Mario Draghi: Moving to the frontier - promoting the diffusion of
innovation
Welcome address by Mr Mario Draghi, President of the European Central Bank, at the joint
conference by the ECB and the MIT Lab for Innovation Science and Policy "Fostering Innovation
and Entrepreneurship in the Euro area", Frankfurt am Main, 13 March 2017.
* * *
It is my pleasure to welcome you to this joint ECB-MIT conference on fostering innovation and
entrepreneurship in the euro area.
This might at first glance seem an unusual topic for a central bank conference, since monetary
policy principally operates through the demand side of the economy. But the long-term supply
picture evidently also affects our ability to deliver on our mandate.
Much of the debate today about the true level of the real equilibrium interest rate, for example, is a
debate about the outlook for productivity growth, which of course depends in large part on
innovation and entrepreneurship. Higher productivity growth is also vital to safeguard Europe's
economic model of high wages and social protection, and hence to counter the sense of
economic insecurity that is currently prevalent in several advanced economies.
But aggregate productivity growth is more than just the development and application of innovation
and new technologies which enhance or even revolutionise production processes. New
technologies invented elsewhere need to be adapted by firms into their own production
processes to make them more efficient. In short, productivity growth depends not only on
the creation of new ideas, but also on their diffusion.
To raise productivity growth, which has slowed in the euro area and in many other economies in
recent years, we need to focus on both areas.
Innovation
There is a lively debate underway as to whether the rate of innovation has slowed or not. Some
argue that the great innovations of the past - electricity, railways, etc. - will not be matched in the
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future, or that we have exhausted the gains from the information and communication technology
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(ICT) revolution. Others remain more optimistic that the current slowdown in productivity
reflects a transition to a knowledge-based economy, and that general purpose technologies such
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as ICT improve over time and generate complementary innovations.
My view on the topic is that we should not be overly gloomy about the global prospects for
innovation, for two reasons.
The first is that we clearly have potential to boost innovative capacity in the euro area. Consider,
for example, the persistent gap between R&D spending in Europe and other major advanced
economies. According to the World Economic Forum's Global Competitiveness Indicator, only
three euro area countries are in the world's top ten for innovation.
So if, as the world's second-largest economic area, we were to dismantle barriers to innovative
activity in the euro area, it would clearly give a boost to global innovation. I will not go into detail
here about what policies this might entail, but clearly government support for innovation matters:
in Europe differences in innovative capacity between countries are closely related to public
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spending on R&D, particularly in basic research.
The second reason why I am reasonably optimistic is that there is no clear evidence yet of a
slowdown in innovation. The available data in terms of global R&D spending, and the ongoing
historically high rate of high-tech patent registrations seem to challenge this perception.
Moreover, despite the global slowdown in aggregate productivity, firms at the global productivity
frontier have continued to post strong productivity gains over the past decade. The performance
of euro area businesses at the global frontier is on a par with businesses in other developed
economies, particularly in manufacturing. It is the performance of firms away from the frontier
that has been lagging (Charts 1 and 2). Although this is a common feature for all OECD
countries, it is particularly the case for euro area services, where productivity growth for the
laggard firms has stagnated.

Diffusion
It seems, therefore, that a large contributing factor to the slowdown in aggregate productivity is
the second link in the chain: the lack of diffusion of innovation.
This is a long-standing issue for the euro area: better adoption of ICT in the United States
appears to explain most of the productivity gap between the US and the EU15 from 1995 to 2007.
The contribution to aggregate productivity growth from non-ICT sources of capital deepening and
total factor productivity (TFP) growth over that period was broadly equivalent in the two regions.5
But what is now becoming clearer is where the diffusion gaps lie. Recent work carried out by the
ECB using micro data shows that the difference in productivity between the most productive and
the least productive firms in each narrow, two-digit sector is considerable. The top 10% of firms,
in terms of productivity, are on average three times more productive than the firms in the bottom
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10% (Chart 3). Similar differentials occur in the United States. This massive intra-industry
productivity differential dwarfs inter-industry differentials. For comparison, firms active in the
tradable sector are on average around 50% more productive than those producing mainly
nontradables.
How, then, can we improve the diffusion of innovation from the frontier to the laggard firms,
especially within sectors? Research suggests three main areas that will improve the capacity of,
and incentives for, firms to adopt new technology: (i) investing in human capital and managerial
ability, (ii) investment in intangibles, and (iii) improving economic dynamism.
Investment in human capital and management
First, there is now an extensive literature on the complementarities between technology and
workforce skills, and on how better human capital increases the capacity to absorb
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technologies. Human capital includes not just formal education, but also on-the-job training and
job security - firms with a large proportion of workers on temporary contracts underperform in
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terms of innovation.
Managerial ability is also key for the adoption of technology. New technologies often require new
structures and a reorganisation of production to maximise efficiency gains. While managerial
quality is hard to quantify, the existing studies find a statistically strong correlation between a
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firm's managerial quality and its total factor productivity. One of the channels through which
managerial practices enhance firm performance has been found to be the increased capability of
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firms to absorb new technologies.
Certainly there is potential to improve education systems in the euro area and thereby to give
greater numbers of graduates the necessary technical and scientific skills. Our co-hosts today,
MIT, came top of the latest QS world university rankings. There are nine UK universities and two
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Swiss universities in the top 50 of those rankings, but only one euro area university.
And education is not just for the young. Improving the provision of life-long learning and retraining
programmes will aid the flow of skilled labour towards more productive businesses.
Investment in intangibles
Second, numerous studies have shown that firms which invest more in intangibles are in a better
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position to understand and benefit from new technologies. Such investment includes
conducting their own R&D and developing their own intellectual property, as well as investment in
branding, software and databases.
Investment in intangibles also appears low in the euro area compared with a number of other
advanced economies, although it has been on an upward trend. The aggregate number also
masks a wide country-level disparity, with the lack of intangibles investment particularly acute in
some countries. Increasing the resources devoted to R&D would improve the ability of euro area
firms to absorb more innovation.
Economic dynamism
The third main factor increasing absorptive capacity is the framework in which the business
operates. Greater economic dynamism, from competition to higher rates of business entry, plays
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an important role in incentivising firms to adopt new technology. Ensuring that failed firms are
able to smoothly exit the market is also key to enabling capital and labour to be allocated to
where it can be more productively used.
Business churn - the combined rate of business formation and closure - has been declining in
Europe and the United States since just before the crisis (Chart 4). In lock step with the decline in
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churn, evidence suggests that capital misallocation has been rising in both regions.
As an example of barriers to business creation, it takes on average about 10 days to start a new
business in the euro area. Depending on the country it can take between four days and almost a
month. Yet in the global best performer - New Zealand - it is possible to set up a business in
less than a day. There are barriers as well to the orderly exit of firms. Resolving insolvency takes
an average of almost two years in the euro area, three times longer than in the best three
performing countries.
This is why we talk frequently about the need for structural reforms of regulatory and judicial
processes to bolster business dynamism, as well as the need to complete the Single Market.
This is especially true in services, where the laggard firms are noticeably behind the frontier.
Of course, creating the right regulatory framework and market conditions to nurture innovation
and promote its transformation into new products and processes is complex, and there is no
particular established winning formula. But there are a number of countries in the euro area that
have proven relatively more successful at putting in place an effective "innovation ecosystem".
One of the aims of this conference is to investigate international and euro area best practice and
facilitate the sharing of that knowledge with countries where an effective ecosystem has yet to be
established.
Conclusion
Let me conclude.
There are many reasons why it is a priority today in the euro area to address weak productivity
growth. But while some progress can be made in innovation, it is not in my view the sole issue. It
is equally important for the euro area to facilitate and encourage the spread of new technology
from the frontier to the laggard firms.
Simply by diffusing better the technology we already have in the euro area, we could make
sizeable gains in productivity. In other words, there is much we can still do to reverse the
aggregate productivity slowdown and dispel pessimism about our future.
1
Gordon, R. (2016), The Rise and Fall of American Growth: The US Standard of Living since the Civil
War, Princeton University Press.
2
See Fernald, J. (2014), 'Productivity and Potential Output Before, During, and After the Great Recession', Federal
Reserve Bank of San Francisco Working Paper Series (2014-15) and Cette, G., Fernald, J. G., and B. Mojon,
2016. "The Pre-Great Recession Slowdown in Productivity." Federal Reserve Bank of San Francisco Working
Paper 2016-08.
3
See, e.g. Brynjolfsson, E. and A. McAfee (2014), The Second Machine Age: Work, Progress, and Prosperity in a
Time of Brilliant Technologies, W. W. Norton & Company.
4
See Veugelers, R. (2016), "The European Union's Growing Innovation Divide", Bruegel Policy Contribution,
Issue 2016/08, April 2016 and Mazzucato, M. (2013), The entrepreneurial state: debunking public vs. private
sector myths, Anthem.
5
Bloom, N., Sadun, R. and van Reenen, J. (2012), "Americans Do IT Better: US Multinationals and the Productivity
Miracle", American Economic Review, 102(1): 167-201 and van Welsum, D., Overmeer, W. and van Ark, B.
(2013), "Unlocking the ICT growth potential in Europe: Enabling people and businesses", report prepared for the
European Commission.
6
For example, Syverson, C. (2004): "Product Substitutability and Productivity Dispersion." Review of Economics
and Statistics, 86(2): 534-50 shows that within four-digit industries in the US the top 10% of firms are, on
average, two times as productive as the bottom 10%.
7
See, for example, Acemoglu (2007), "Equilibrium Bias of Technology", Econometrica, 75: 1371-1409
8
See Albert, García-Serrano and Hernanz (2005) and Lopez-Garcia and Montero (2011), and Bentolila, S. &
Dolado, J. and Juan Jimeno, J., (2012), "Reforming an insider-outsider labor market: the Spanish
experience," IZA Journal of European Labor Studies, 1(1): 1-29.
9
Bloom, N. and J. Van Reenen (2007), "Measuring and Explaining Management Practices Across Firms and
Countries", Quarterly Journal of Economics, 122(4): 1351-1408 surveyed managers from over 700
mediumsized firms in the United States, United Kingdom, France, and Germany and find that spanning the interquartile
range of the management score distribution, for example, corresponds to a productivity change of between 3.2
and 7.5 percent. This is between 10% and 23% of TFP's 32 percent interquartile range in their sample.
10
See, for example, Garicano, L. and P. Heaton, (2010). "Do Computers Help Police Fight Crime?," CentrePiece -
the magazine of economic performance 247, Centre for Economic Performance, LSE; and Bloom et al.
(2012), op. cit.
11
QS world university rankings, www.topuniversities.com/university-rankings/world-university-rankings/2016
12
Numerous studies have demonstrated that a country's ability to absorb international technological advances
relies on its exposure to them, and its absorptive capacity as proxied by investment in R&D and labour force
qualifications. See Coe, D.T., Helpman, E. and A.W. Hoffmaister (1997), Engebrecht (1997), Frantzen (2000) and
Griffith, Redding and van Reenen (2004).
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See, e.g., Bartelsman, E., Haltiwanger, J. and S. Scarpetta (2013), "Cross-Country Differences in Productivity:
The Role of Allocation and Selection", American Economic Review, 103(1): 305-334 and Haltiwanger, J., Jarmin
R., Kulick, R. and J. Miranda (2016), "High Growth Young Firms: Contribution to Job, Output and Productivity
Growth", mimeo.
14
Gamberoni, E., Giordano, C. and P. Lopez-Garcia (2016), "Capital and labour (mis)allocation in the euro area:
some stylized facts and determinants", ECB Working Paper No 1981 and Hsieh, C. and Klenow, P. (2009):
"Misallocation and Manufacturing TFP in China and India", Quarterly Journal of Economics, 124(4) 1403-1448.
Note that data for the US refer to different waves of the US Census up to 1997.