table + massiveFDIinflows from much larger world; • EU: the more extensive the economic integration – the grater the scope for producers to reallocate to low-cost countries and regions within EU – greater incentive to reform in order to become a beneficiary rather than a victim of that process (+Easter enlargement);

12. Lisbon Agenda • Lisbon European Council 2000: new strategic goal till 2010– to become the mostcompetitive and dynamic knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion; • Strategy aimed to • The transition to a knowledge-based economy by better policies for the information society and RD; structural reform for competitiveness and innovation and by completing the internal market; • Modernize the European social model, investing in people and combatingsocial exclusion; • Applying an appropriate macro-economic policy mix; • All-embracing is understatement - Result of bargaining process to achieve unanimity where individual national leaders ensured that measures particularly important to them were included + disagreement how economic performance should be improved (UK vs. FRA); • Open method of coordination: • Council agreeing guidelines that contain targets and recommendations which are adopted at the discretion of member states (intergovernmental process); • Policy operates via reports – containing the policy, objectives and progress; • Enforcement is by recommendation, peer pressure and benchmarking; • No penalties – government implement policies in line with their own priorities;

13. EU is continuing to lag behind – not only in productivity but also in amount of inputs used – slower population growth and rigid labor markets (late from school, less hours, early retirement + higher benefits and less part-time jobs); • Lisbon is about everything and thus nothing (Kok’s Report 2004); • Commitment is rhetorical and was agreed at the height of the Dotcom boom; • States are committed only to parts of agenda; • Mid-term review: Barroso’s Commission’s plans – three priorities for the policy concentrating on growth and jobs (Revised Lisbon Agenda) : • Making Europe a more attractive place to invest and work – completing the Single Market and business-friendly regulation; • Knowledge and innovation for growth: raising expenditure on RD to 3% of GDP; • Creating more and better jobs – increase employment by making the labor force more adaptable through raising the level of education and skills; • Concerns that slimmer agenda downgraded the environmental and socialaspects of agenda;

14. Strategy Europe 2020 • Global crisis destroyed progress reached in last years (20 years of attempts for fiscal consolidation – in 2009 average fiscal deficit 7% and public debt 70%) + there have to be careful management of exit fiscal stimulus's; • Goals: • Intelligent growth – development of economy based on knowledge and innovations; • Sustainable growth – support for more competitive and ecological economy less energy intensive; • Growth supporting social inclusion – economy with high level of employment and economic, social and regional cohesion; • Targets: • Higher employment for 20-64 year old – from 69% to 75%; • Increase investment into RD up to 3% GDP EU (US 2,9% vs. EU 1,7%); • In energetic policy reach the goal 20-20-20 (less greenhouse gases, more renewable, more energy efficiency); • Share of tertiary educated from 31% to 40%; • 25% less people living in poverty (from 20 mil.);

15. Global Competitiveness of European Countries (Global Competitiveness Report 2010/2011)