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European Commission

MEMO

Brussels, 11 September 2014

Factors influencing industrial competitiveness in the EU

The 2014 European Competitiveness Report 'Helping Firms Grow' confirms that manufacturing in the EU still has considerable competitive strength. It also identifies factors to enable the EU to build on this strength and promote growth.

The report finds that the EU has maintained its competitive strength in a number of manufacturing sectors; thanks to highly skilled workers, high domestic content of export goods, and comparative advantages linked to complex and high-quality products. It also confirms that the fall in the value-added share of manufacturing in recent years is due to falling relative prices of manufacturing in relation to services.

With respect to small and medium sized companies (SMEs), the report confirms that small and young firms find it more difficult to obtain bank credit compared to other firms, even if their financial performance is the same. This indicates that the market for bank credit is not functioning efficiently. In parallel, smaller and younger firms are less likely to enter foreign markets.

Other factors shown by the report to influence industrial competitiveness include public administration, innovation, and energy prices. Firm growth was found to be directly impacted by the efficiency levels of public administration. Regarding innovation, its employment-generating effects vary over the business cycle and were shown to be greater for product innovators than for process or organisational innovators. Competitiveness was negatively affected by electricity and gas prices. These are higher in the EU than a number of other economies, and have recently risen more in comparison to other economies. The report also finds that energy efficiency improvements have not fully offset the negative impact of increasing energy prices.

EU exporters have comparative advantages in most manufacturing sectors

EU exporters have comparative advantages in most manufacturing sectors, including sectors characterised by high technology intensity - such as pharmaceutical products - and sectors characterised by medium-high technology intensity - such as chemical products, machinery and equipment, motor vehicles and other transport equipment.

Europe adds a high level of value to its exports, creating employment

The share of EU added value in EU manufacturing exports is around 85%, comparable with the domestic content of Japanese or US manufacturing exports. The domestic content of Chinese and South Korean exports is much lower, as their exported goods rely more on foreign intermediate goods and services, of which more than 5% originates from the EU. The report also finds that EU manufacturing exports are more sophisticated and complex than exports from many other economies and that EU manufacturing is characterised by a growing share of high-skilled labour.

Reindustrialisation targets are still at risk

The EU economy is still far from reaching its 2020 reindustrialisation targets: 20% of Gross Domestic Product (GDP) for manufacturing, research and development expenditure of 3% of GDP and gross fixed capital formation of 23% of GDP. The aggregate proportion of manufacturing in GDP fell from 18.5% in 2000 to just over 15% in 2013. The report shows that the declining share of manufacturing in the last 25 years is also due to the effect of the falling price of manufactured goods relative to the price of services. This is a consequence of higher productivity growth in manufacturing.

In the EU, recovery has been slow. While Poland, Slovakia, Romania, Estonia and other Member States have already surpassed their pre-recession peak levels of manufacturing output, most Member States are still producing less than before the crisis, with some - notably Cyprus and Greece - still at, or close to, their lowest point since the start of the recession.

Financing gaps hinder firm growth

Access to external finance is essential for enterprises to invest, innovate and grow. As a consequence of financial market imperfections, 'financing gaps' may limit enterprises' investment and growth options as viable projects may not be financed.

In general, the level of financing constraints has been higher in the Member States hit harder by the financial crisis, e.g. Ireland, Greece and Spain. Conversely, the lowest levels have been registered in those Member States where the impact has been less and, in some cases, where the financial sectors have remained stable, e.g. Finland and Sweden.

Figures and graphics available in PDF and WORD PROCESSED

Small and young firms find it more difficult to obtain bank credit compared to other firms, even if their financial performance is the same. This indicates that the market for bank credit is not functioning efficiently. These market imperfections may stem from information asymmetries affecting lenders and borrowers.

In terms of sectors, access to external finance is more important as a driver of new investment for manufacturing and construction sectors than for services. The report also finds that less financially constrained firms are more likely to export but financial constraints do not affect the export sales intensity1 of firms that are already exporting.

Policy intervention could help to address financial market inefficiencies. For example, standardising the financial information on SMEs through the establishment of centralised credit rating agencies at a national or EU level, could help lenders. With respect to borrowers, increasing small and young enterprises’ market knowledge, as well providing training in the preparation of loan proposals, would be valuable. The report also finds that companies need additional financial resources to export. Hence specific financial policy measures may be warranted to help companies to do this. These could be in the form of export credits and insurance.

How SMEs internationalise and what factors influence internationalisation

The report finds that SMEs tend to enter foreign markets primarily as exporters because of lower levels of required capital investment and of associated risk. Foreign direct investment (obtaining equity in a foreign firm or establishing a new firm abroad) is a less common channel of internationalisation for SMEs than for larger firms. Franchising and licensing are important channels of foreign entry for the retail, accommodation and restaurant sectors, where exports play a less significant role.

Firms involved in manufacturing and in software and business services have higher export participation rates. Home country administrative burdens, such as greater export and business regulations, lead to lower SME export participation rates. Target country factors including market size, language and geographic distance are also significant in influencing SME internationalisation activity, particularly for micro-sized firms. Skill-intensive SMEs have higher output and employment growth rates than those with a less skilled workforce, while overall there is a strong link between innovative SMEs and levels of export participation.

The factors influencing SMEs' decisions to enter foreign markets can be divided into internal firm-specific factors and external factors. Firm-specific factors include firm size, labour productivity, skill intensity, innovation activities, and foreign ownership. External factors include home-country characteristics such as export promotion programmes, administrative and transport costs associated with exporting; and host-country characteristics such as tariffs, regulations, political risk factors, geographical distance and cultural factors.

Efficient public administrations enhance industrial competitiveness

The efficiency of public administration (PA) has an impact on firm growth, both in terms of the share of high-growth firms in the total number of firms and also of employment. Increased PA efficiency induces higher numbers of fast-growing firms, in particular by increasing firm’s financial turnover and net entry into the market. The quality of the governance system, including the presence of an independent judiciary and absence of corruption is particularly important in this respect.

The above table illustrates the potential impact of institutional reforms on the share of high growth firms in all firms. It shows for instance that if a country like Poland improves its judicial system to reach the level of the best performers (b.p.) in this area (Denmark and the Netherlands), the share of high-growth firms in Poland will grow by almost 3 percentage points. Whereas the estimates are merely indicative, they illustrate the scale of positive effects that could be achieved through improvements in the quality of public administration.

Innovation, especially product innovation, creates employment

The amount of employment created by innovation varies over the business cycle and is higher for product innovation than for process or organisational innovation.

The report includes a study of the relationship between employment growth and innovation based on an analysis of a large sample of European firms (the Community Innovation Survey). In particular, it investigates how the relationship between innovation and employment changes over various phases of the business cycle.

The report finds that more employment is created by innovative firms compared to non-innovative firms, in all phases of the business cycle. This pattern is particularly pronounced in downturn and recession periods.

Product innovators generate more employment growth than non-product innovators because they create more employment through higher sales of new products than they lose due to decreasing sales of their old products. In most cases, a 1 % increase in successful product innovation leads to a 1% gross increase in employment. The effects of process and organisational innovation on employment growth are smaller than the effects of product innovation.

The contribution of product innovation to employment growth is largest during upturn and boom periods, when favourable economic conditions lead to higher sales of new products. But product innovation is also important during recessions, when it has an employment-preserving effect. During such periods, employment losses for product innovators are much smaller than for non-product innovators.

The study highlights the importance of policy support for innovation, including support for investment in innovation related activities. This would be especially beneficial during recessions because innovation drops when firms fear that future demand will grow more slowly, or not at all. The finding that product innovation plays an important role in stabilising employment growth during recessions supports the view that continuing to investment in research and development during recessions is fundamental.

Energy costs increased despite improvements in efficiency

Electricity and gas prices have grown more in the EU than in many other economies. Although energy costs are slightly less than 5% of gross output in advanced economies such as the EU, Japan and the US, they have been generally increasing over time. For energy-intensive sectors, energy cost shares can be a fundamental determinant of competitiveness.

In terms of energy intensity, a strong downward convergence has taken place across major economies, particularly in Europe. The process has been mostly driven by technological improvements, but a structural shift towards industries with lower energy intensity has also played a role, particularly in the EU-12 countries. By contrast, in the EU-15 countries a structural shift towards chemicals and chemical products has limited the reduction of energy intensity.

High gas and electricity prices affect competitiveness

End-user gas and electricity prices for industry vary considerably across countries. In the case of natural gas, this reflects the regional fragmentation of wholesale markets, the differences in wholesale gas pricing formulas and the varying degree of end-user price regulation.

In the US, gas prices are largely independent of the oil markets and tend to be much lower. The recent shale gas ‘revolution’ and the high degree of pass-through of lower prices have also contributed to keeping industrial prices at around a quarter of the OECD-Europe average. Gas prices for industry in China vary strongly by region, but on average they are broadly in line with the European level. Europe’s electricity prices are currently twice as high as those in the US and the gap is expected to widen. Network costs and electricity taxation has significantly contributed to the strong electricity price growth in Europe. However, there are substantial differences across Member States, reflecting differences in how energy generation is generated, in taxation and in the allocation of subsidies for renewables. Energy costs have decreased in some Member States thanks to the expansion of renewable energy, because the variable costs of renewable electricity are very low.

Energy efficiency gains are not yet sufficient to offset higher energy prices

Increases in energy prices, if not counterbalanced by improvements in energy intensity, may have strong repercussions on both production costs and industrial competitiveness. In terms of energy efficiency gains, the EU performed better than its main competitors in several manufacturing industries. The report finds, however, that these improvements have generally not been sufficient to fully offset the adverse impact of rising energy prices: changes of energy intensity in response to a 1% increase of electricity price are negative but smaller than one for almost all sectors, resulting in an overall increase of energy costs in production and value added.

Building on these results, the report demonstrates that increasing energy costs had a negative impact on export competitiveness, confirming the importance of the work undertaken by the Commission in the field of energy costs and prices. As would be expected, energy-intensive industries were the most heavily affected by increasing energy costs.

About the European Competitiveness Report

The 2014 European Competitiveness Report aims to give an overview of the performance of EU manufacturing industries so as to provide evidence-based indicators for the evaluation of EU industrial policy targets. It gives a quantitative assessment of the competitive performance of EU industries. This year’s report focuses on some of the most important drivers of firm growth: access to finance, SME internationalisation, the efficiency of public administration, and innovation through the business cycle. The report also devotes a chapter to energy costs and efficiency, which underpin the competitiveness of all firms.

The European Competitiveness Report has been published annually since 1997.

For the full report – click here.

1 :

Energy intensity describes how much energy it takes to produce one unit of output


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