This polarisation of jobs can also be seen in terms of tenure. During the crisis, manufacturing job tenure increased showing that job destruction was centred in the late arrivals to the sector which should be the youngest and more qualified.

The distribution of job creation across sectors and the quality of those jobs presents significant differences across Member States (Figures 2.9 and 2.10). Germany and France have experienced employment creation mainly in the lower quintiles of the wage distribution. While Germany has seen employment growth both in the manufacturing and services sector, France has only created net employment for the latter. On the other hand, employment losses continued across the board in the southern Member States, more so in Greece and Spain where no wage quintile has experienced net job gains during the period 2011-2014. Italy has only seen a significant growth of low-paid services jobs. Zooming into the creation of jobs in industry, high paid jobs are being created, or destroyed at a slower pace, in high-tech sectors.

The changes in the composition of GVA of the EU and its economic structure have impacts on the distribution of jobs across sectors and the absolute level of employment, but they also have an impact on the quality of those jobs and the distribution of wages. The new jobs created in manufacturing will not have the same characteristics as those destroyed during the crisis. Since 2011, net employment has been created mostly in the low and high-paid levels leading to a greater polarisation of employment (Figure 2.7). This trend is repeated for manufacturing (Figure 2.8). However, high-tech industry has been capable of providing a wider range of mid and high paying jobs, corresponding to mid-paid technicians and well-paid managerial administrative roles, while employment has been destroyed across all wage quintiles for low-tech industry. However, during 2014 the polarisation trend was somehow eased. While services continued creating jobs at the lower extreme of the wage distribution, manufacturing created jobs in the top three quintiles, contributing to a more even distribution of jobs along the pay scale.

2.1.3 The impact of changes in the economic structure of the EU on wages and the quality of jobs

Concerning services sectors, they now employ more people than ever before and are set to continue expanding their employment. Employment in services diminished in 2008 and 2009 as a result of the crisis but quickly recovered and is now higher than ever before.

There is no contradiction between the long-term trends of falling manufacturing employment and cyclically growing output (see Figure 2.6), on the one hand, and the diminishing contribution of manufacturing to total value added on the other hand. Both are in fact driven by the higher productivity growth in manufacturing than in services. Being able to produce as much or more goods with less input (of labour, capital, energy, intermediate goods, raw material) means that output can increase even though employment goes down, while at the same time the relative prices of the goods are pushed down because of competition. Therefore the value of the produced goods does not increase by as much as the volume and over time manufacturing tends to represent a smaller proportion of total value added.

In EU manufacturing, both employment and production fell sharply during the longest and deepest recession in European post-war history but have since recovered somewhat and, in the case of manufacturing employment, returned to the same level as in 2010. Between 2013 and 2014 employment in manufacturing grew by 160 000 units. However, 1.7 million jobs still need to be recovered in the EU manufacturing sector with respect to 2009.

As concerns services, reliable data on output volumes are difficult to obtain except for retail trade, where trade volume grew rapidly and consistently until it peaked in 2008. After the crisis and throughout the recession it fell back but is now rising again. For all services apart from retail trade, only turnover data are available, showing a steady increase over time, although with no reliable way of distinguishing between the effects of price and volume changes.

Given its importance in terms of upstream and downstream links to other sectors of the EU economy, as well as internationally in the global value chain, it is worth highlighting the motor vehicles, trailers and semitrailers sector and its remarkable recovery after the crisis. The initial impact was considerably more severe than in most other EU manufacturing sectors: from early 2008 to early 2009, output fell by more than 40 %, production plants were closed down or offshored, employees were laid off, and some manufacturers went out of business. However, the sector survived in a smaller, restructured and (presumably) more efficient form and rapidly expanded production. Two years after its lowest point in 2009, production had increased by 70 %, and since then it has edged within a few percent of its peak in early 2008. For 2014 as a whole, production reached an all-time high.

From a sectoral perspective, most sectors experienced growth in 2014 (see Figure 2.5). However, in spite of recent strong output increases in certain sectors, only three sectors have exceeded their pre-crisis production levels (pharmaceuticals, other transport equipment and food and beverages) while motor vehicles is nearly at the same level of production as before the crisis. At the other extreme of the performance spectrum, other non-metallic products, textiles, basic metals and chemicals saw their production levels fall and are still far from their peak production.

In other parts of the world, manufacturing has recovered more quickly than in the EU. Despite initially rebounding quicker than in the United States, EU manufacturing has since fallen behind in recovering from the recession. In many Asian economies, manufacturing output plunged deeper than in the EU or the United States, but recovered much faster. A case in point is South Korean manufacturing, which returned to pre-recession levels of production in less than 18 months. Even in Japan — initially hit harder by the crisis than any of the other three economies — the economy recovered almost at a par with South Korea for some time, until the devastating earthquake and tsunami of 2011 dealt a second blow to the economy.

After several difficult years at the start of the century, EU manufacturing output expanded rapidly from 2003 to 2008, when it peaked. It then fell by almost 20 % in 2008 and 2009 as the full force of the recession required manufacturers to close down, or at any rate downsize in order to survive. From its lowest point in 2009, manufacturing has recovered more than half the output lost in 2008–2009 but remains lower than pre-recession peak production in most Member States. On average across all Member States, the negative gap is around 9 %, but in crisis-stricken economies such as Cyprus, Greece and Spain, manufacturing output only represents 60–75 % of pre-recession levels. In fact, in fifteen Member States manufacturing output remains lower than before the recession, in nine it is higher, and in the remaining four (Austria, Germany, Hungary, Netherlands) it is very close to pre-recession levels.

The relative importance of manufacturing has increased overall by 0.5 percentage points, with respect to 2009. However, performances vary slightly among Member States and across time, as shown in Figure 2.4. It is interesting to note that, with the exception of Germany, the seven Member States with a larger manufacturing sector (as percentage of GVA) — the Czech Republic, Hungary, Slovenia, Germany, Romania, Slovakia and Lithuania — mostly catching-up economies that are likely to grow more than the EU average in years to come.

The share of services in GVA has increased overall by 0.4 percentage points, with respect to 2009. Figure 2.3 below shows that the service sector accounts for more than 59 % in GVA in all Member States. In ten of them – Luxembourg, Cyprus, Malta, Greece, the United Kingdom, France, the Netherlands, Belgium, Portugal and Denmark – it even accounts for more than 75 % of GVA in 2014. Only six Member States – Germany, Estonia, Lithuania, Hungary, Slovenia, and the Czech Republic – have seen a reduction in the weight of the services sector. These are Member States were the relative importance of this sector was already below the EU average, while that of their manufacturing sector was well above the EU average.

Figure 2.2 below shows that during the period 2000 to 2014 the shares of agriculture, industry and construction in GVA decreased, while the shares of services increased. These changes resulted in services (market and non-market) accounting for 74 % of the GVA in 2014. During the same period, the share of manufacturing decreased from 18.8 % to 15.3 %.

There are several possible explanations for the increasing importance of services in the economy. First, income elasticity of demand for certain services (education, health, leisure related, and personal services, among others) is higher than for most manufactured goods. This high income elasticity together with increases in income in the EU-28 during the period studied resulted in a disproportional increase in the share of services in the economy. Second, the use and relative cost of services as intermediate inputs in manufacturing increased during this period. Third, productivity increased faster and prices increased more slowly in manufacturing than in services. Finally, manufacturing was more exposed to competition from low cost producers outside EU, which could lead to reduction in manufacturing production and reallocation of resources within the EU towards services, which were less exposed to such competition.

Economic development has been characterised by a gradual shift of activity and resources from agriculture to manufacturing, followed by a shift from manufacturing towards the service sector. The tertiary sector has gained in importance, both in terms of employment and output, and all EU economies are becoming increasingly services economies, in terms of both the share of value-added and the share of employment generated in services sectors. However, there are still relevant differences across Member States. As shown in Figure 2.1 below, the weight of manufacturing is overall higher in Central and Eastern European (CEE) Member States and several EU-15 Member States. As concerns services, all CEE Member States have a share of total value added below the EU average.

The problem of low productivity remains therefore one of the greatest threats to improve competitiveness and raise living standards. The generalised productivity slowdown and the opportunities from a better allocation of resources and innovation offer a window of opportunity to the EU to improve global competitiveness. A strong commitment to productivity-enhancing structural reforms is needed. However, while common principles may apply, reforms should be country and sector specific.

The economic recovery in Europe is gaining strength. While this is encouraging, we seem destined to return to weak growth rates. Economic expansion alone is not enough to guarantee lasting and sustainable growth. As the possibilities for accumulating capital and labour appear limited, the onus is on productivity to drive long-term growth. But the long-term trend of declining productivity growth has not been reversed yet. The barriers that have hampered investment and lowered capital accumulation (see chapter 1) are also responsible for the slowdown of productivity growth. Revitalizing investment is needed to improve productivity.

The Letter of Intent from President Juncker and First Vice-President Timmermans to the Presidents of the European Parliament and the Presidency of the Council accompanying the President's State of the Union speech 2015 indicated that the identification of key obstacles to investment at national level will be a priority of the 2016 European Semester.

Third, Single Market barriers, like differences in business services across Member States, public procurement inefficiencies, other restrictions like in the area of acquisition of land or real estate and several barriers in the area of e-commerce. These obstacles can limit cross border expansion opportunities, creation of new business models and investment in innovation. The Single Market Strategy to which this report is attached, aims at deepening the Single Market by removing unnecessary barriers to the free movement of goods and services and above mentioned restrictions in order to favour investment inter alia in innovation.

Second, obstacles linked to financing constraints. Although there are significant discrepancies among EU Member States, European firms are in general too dependent on bank lending and equity markets remain underdeveloped in comparison to other big economies like the US. This coupled with information asymmetries and other restrictions, limit investment opportunities, expansion potential and innovation of EU firms. In this case, investment in innovation is particularly hit as smaller and more innovative companies face significant challenges in accessing seed stage and early stage venture capital. The financing strand of the Investment Plan will mobilise finance for additional investment through the European Fund for Strategic Investments (EFSI) while the Capital Markets Union will explore ways of reducing fragmentation in financial markets, diversifying financing sources, strengthening cross border capital flows and improving access to finance for businesses, particularly SMEs.

First, barriers linked to regulatory instability, unpredictability, overregulation or bad regulation which impact all types of investment decisions but mostly longer term ones. Investments with longer pay back periods like the ones in the energy sectors need in general not only political but also regulatory stability. It was also shown that regulatory inefficiencies generally increase running costs for businesses especially for SMEs. The third strand of the investment plan aims at improving the investment framework conditions. The Better Regulation package adopted earlier this year, aims at making regulation more lean, consistent and agile.

The fact that European economies (unlike in the US) did not manage to rebound to their pre-crisis investments levels shows that there are some consistent barriers that continue to hinder investment in the EU. This chapter tried to analyse these barriers and to identify their impact on specific sectors or types of investment by giving some specific examples where possible from Member States. The taxonomy proposed includes three types of obstacles:

Further to these initiatives, the Commission has started working on the identification of country and sector-specific barriers to investment that will be addressed in the context of the European Semester. Moreover, a set of investment barriers in chemicals, minerals and recycling, has been outlined as a result of consultations with potential investors. Specific obstacles concern for example difficulties with long-term electricity contracts, land-use planning and sometimes an inappropriate approach to the implementation of permitting, regulatory barriers for bio-nutrients, regulatory uncertainty for carbon capture and use, regulatory uncertainty for plastics recycling, or unfair competition on biomass markets or the functioning of waste markets. Work on identifying investment barriers in other industry sectors than the ones mentioned above is currently ongoing.

In addition, the Single Market Strategy targets at deepening of the Single Market by removing barriers to the free movement of goods and services and enhancing implementation of existing Single Market rules. The Better Regulation package adopted by the European Commission earlier this year sets the scene for better regulation in the coming years by having as main objectives the better assessment of impacts, more consultation with stakeholders and better evaluation.

For the first two strands of the Investment Plan to be successful, improving the investment framework conditions in the European economies is crucial. As already mentioned, many obstacles for investment are linked inter alia to the regulatory framework but also to deficiencies in the product, services, and capital markets. The identification and removal of barriers to investment across EU Member States is the key objective of this strand. To improve the business environment and financing conditions, the Investment Plan will include progress towards a Digital Single Market, Energy Union and Capital Markets Union. The Digital Single Market will unlock on line opportunities by bringing down barriers. The Energy Union will create a fully integrated internal energy market by reducing technical and regulatory barriers. The Capital Markets Union (CMU) will create deeper and more integrated capital markets in the 28 Member States of the EU. The Capital Markets Union Action Plan launched in September 2015 is based on four key principles: creating more opportunities for investors; connecting financing to the real economy; fostering a stronger and more resilient financial system; deepening financial integration and increasing competition. The Action Plan foresees some key early actions.

The first strand (or financing strand) is about mobilising finance for investment through the European Fund for Strategic Investments (EFSI). An EU guarantee of EUR 16 billion aims at directing through the multiplier effect more than EUR 315 billion to the real economy. The fund will focus its financing on investments in infrastructure and innovation, as well as finance for small- and medium- sized Enterprises (SMEs). The second strand is all about making this finance reach the real economy. The EU investment project portal (EU IPP) will give the possibility to project sponsors to submit their projects to an open and transparent system thus addressing a major obstacle to investments - the lack of information - by informing investors about available existing and potential future projects. The European Investment Advisory Hub (EIAH) which will be Europe's gateway to investment support, draws together existing expertise in technical assistance, project design and implementation in Member States, the EIB and the European Commission to create a single contact point for project sponsors and investors who need such assistance in order to improve their project plans.

Implementing the President's political guidelines, presented to the European Parliament in July 2014, the Commission proposed an Investment Plan which aims to mobilise at least EUR 315 billion in the next three years by supporting investment in the real economy and creating an investment-friendly environment. It will help maximising the impact of public spending and unlocking private investments. Its main objectives are to reverse the drop in investment, boost competitiveness in strategic areas and strengthen the European dimension of EU knowledge, human capital and physical infrastructure, and the interconnections that are vital to the EU Single Market. This is addressed through three mutually supportive strands.

Investment in innovation can be hampered by a non-harmonised Single Market in several sectors. For instance, digitisation of the health sector is hampered by several regulatory inefficiencies and non-harmonised rules linked to security (e.g. varying rules on secondary use of data), access and update of data (e.g. lack of harmonisation on patients’ consent as well as rights to erase and correct data and/or the lack of harmonisation of professionals having access to the data), barriers to cross-border transfer of data and the lack of a common strategy to coordinate deployment of e-prescriptions.

Several barriers in the EU hamper the development of e-commerce though the establishment of new businesses or the expansion of existing ones or the development of new business models. For instance data localisation requirements force companies to store data on servers physically located inside a particular Member State not allowing them to keep processing facilities outside their territory. Processing of consumer data is extremely important for several industries and this situation limits their growth potential. Indeed it has been estimated that the negative impact of data localisation requirements on EU GDP is 0.4 %. In the area of veterinary medicinal products some Member States introduced national controls on online sales of veterinary medicines (e.g.: United Kingdom, Germany, Ireland), and others have no controls or forbid it (Austria and Belgium). This fragmentation reduces the potential benefits that retailers of veterinary medicines (in particular SMEs and micro-enterprises) could have from operating on a larger, EU-wide market and from developing new services for consumers.

Inefficiencies in public procurement across EU Member States can also limit cross-border expansion or growth in the domestic market or even the development of new business models. Uncompetitive practices (for instance non transparent public procurement procedures and fragmentation of calls) are an obstacle to companies' involvement in public procurement. These restrictions prevent smaller companies to grow as they are more vulnerable to uncompetitive practices such as obstacles to involvement with public procurement. A recent study indicates that the increased publicity requirements induce more entry into public procurement while increasing the likelihood that the winner would come from outside the region of the public administration. However transparency of below threshold procurement varies greatly: National thresholds for publication range from less than €10,000 in Portugal to €134,000 in Italy for goods and services, and there is similar diversity in works. Finally, there are also divergences as regards the length of review procedures and costs of litigation, which may further discourage cross border participation.

Several Member States have restrictions that limit the possibility for a company to expand cross border and grow (see Figure 1.13). For instance in Greece, significant restrictions exist for investment in sectors like maritime and air transport. In the maritime transport sector, the limitation on foreign equity participation is set to less than 50 % and cabotage is not permitted for non-EU registered vessels, with the exception of cruise ships. In air transport, the air transport investment regime restricts foreign equity participation to less than 50 % and effective control of the airline must be in EU hands. Retail establishment rules are particularly restrictive in Denmark and Finland, in particular for the opening of new large retail outlets. Operational restrictions are also present in Hungary, with the presence of a food safety inspection tax, restrictions prohibiting Sunday and night opening for large shops and a provision prohibiting selling groceries by companies operating with a loss in two consecutive years.

High levels of trade restrictiveness in business services can hamper the cross border expansion of firms or the development of new business models. Cross border services within the Single Market as a percentage of total services (6-20 % total) are far below those in the US (27-32 %). Across Member States differences are significant too. Figure 1.12 shows that in several EU countries service trade restrictiveness on business services is high. The flash Eurobarometer survey on European businesses and public administration shows that currently only 8 % of SMEs engage in cross-border activities. As also noted in the Commission Staff Working Document ''A Single Market Strategy for Europe – Analysis and Evidence'' despite a considerable reduction in authorisation, registration and licencing requirements following the implementation of the Services Directive, there are still multiple restrictions in place: These are linked inter alia to the obligation of service providers to obtain authorisations in the country where they provide services even if they have already obtained the same or similar authorisations in their country of establishment, the limited validity of authorisations (territorial and/or time restrictions), and the requirement to register with a chamber or professional association. For retail services, in addition to the large number of obligations for authorisations and permits, conditions are often associated to the size and location of the establishment. Moreover, certain operational requirements may have significant effects on the competitiveness of the retail sector or on cross-border trade and investment.

The uncertainty around IPRs mentioned before, acts as a burden to both bank lending and the flourishing of equity markets. The need to ensure that intellectual property assets are appropriately valorised so that innovative firms, in particular SMEs, can raise capital to enhance their economic performance is a key challenge for job creation and growth. According to a recent study undertaken for the European Observatory against IPR infringements by OHIM, intellectual property reliant industries account for 26 % of the EU’s employment and 39 % of EU’s GDP

Given the stagnant public spending in ICT R&D, this gap in private funding limits growth opportunities for start-ups and affects investment in innovation too. Examples of how these financing constraints affect the growth of innovative companies can be found in some Member States. For instance in Cyprus, there is a grant scheme for Entrepreneurial Innovation-Developing Innovative products and Services for the international market, supporting 39 innovative companies. Three of them cannot expand further although they have secured international patents because in Cyprus there is no venture capital market and the banks do not give loans to innovative companies that have only intellectual property as collateral. Financing constraints also affect long term investment: more than 75 % of the Member States pointed out the financing constraints (both in terms of public and private sources of financing) as barriers to long term investment.

Information asymmetries between lenders and borrowers and lack of credit information for potential investors also hinder financing. Around 25 % of all companies and around 75 % of owner-managed companies do not have a credit score. This lack of credit information is due to many factors, including: lack of clear accounting guidelines to value intangible assets which affects most start-ups and innovative businesses in the EU; differences in national laws that hinder the collection of information and lack of positive data sharing (e.g. on payment records) in many Member States; fragmentation on the provision of financial information to investors more generally (ex. the financial statements prepared by companies vary greatly from one Member State to another); expensive provision of good quality independent research leading to lack of investment research and analysis on SMEs.

One of the main issues in the EU financial market is that European corporations are in general too dependent on bank lending and equity markets remain underdeveloped in comparison to other big economies. SME's particularly cannot tap capital markets due to, among others, their size, scant credit information and regulatory and other barriers to SME listing. Only a small minority of them reported having used (or considered using) alternatives to bank loans financing instruments, such as equity (16 %) or debt securities (4 %). Moreover, there are significant differences between Member states regarding access to stock markets as a source of funding (Figure 1.10). Alternative financing mechanisms like venture capital, private equity and other non-bank channels play a very limited role especially for EU SMEs. Private funding for start-ups in the EU is very limited compared to that of their US peers (see Figure 1.11).

Financial flows to non-financial corporations in the EU are increasing but remain subdued. Financing discrepancies among Member States have been exacerbated, i.e. while certain countries have historically low financing costs, others - especially in the euro area periphery - are still struggling with prohibitively high costs of long term financing, which is a major hurdle for achieving a well-functioning Single Market. Across firms' size, there are significant discrepancies too. SMEs, the backbone of the EU economy, continue to be disadvantaged compared to large firms in terms of interest rates and the overall cost of borrowing, as European banks have increasingly differentiated the lending rates between small and large loans, in particular in the distressed countries of the euro area. This impacted particularly small and newly established businesses.

It has to be noted that the effectiveness of justice systems and of public administrations is very important in order to reduce the above mentioned transaction costs for companies. The 2015 EU Justice Scoreboard shows that there are significant divergences in the effectiveness, i.e the quality, the independence and the efficiency of the justice systems in Member States, and some of them continue to face challenges relating to the functioning of their justice systems. The effectiveness of the public administration is very important too. Despite the fact that many Member States are planning or even implementing ambitious reforms aiming at modernising public administrations and thus facilitating the general business environment, overall data shows that government effectiveness has not improved much across the EU over the past five years. In addition, according to feedback received from Member States, public administrations in general are suffering from insufficient administrative capacities to manage complex projects and lack of technical skills on evaluating, structuring and executing projects, especially PPPs or private-sector delivery models more generally.

Excessive red tape impedes market entry but can also affect the prospects of companies', especially small businesses by limiting their possibilities to grow domestically and internationally or to export because transaction costs are increased by unnecessary administrative procedures. Particularly burdensome areas are related to time and cost to start a business and to acquire licenses. In several EU countries like for instance in Slovenia, Spain and Italy, the time needed for an investor to obtain a building permit is particularly lengthy while costs are not negligible.

Regulatory fragmentation across the Single Market or disproportionate restrictions, hamper the opportunities to expand business at EU level especially for companies in the transport sector. In transport, logistic costs are very important and logistic restrictions can be as much as 10 % of total logistic costs. Unnecessary load and size limits, traffic restrictions, local restrictions in ports that hamper competition and administrative procedures that drive up costs, reduce freight attractiveness for firms. In road transport there are logistics related to regulatory differences or restrictions that impact on the growth opportunities of companies. In rail transport, the lack of interoperability between systems (lack of full ERTMS deployment) holds back rail freight growth.

Uncertainties around intellectual property rights (IPRs) affect investment in innovation. High costs and complexity of litigation have a dissuasive impact on SME's using and enforcing IPRs. This leads to SME's in the EU under using IPRs as a means to ensure that they earn sufficient returns on their investment in innovation. Regulatory uncertainties and fragmentation across Member States may inhibit the development and growth of the new business models like for instance in the area of collaborative economy. Grey zones in the liability of service providers, business authorisation and registration requirements deters market access for platforms and limits investment opportunities estimated at around USD 15 billion.

There are sectors like pharmaceuticals, where a harmonised and agile approval process to reduce the time to market and an efficient and predictable IPR framework are critical to attract innovative investments in the EU. In the pharmaceutical market conducting clinical trials entails considerable investment and growth in the EU. The Clinical Trials Directive is heavily criticised and also one of the possible reasons for part of the decrease in the number of applications for clinical trials in the EU. In the market of veterinary medicinal products, the total annual administrative burden imposed on business by the veterinary medicines legislation was estimated to be around 13 % of the turnover of veterinary medicines sector - twice of that estimated for the human sector. In addition, there is a concern expressed both by regulators and the pharmaceutical industry, that the current veterinary pharmaceutical legislation is not suited to innovation. A reason behind this is that the current data protection provisions do not take into account the difficulty found by the veterinary sector in recovering investments spent in the development of new veterinary medicines.

Disproportionate regulatory burden at EU or at Member State level could increase the cost of doing business and thus have a negative impact on investment decisions or dislocate investment. The Fitness Check on the Refinery sector shows that up to 25 % of the sector's margin decline can be attributed to the impact of 10 pieces of EU legislation. In metals, regulatory costs represented on average 8 % of total production costs over the entire period (2002-2012) but were in the area of 16 % to 39 % of profits. In the chemical industry, some EU restrictions through REACH may contribute in making operating more costly in the EU than in competing locations. Figure 1.8 depicts the costs associated with EU legislation in these industries while Figure 1.9 shows that some energy intensive industries like building materials, paper & wood, metals and chemicals, experienced a more pronounced drop in investment during the post 2009 crisis period than the same industries in the US. Of course this analysis is one side of the coin as it does not take into consideration the many benefits stemming up from EU legislation.

Figure 1.7:Regulatory efficiency: The EU is below the world wide average in regulatory efficiency and has lost significant positioning in the last 8 years

Some investment projects submitted by Member States for the EU investment plan have also highlighted the importance of regulatory predictability at EU level.

The uncertainty of the general regulatory framework from frequent or unforeseen changes of the EU or national legislation results in a higher risk for investors. As a consequence, companies may defer investment decisions particularly in sectors with typically longer term pay back periods. The life cycle of a long term project typically spans beyond any government administration or individual regulatory settlement period. Investors are therefore not only analysing the project-specific risks, but are also giving substantial consideration to political risk and stability of the regulatory framework.

Several surveys point out that regulation in EU Member States is inefficient, impacting businesses and their investment decisions. For instance, the OECD ranks the EU average below the global average in regulatory efficiency and shows that the EU has lost significant positioning in the last 8 years (see Figure 1.7). The World Bank rankings 2015 on doing business report on how easy it is for a local entrepreneur to open and run a small to medium-sized business when complying with the relevant regulations. Results show that there are noticeable differences in the performance across Member States. The magnitude of the problem for EU businesses is confirmed by the results of a flash Eurobarometer survey on European businesses and public administration.

It is important to mention in this context that the Letter of Intent from President Juncker and First Vice-President Timmermans to the Presidents of the European Parliament and the Presidency of the Council accompanying the President's State of the Union speech 2015 indicated that the identification of key obstacles to investment at national level will be a priority of the 2016 European Semester.

The scope of this chapter is to analyse the most important reasons for the low investment in the EU and identify the types of investment that are affected the most, by giving where possible some examples from Member States. This analysis is not exhaustive and does not focus on the importance of input costs (like labour or energy costs) or infrastructure. Drawing on the analysis of several surveys and a collection of detailed evidence from Member States feedback, it helps single out specific aspects in the barriers affecting a relevant number of Member States and sectors that negatively impact investment across the EU (see Figure 1.6). Empirical analysis also corroborates the existence of the following barriers to investment:

Adverse effects are also created on the EU international competitiveness, as companies in competitor countries like the US, who saw their productive investment rebound to pre-crisis levels, are gradually upgrading their equipment, something that does not happen in Europe. Finally, the decline in investment resulted in a slowdown in innovation too, not least because SMEs – as drivers of innovation and growth – face great financing challenges.

The main result from this subdued investment in the EU is that the European economy is recovering much more slowly than its main competitors since the onset of the economic crisis of 2008. Other negative impacts are identified on employment and on the medium-term growth potential. According to European Commission estimates, the investment shortfall in Europe accounts for the largest proportion of the fall in GDP during the post crisis period. Unlike services, the impact of the 2008 crisis in manufacturing can still be felt in Europe, with production levels still nearly 10 percentage points below the peak achieved in the first quarter of 2008 (see Figure 1.5). This can be attributed, like in the case of investment ratios, to the fact that manufacturing is more cyclical than services. Moreover services are less tradable than manufacturing and therefore the impact of the world trade decrease following the crisis was more felt in the output of the manufacturing sector.

Figure 1.4 shows the growth rates of investment by asset before and after the financial crisis of 2009. All assets experienced a profound drop due to the crisis but investment in ICT proved to be more resilient to the negative effects of the crisis relative to investment in other assets.

At sectoral level, investment in the EU manufacturing sector was particularly affected in 2008 and it has since then, and unlike what has happened in the US, not managed to regain its losses (see Figure 1.2). Particularly affected sectors include the energy intensive industries. On the other hand, computer and electronics, electrical equipment, motor vehicles and pharmaceuticals have proven to be more resilient to the negative effects of the crisis. In services, investment managed to rebound in most of the sectors to pre-crisis levels mainly due to the fact that services are less cyclical than manufacturing (see Figure 1.3).

Almost all countries experienced a fall in investment from their peak levels, driven particularly by a fall in private investment. This drop was more pronounced in the economies of the euro area periphery than in core economies and particularly in Greece and Cyprus where private investment in recent years has been as little as 11 % of GDP.

The financial crisis that hit the world economy at the end of the previous decade took a heavy toll on investment in Europe and other major economies like the US. This negative impact was more prominent in developed countries. The global average investment rate fell from its peak pre-crisis level of around 23.5 % in 2007, to less than 22 % in 2009 and 2010. It has since regained some of the loss and is now around 22 %. However, unlike other big economies, the deviation from the global average investment rate in the EU continues to widen (see Figure 1.1). According to Commission calculations this deviation has resulted in an investment shortfall of EUR 230 –370 billion while the accumulated investment gap from 2009 to 2014 exceeds EUR 1.2 trillion. In order to reverse the trend, the EU has put in place the Investment Plan which aims to mobilise at least EUR 315 billion in the next three years by supporting investment in the real economy and creating an investment-friendly environment.

The report presents an overview of the main issues that have been identified in the assessment of the competitiveness and integration performance of the EU and its Member States. The report consists of the following chapters: The first three deal with the key issues of (i) investment, (ii) competitiveness and innovation and (iii) the integration of EU firms in EU and international value chains. A fourth chapter looks into the financing of the real economy.

New studies of productivity at firm level call for important reallocations of resources within sectors, across sectors and across countries to boost productivity growth. The need for important improvements in the functioning of the Single Market in areas such as mutual recognition, public procurement and most importantly, in services is more evident now than before 2008. Technology developments will also trigger further resource reallocation. All this underlines the importance of flexibility and the elimination of barriers to resource mobility, giving a new dimension to the Single Market and structural reforms.

Despite the asymmetric shock of the crisis, the Single Market could not smoothen and compensate sufficiently the impact of the crisis on countries with structural current account imbalances. In addition, intra EU integration in products seems to have stalled well before 2008, especially in the 15 Member States that integrated the Union before 2004. Remaining obstacles to integration in services and construction still hold back the potential of the Single Market. These are important developments which require further work into their causes and possible remedies.

Delays in the introduction of EU and national structural reforms in products, services and labour markets in some Member States have added to the cost of the crisis delaying the recovery. In general, countries that introduced structural reforms before the crisis have fared better than the rest. This shows the importance of structural reforms for the overall performance of the EU.

Integration in capital markets was put to the test and the seemingly high level of integration in financial markets could not withstand the shock of the international financial crisis. This experience has revealed the importance of governance issues for the performance of the Single Market.

Against this background, this report presents both recent developments and pre-/post-crisis comparisons concerning the state of integration and competitiveness in the EU and its Member States. It also looks into some long-term trends because the crisis has brought into the open some major imbalances of the EU economy that were already present before 2008:

The economic performance of the EU has improved in 2014 relative to the two previous years. Growth rates remain low and it will take time to reduce unemployment in some Member States, but the EU is steadily recovering despite political and international economic uncertainties. The low exchange rate of the euro and the fall in oil prices are providing an additional boost to the EU economy and particularly to the euro area that has presented record trade surplus figures in the first half of 2015.

Coordination. The economic crisis has made apparent the close relationship and mutual dependence between financial, products and services markets. The relationship between labour, product and services markets is well known. A closer integration of the existing instruments for economic policy coordination will surely improve the effectiveness and the efficiency of economic reform efforts in the EU.

Learning from common experiences. The process of reforms in the EU is a common process where Member States can learn from the experiences of others. Recent Commission studies and reports have made clear the broad differences in the costs of implementing similar EU directives by different Member States. Member States can learn from each other's experience to minimise the social and economic costs of reforms.

Complementarities. To minimise the regulatory fatigue, reforms at EU and Member State levels must be complementary. As Marinello et al (2015) point out, the potential of the Single Market to deliver its expected positive impacts on productivity and growth faces several limitations related not only to the remaining barriers, but also to the lack of complementary policies and the lack of alignment of Member State policies with Single Market objectives. Only feasible, coordinated and relevant reforms with positive expected and actual impacts are likely to succeed in being implemented timely and successfully by Member States. Reforms at EU level must facilitate these changes by increasing the payoffs to reforms and minimising the joint cost of reforms.

As indicated by the Single Market Strategy, economic reforms deliver benefits in terms of growth and jobs but the cost of reforms must be taken into account when choosing the path to reform in the Member States and at EU level. In the EU context, three elements can help us maximise the difference between benefits and costs.

Therefore, significant static gains in the allocation of resources are possible but more durable and lasting gains could be achieved if dynamic efficiency was improved. A higher competitive tension both in goods and services markets, more active innovation and a more favourable potential for the emergence and growth of start-ups could boost total factor productivity.

In summary, the Single Market presents both symptoms of stagnation in the EU-15 in goods markets but integration is still making progress in the EU-13. In services and construction sectors, significant potential remains to be exploited. Over twenty years of integration have contributed to improving the allocation of production and resources in manufacturing markets and the fruits of these changes have been visible in those markets for several years now. However, this seems to have been a stepwise improvement that will not deliver further new gains unless new barriers are removed. In services and construction, the potential is there, but the partial results obtained so far in the implementation of the Services Directive can be significantly increased if further barriers to exchanges in services and establishment are removed.

Structural, behavioural and regulatory barriers remain present in the Single Market. Some of them have particular adverse effects on new dynamic and exporting "start-ups". Others have a particularly negative impact on the construction sector, especially as regards the cross-border circulation of construction materials, which remains an open building site for the Single Market. Financing issues are critical for SMEs and the new measures for the diversification of financing sources alternative to bank credit will be critical to enable investments and innovation.

A number of important improvements and good practices can be detected in public procurement markets. However, Member States are progressing at very different speeds in the implementation of e-procurement, the level of publication of public tenders remains relatively low and the level of professionalization of buyers remains low. Additional work is also pending on the introduction of procurement procedures that can create incentives for innovation and SME participation in procurement.

The regulatory environment has improved but again, the EU-15 present a slow-down in this improvement since 2005. It is precisely after that year that more significant improvements can be found in the regulatory environment of the EU-13.

The analysis of efficiency in the allocation of labour presented in Chapter 3 shows very significant differences across sectors. While high levels of efficiency prevail in manufacturing, the situation is very different in services and construction. Furthermore, deteriorations in allocative efficiency can be reported in the construction sector in particular. This is an indication of the importance of the introduction of reforms to turn around the productivity performance of the Union in the coming years as suggested in Chapter 2.

The current assessment of the benefits of the Services Directive makes apparent the need to improve the implementation and subsequent enforcement of this Directive that is critical for the overall performance of the Single Market in the services sectors and for the EU economy as a whole.

Both trade in goods with the whole of the EU and intra-EU investment of the EU-15 – i.e. Member States that acceded to the EU before 2004 –, seem to have stalled for over a decade. The more recent Member States (EU-13) have displayed a very dynamic process of integration and reached higher integration indicators than the EU-15. Integration proceeds in the services sectors albeit at a relatively slow rate. According to UNCTAD, global exchanges in services grew by 4 % while intra-EU exchanges in services increased by only 2.5 % in 2013. There are significant differences across sectors and there is considerable potential for more exchanges in business services, especially those provided by services professions or in the construction area.

The review of the situation of the Single Market shows that a considerable effort is necessary to introduce structural changes to remove the remaining barriers hampering the performance of the Single Market. However, this review also reveals the potential of the Single Market as a major source of microeconomic reforms in the EU to deliver growth and jobs.

New technologies and stronger integration in EU and global value chains will create new business opportunities but there are regulatory, structural and behavioural obstacles that may frustrate the realisation of these opportunities. Structural reforms are needed at EU and Member State levels to remove these obstacles.

The reallocation of resources will have to proceed along three axes. First, it will require moves of capital and human resources from low to high productivity firms within sectors in the Member States. This had been a major source of productivity growth before the crisis but its contribution has diminished recently. Cross-sectoral reallocation of resources, on the other hand, had not been a major source of productivity growth in the past. New technological developments, changes in input prices (shale gas in particular) and the emergence of new business models suggest that cross-sectoral reallocation of human and capital resources may take increasing importance in the future as a source of productivity growth. Improvements in productivity are possible by more investment in new digital and clean technologies in current production activities by the reallocation of more human, capital and technological resources towards higher value added activities. Finally, a third source of productivity growth will come from the geographic reallocation of resources within the Single Market and from a better insertion of EU firms in international value chains. This would also allow to better exploit backward and forward linkages in global value chains, e.g. by strengthening the integration in key sectors such as business services and logistics.

This report also suggests that conditions are favourable to improve competitiveness if efforts are made to introduce reforms at both national and EU levels. Labour and total factor productivity growth could be increased in the EU if regulatory barriers to competitiveness and integration are removed thus allowing for improvements in the allocation of resources across firms and sectors in the Single Market.

During the 2000-2014 period, EU investment in ICT and Intellectual Property products grew faster than any other form of investment, with annual rates of 3.5 % and 2.8 %, respectively. However, the process of digitisation of the EU economy started late and the accumulated levels in these types of investment are just one third of those in the US.

The first big challenge to restore productivity and long term growth is to revitalize investment. A number of barriers have lowered the intensity of tangible and intangible capital accumulation in the EU. In 2014, Gross Fixed Capital Formation recovered by 2 percentage points of GDP, but this is still below the investment levels needed to cut down our productivity gap with respect to the USA. A subdued level of investment over several years has produced a significant accumulated lag in investment, especially in Information and Communication Technologies (ICT).

There is growing consensus on the existence of a slowdown in productivity growth affecting both advanced and emerging economies. Differences in labour productivity and total factor productivity growth rates between Japan, the USA and the EU are getting narrower as a result of this slowdown. This opens a window of opportunity that could allow Europe to accelerate the catching up process in productivity if economic reforms are implemented.

Europe has accumulated a considerable productivity gap with the USA, especially as regards dynamic efficiency. According to the Conference Board, EU labour productivity in 2014 was 70 % of the US level. Last year and contrary to previous years, the difference in productivity growth rates between the EU and the USA has not widened.

There are encouraging signs suggesting that the EU has embarked on the path towards economic recovery. And yet, economic recovery does not necessarily ensure a better allocation of resources which would allow the EU to improve its productivity growth and higher competitiveness levels in the longer run. Unfortunately, the recent experiences of some EU Member States have shown that, even during periods of growth and capital inflows, resources can be misallocated, generating important unbalances that are costly to redress. In other cases, regulations in labour and product markets can block the reallocation of resources.

The economic performance of the EU has improved in 2014 relative to the two previous years. While growth rates remain low and it will take time to reduce unemployment in some Member States, the EU is steadily recovering despite political and international economic uncertainties. The fall in oil prices is providing an additional boost to the EU economy which has presented record trade surplus figures in the first half of 2015.

This report has been written by the staff of the Directorate-General for Internal Market, Industry, Entrepreneurship and SMEs, European Commission.

COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS

The innovation performance of Member States is converging but only gradually. It is noteworthy that more innovative Member States (Denmark, Finland, Germany, Sweden) are hardly converging amongst themselves, while innovation performance amongst more modest innovators (Bulgaria, Latvia, Romania) is even diverging. Moreover, several Member States show poor results in business innovation activity. Yet, it is precisely in this area where the gap vis-à-vis global competitors is larger, that one would expect more rapid growth. Effective innovation policies must take into account the specific conditions of the relevant country, region and sector.

Fostering the completion of the Single Market would facilitate the allocation of resources to the sectors with higher productivity growth. This could increase the competitiveness of EU industrial and service sectors thus boosting growth and job creation. There is room for policy and structural reforms to foster productivity growth by improving the use of productive inputs (adoption of best practices) and resource allocation (allocative efficiency) across sectors, countries and regions. Tackling the existing barriers in the Single Market with EU-wide actions such as those proposed by the Single Market Strategy will contribute to a better allocation of resources across firms and sectors. Yet, sector and country specific product market reforms should also be adopted by Member States in those cases where structural reforms must take into account national and regional specificities of the national or regional economic structure.

Productivity can be increased by technological progress (expansion of the technological frontier) and by the adoption of existing technology (catching up process by laggards). These processes take place along national lines and across sectors. However, policy distortions and regulatory fragmentation can hamper them and lead to an inefficient allocation of resources towards less productive firms.

Yet, the convergence of productivity amongst EU economies is stalling. As product and process innovation may be running out of steam, this slowdown reduces growth prospects. For certain EU Member States the problems of declining or stagnating TFP date back to before the crisis. For countries like Italy, Spain and even France and Belgium, the stagnation in terms of TFP in manufacturing started long before the crisis, providing strong evidence for structural rather than cyclical problems. TFP performance is also affected by the quality of factors of production, as measured, for instance, by energy prices, infrastructures, skills and technology.

A major resource re-allocation across sectors is taking place in most developed economies. This structural transformation may lead to higher growth and competitiveness if it is driven by technological progress and efficient allocation of resources.

In general, larger countries use relatively less intra-EU production inputs, both from industry and from services, reflecting their sizeable domestic production capacities. The UK, Italy, France and Spain were the lowest users together with Greece of intra-EU industry inputs, and these countries (UK, IT, FR) together with Bulgaria and Germany were the lowest users of intra-EU services. In contrast Hungary, Belgium, Czech Republic, Malta and Slovakia were the top five Member States with the largest level of intra EU cross-border outsourcing of industry and Luxembourg, Ireland, Malta, Belgium and Denmark were the top five Member States with the largest level of intra EU cross-border outsourcing of services.

The overall trends in EU outsourcing over the period 2004–2011 indicate that the role of intra-EU outsourcing has diminished both in industry and services (Figure 2.33). The level of intra-EU outsourcing in the industry has diminished in several Eastern European EU Member States (LT, LV, BG, EE, SK, SI, MT, CZ and HU) after the crisis. Similar developments, though at a much lower scale, given the lower starting point, were observed in services. Similar trends were observed for extra-EU industry outsourcing into Eastern EU Member States (Figure 2.34). On the contrary, the share of output supplied by third countries in services increased in almost all EU Member States, indicating increasing involvement of third countries services' providers into EU value chains.

The lowest proportion of low-skilled labour (4.67 %) is found in financial and insurance activities, closely followed by professional, scientific and technical activities (4.7 %). More than 25 % of the workforce in chemicals, other transport equipment, beverages and tobacco manufacturing are high-skilled. Low-technology manufacturing industries such as textiles, clothing, leather products and wood products employ small proportions of high-skilled labour. The same applies to labour-intensive service industries such as accommodation and food, and agriculture and forestry.

Service sectors among the most human-capital-intensive include: education, information and communication; professional, scientific and technical activities; and financial and insurance activities. Shortage of highly required professionals, such as ICT programmers, poses increased risks to EU competitiveness, especially in high-tech sectors, but the shortage of ICT specialists is generally affecting all sectors.

Manufacturing sectors that produce goods requiring a high proportion of high-skilled labour are: pharmaceuticals; computer, electronic and optical industries; and coke and refined petroleum. While the first two are sectors with high technological intensity, coke and refined petroleum is classified as a mid-low-tech sector. However, this sector has an above average labour productivity, and is dominated by large enterprises (more than 250 employees), mostly operating in the global markets.

Most European countries are faced with skills challenges, as a consequence of the ongoing structural changes taking place in their economy. For instance, in the period 2008-2013, the share of low-skilled workers has decreased for all sectors, whereas the share of high-skilled workers has slightly increased. The overall picture for medium-skilled workers is less clear, since roughly half of the sectors experienced a decrease. This finding might be explained in different ways. First of all, since the level of education is generally increasing in Europe, this can partly explain the general decrease of low-skilled workers. Secondly, the economic and financial crises may have hit stronger low pay jobs, determining an overall decrease of low-skilled workers (and medium-skilled workers in some sectors), while high-skilled ones managed to keep their position. Finally, labour hoarding is more likely to be observed for highly educated and specialised workers.

Long-term growth can be achieved by improving the quality of labour input since highly qualified workers can help firms innovating and make the best use of high-tech processes. Human capital is not a perfectly substitutable input which can be transferred between sectors at no cost. It is therefore an input factor which can explain differences in growth across countries, although it is not easy to measure.

Boosting productivity, employment and economic growth, while exploiting the benefits of energy and resource efficiency and the green economy is a challenge and an opportunity in many Member States. For example as regards eco-innovation, the gap between the best performers (including Sweden, Finland, Germany, Denmark and the UK) and the Member States lagging behind (including Bulgaria, Poland and Cyprus) remains significant. Accelerating the market uptake of eco-innovations in all sectors could be effectively promoted by addressing the obstacles faced by eco-innovative businesses and through supporting market replication and clusters of SMEs, developing targeted financial instruments, and the public procurement of cleantech innovations.

European manufacturing firms spend on average 40 % of their costs on raw materials, with energy and water pushing this to 50 % of total manufacturing costs, to be compared to a share of 20 % for labour costs. () Resource efficiency is thus an important driver of innovation and competitiveness and will play a crucial role for industry to open up new markets. Resource productivity varies considerably across Member States due to their different GDP levels, their stages of economic development, and the structure of their economies. Countries showing highest values in resource productivity include the Netherlands, Luxembourg, the UK, Spain and Italy. The lowest resource productivity can be observed in Finland, Latvia, Bulgaria, Estonia and Romania. Energy intensity in the industry is the lowest in Ireland and Denmark whilst Lithuania and Bulgaria have the highest energy intensity.

Upgrading and better connecting the energy infrastructure are among the key objectives of the Energy Union Strategy. The work on infrastructure projects has accelerated in recent years and many Member States have launched large-scale projects which are now in the implementation phase, including the "Projects of Common Interest" identified in 2013 under the trans-European energy networks Regulation (TEN-E).

The availability of fixed broadband infrastructure, which is crucial for digital markets, has progressed moderately but steadily. However, fixed rural coverage is still below 80 % in five Member States, and remains a challenge in Member States such as Bulgaria, Finland, Latvia, Poland and Slovakia, with some progress registered in Croatia, Slovenia and Romania. Whilst more than two thirds of the EU households are covered by high speed broadband, Italy, Croatia and Greece need to upgrade most of their networks to keep pace.

Overall, the quality of transport infrastructure in the EU increased slightly over the last five years. The new Member States continue to catch up and significant investment has taken place in the context of cohesion policy since 2007. By contrast, there are indications of under-investment in most advanced EU economies since 2009 (Austria, Belgium, Germany, Finland, France, Luxembourg, the Netherlands, Denmark, Sweden and the United Kingdom). Member States' budgets allocated to maintenance were often not sufficient to prevent a deterioration of the existing network.

Efficient infrastructure and network industries (e.g. energy, transport and broadband) are fundamental for a competitive business environment. However, the quality and availability of these production inputs still varies considerably across the EU.

Figure 2.31 presents the market shares of the EU, USA, Japan and China in 1995, 2005 and 2013 for exports with high, medium and low unit value. Figure 2.32 shows the contribution to manufacturing exports and to high unit value export segment by Member State. The former figure shows a higher and even growing market share of EU exports in the high unit value export segment. These results point out in a similar direction as Vandenbussche H. (2014). However, the EU competitiveness could be further enhanced by reducing the existing barriers on allocative efficiency, which negatively impact competition in a number of Member States, as pointed out in the Staff working document accompanying the Single Market Strategy.

Quality competition and moving up the ladder in the value added contents of the activities carried out in medium-tech sectors seems to be contributing to sustain EU competitiveness. This appears to be confirmed by evidence provided by the analysis of the qualitative changes in the contents of our exports based on their unit values. These values can be interpreted as quality-adjusted price of products and provide a better insight of the changes in the composition of EU exports.

This is a relatively good performance in a world with many and powerful emerging economies like China and stronger competition from the USA. Europe's export performance is particularly remarkable given its relative input price disadvantage.

Exceptions to this are the capital city regions, especially in the CEE countries. Accordingly, revealed advantages in business services exports are highly correlated with GDP per capita levels. This correlation and the generally low competitiveness of business services in the peripheral regions are of direct policy relevance, as it opens up the possibility to design concrete policy measures targeting the development of such services in the less developed EU regions. Such policies not only would improve those regions’ competitiveness in business services, but at the same time would also create additional employment and contribute to the general economic development of those regions, as improved business services would have positive repercussions on the manufacturing industry sectors, via R&D and the transfer of knowledge, increases in the technological capacities, marketing etc. As a final consequence, such targeted policies would thus also contribute to economic cohesion of the EU regions.

The graph shows the geographical distribution of regional revealed advantages in value added exports for business services in 2011. In the context of the analysis, business services are understood to comprise the following elements: a) the renting of machinery and equipment, b) computer and related activities, c) research and development and d) other business activities such as legal and accounting activities, tax and business consultancy, market research. They do not include financial services such as banking and insurance. In the EU, there is a clear geographical divide, as the high income countries and regions tend to have revealed advantages in the value added exports of business services, while the less developed countries and regions in the South (Greece, Portugal and Spain) as well as in the East have revealed disadvantages.

Over a long time period, Europe has succeeded to be better than the USA and Japan in maintaining relatively high market shares in world trade. The share of the EU in global exports has fallen by 3.5 percentage points (ppt) between 1995 and 2013 while it has decreased by 8.9 ppt for Japan and 4.7 ppt for the USA. China with over 13 ppt gain in the share of global exports is the main beneficiary of the losses reported by the other main global trading partners. In some cases, such as transport equipment, the EU's world market share has increased by 5.2 ppt from 1995 to 2013. Europe has also succeeded in maintaining its comparative advantage in sectors such as machinery and chemicals, but not in the upcoming digital and communication technologies.

The evolution of comparative advantage is clearly path dependent and this is an important fact to take into account in the design of policies; a background study presents a detailed account of the evolution of specialisation at NUTS 2 level for low to high-tech sectors. A snapshot of this analysis for business services in presented in Box 2.1 below.

Given their nature, revealed comparative advantages can only be reported for a limited number of traded services sectors in Figure 2.30. Europe has a high comparative advantage in personal, cultural and recreational services but it has also a strong specialisation in financial services. ICT and business services that have a crucial importance for manufacturing and other business activities seem to have a positive but relatively low comparative advantage level.

As shown in Figure 2.29, the EU has a comparative advantage in high-tech sectors (pharmaceuticals), medium-high tech sectors such as machinery and transport equipment, including motor vehicles and low-tech sectors (paper, print and beverages). Over the last twenty years, European comparative advantage has remained stable in most sectors but some improvements can be reported in the motor vehicles, the paper and printed product and the machinery value chains.

The importance of export growth for the EU in recent years has been considerable. EU exports have been growing above the world trade index since the crisis. External demand has contributed by around 3 % to GDP in the early years of the recovery and has compensated the negative contribution of internal demand in 2012 and 2013. Although energy prices have been a disadvantage for the international competitiveness of EU firms, the evolution of unit labour costs has contributed to improve it. But this has not been the only factor supporting our export performance.

Among the Member States with an increasing integration in the Single Market, most of them have experienced an improvement of their price competitiveness position. Some of these countries (Estonia, Latvia, Romania as well as Luxembourg) benefited from improving the quality of their exports as well. As regards the group with decreasing or stagnating integration, Belgium, Luxemboug, Malta, Finland and Greece suffered from cost competitiveness losses. Only Finland and Sweden exported less in 2010-2014 than in 2004-2008. Ireland leads the table in services exports, followed by Portugal, France, Malta and Belgium. Bulgaria, Cyprus, Italy, Slovakia and Croatia are the only countries presenting worse results in 2010-2013 than in 2004-2008.

As explained in the next chapter, the EU is now integrating faster with third countries than internally, which reflects the globalisation process and the faster demand growth in many emerging markets. There is however no trade-off between intra-EU trade and global trade. Member States which integrated further in the global economy are also those that have shown the highest integration dynamics within the EU.

The situation looks similar when focussing on the exports of goods, but the growth rates are relatively more modest with a maximum growth of exports of around 30 percentage points in Lithuania. Obviously, this implies a relatively faster expansion in the exports of services. Finland and Sweden are the two countries reporting export contractions as far as goods are concerned.

There is a very clear distinction in the exporting performance of different Member States compared to their results in 2004 (Figures 2.27 and 2.28). Seven of the Central and Eastern European Member States have improved their performance in a remarkable way. Their exports to the EU and to the rest of the world have increased by over 20 percentage points. Ireland and the Netherlands are the only EU-15 countries exhibiting a comparable performance. These have and remain very open countries with a high degree in the internationalisation of their activities. There are just two EU Member States where exports have contracted in the last decade: Finland and Cyprus.

Figure 2.28:Growth in total exports of goods and services to the EU and to the rest of the world (2004-2014)

Figure 2.27:Growth in total exports of goods to the EU and to the rest of the world (2004-2014)

Driven by improvements in productivity in some Member States and by the internal devaluation, EU exports have increased considerably after the crisis with respect to the 2004-2008 period. This expansion applies equally to goods and services. However, there are big differences in the export performance of Member States within and outside the EU. The vigorous growth in global demand resulted in an increase of extra EU exports of goods of 28 % in the 2010-2014 period compared to the five years previous to the crisis. A more subdued internal demand limited sales to other Member States growing just at a 3.5 % rate within the Single Market.

Manufacturing represents 64 % of total R&D expenditures in the EU, while the services sector accounts for 34 % of them. In comparison with the US, the EU focuses more on motor vehicles while the former invests a larger share in high-tech sectors like computer, electronic and optical products, and pharmaceuticals. This signals a different type of specialisation. In other sectors, the differences are less relevant in magnitude, pointing to a more similar pattern.

The difference in the share of business R&D expenditure between the EU, on the one hand, and South Korea (222 % of EU value), Japan (199 %) and the US (151 %), on the other hand, is striking. As concerns the level of R&D intensity per sector, the EU shows a higher intensity than the US in very few sectors, in particular computer electronic and optical products, electrical equipment, and chemicals. Although the overall ranking across sectors is very similar, American firms, on average, tend to invest much more than European firms in innovation and technology. This is a matter of concern.

South Korea, the US and Japan strongly outperform the EU in business R&D expenditure, and, to a lesser extent, in public-private co-publications. Firms in these countries invest more in research and innovation, and the collaborative knowledge-creation between public and private sectors is better developed.

When looking at the performance of innovation systems in a global context, South Korea, the US and Japan have a performance lead over the EU. While EU innovation performance has been improving at a higher rate than in the US and Japan, the innovation gap with South Korea is widening (Figure 2.26).

It is particularly noteworthy that the most innovative countries perform best on all dimensions: from research and higher education systems, through business innovation activities and intellectual assets up to innovation in SMEs and economic effects, reflecting balanced national research and innovation systems. Yet, the level of development and structural conditions of the relevant country, region and sector should be taken into account when designing innovation policies. These factors determine the capacities to access, absorb and create new technologies. Effective innovation policies must therefore take into account the specificities of the relevant country, region and sector.

On EU level, the average annual growth rate of innovation performance (as measured by the Innovation Union Scoreboard) has reached 1.0 % with most Member States improving their innovation performance over the eight-year period 2007-2014. However, compared to last year, innovation performance has increased for only 15 Member States, while it has declined for 13 Member States. Overall, innovation performance has been converging across Member States but performance differences remain high.

From the perspective of SMEs, a lack of financial resources is viewed as the main problem in the commercialisation of innovative products or services. In this context, the few innovative businesses that receive public financial support for R&D or other innovation activities consider it as not effective enough. As explained in the Commission Staff Working Document accompanying the Single Market Strategy, the difficulty in accessing and enforcing Intellectual Property Rights (IPR) also deters SMEs' investments in innovation. The significant cost exposure for IPR and patent litigation is a serious deterrent for SMEs to engage in patenting.

The sharpest declines in the share of innovative businesses have been observed in Cyprus, Germany, Romania, the Czech Republic and Spain. On the other hand, the share of innovative enterprises increased the most in Malta, the Netherlands, Latvia and the United Kingdom. During the period 2010-2012, the highest share of enterprises with innovation activity was recorded in Germany (66.9 % of enterprises), Luxembourg (66.1 %) and Ireland (58.7 %). On the contrary, less than 30 % of enterprises had innovation activity in that period in Romania (20.7 %), Poland (23.0 %) and Bulgaria (27.4 %).

In fact, the crisis has left a notable impact on the private sector's innovative activity, with the commercial uptake of innovations constituting a particular weakness. The number of innovative firms is in decline, as are SMEs’ innovations, patent applications, exports of high-tech products, venture capital investments, and sales of innovative products. While there have been improvements in human resources, business investments in research and development and the quality of science, these are not enough to result in an overall stronger innovation performance. This poses serious risks for the long-term growth potential of the EU, as do other aspects relevant to innovation performance.

In the monitoring of innovation processes, both inputs and outputs need to be considered. Research and development (R&D) expenditures can be regarded as the main input indicator. On the public sector side, government efforts in R&D investment have been largely upheld over the course of the crisis. In about half of EU Member States, the government budget for R&D grew faster (or decreased less) than GDP despite severe budgetary constraints. In parallel, private R&D expenditure as a share of GDP slightly increased between 2008 and 2013. As a result, gross domestic expenditure on R&D (R&D intensity) increased from 1.85 % in 2008 to 2.02 % in 2013 (Figure 2.25). Indeed, at the onset of the economic crisis, EU R&D intensity increased to 1.94 % in 2009 as many EU Member States made an effort to maintain public R&D investment to counter the impacts of the crisis on private investment. This increase is remarkable as it followed a relative stagnation around 1.77 % for the period 2004 to 2007. R&D intensity has then continued to grow marginally since 2011. However, it still remains significantly below the target of 3 % by 2020, pointing to the need for additional investment efforts. In absolute terms, investment in research and innovation has actually decreased during the crisis and remains too low.

Among the EU Member States, Germany holds the strongest position in all KETs. In general, Germany performs well above the other European countries in terms of share of patents, share of production, share in total export, and share in turnover. France, Italy and the UK are often among the top five of each KET for several indicators, while Member States like Belgium and Denmark have excellent positions in individual KETs. In terms of trade balance, only Germany, the Netherlands, Belgium, Ireland and Austria have a trade surplus in all six KETs.

However, when considering a broader set of new technologies, the so-called Key Enabling Technologies (KETs), Europe's performance lacks the lustre it has in Advanced Manufacturing Technology, one of the six KETs. East Asian economies strongly develop their own scientific & technological assets in key enabling technologies, with a global share of KET-related patent applications reaching 44 % in 2011. Europe's share in KETs development has progressively declined from 32 % of patent applications in 2000 to 27 % in 2011 (23 % for North America). Also with regard to performance in trade, East Asia experienced a sharp increase in total exports of KETs-based components and intermediary systems during the last decade, holding now a share of about 57 % compared to 23 % for the EU-28 and 20 % for North America. Europe succeeded however in holding its trade share relatively constant over the past decade.

Europe is however a global leader in advanced manufacturing technologies in terms of the share of patents but also in terms of the share in total exports. Europe also has a high and increasing trade surplus compared to East Asia and North America in this sector. A main reason for the good performance of the EU in advanced manufacturing components is that new technological solutions in Advanced Manufacturing Technology rest on the integration of other technologies (such as micro- and nanoelectronics, advanced materials or photonics) into complex products where Europe has a comparative advantage. Moreover, the EU can benefit from its long history in developing and applying advanced technologies in manufacturing, and a dense network of Advanced Manufacturing Technology producers and users.

Also as regards other advanced technologies, EU companies are not adopting such technologies fast enough or in enough scale. A recent survey shows that almost half of European manufacturing companies have not used advanced manufacturing technologies in the past and do not plan to use them in the next year.

While the digitisation of EU businesses and digital entrepreneurship have increased, significant differences remain across Member States. Moreover, taking into account four advanced technologies (mobile internet, social networks, cloud and big data), overall only 2 % of EU enterprises make full use of all four, while 41 % are not using any of them.

The adoption of a particular technology may have an impact on how efficiently input factors are combined. Accordingly, the use of advanced technologies available may foster the long-term growth of a sector by lowering costs, improving quality and ultimately promoting competitiveness. In recent years, digital technologies are redefining traditional business and production models, resulting in a wide range of product and service innovations. In this way, digitisation has the potential to unfold a catalytic impact on the productivity of large companies and SMEs alike. Ensuring adequate standards in this area is important for keeping and enhancing the comparative advantage of the EU industries, as shown in the economic analysis underpinning the Single Market Strategy.

Thus, productivity growth and resource efficiency can compensate to some extent for higher input prices within Europe. However, this requires further investment. This may have an impact on the cross-sectoral reallocation of resources in the near future.

Over the last ten years, reductions in the energy component of production costs have been limited. Energy prices are the main driver of this cost component. Only in very few cases, energy efficiencies have been capable of reducing the contribution of energy to production costs (Figures 2.23 and 2.24).

Figure 2.22 gives a more detailed account of the evolution of labour costs. In many Member States, the change between 2004 and 2014 in the labour component of production costs has been below the increase in hourly wages. The factors behind this evolution are very different across countries though. Reductions in wages per hour have contributed to smaller increases in the labour component of production costs in Greece, Luxembourg and the UK, and slightly less in Germany and Portugal. Improvements in the productivity per hour have been a major factor limiting labour costs in Bulgaria, Czech Republic, Estonia, Latvia, Lithuania, Hungary, Malta, Poland, Romania, Slovenia and Slovakia. The exchange rate has been a significant factor in Hungary and the UK, too.

This comparison shows that lower labour costs still allow several Member States to remain below the US benchmark of competitiveness in 2014. The figure also shows the difference in total costs in 2014 with 2004. Total costs have increased in all Member States but these cost increases have been more limited in Germany, Austria, Spain, Hungary, Portugal, Sweden and the UK.

Using a similar methodology, Figure 2.21 compares the cost competitiveness of 26 EU Member States (data are not available for Malta and Cyprus) with the US in 2014. We also use labour productivity per hour and different energy input prices from the International Energy Agency (IEA). This explains the differences in the results between the two studies.

European producers face relatively high input prices, especially as labour and capital are concerned. A recent study by the Boston Consulting Group compares the evolution of production costs in the EU and in 10 of the most dynamic US States and with relatively lower labour costs. The study shows that productivity increases can compensate higher input costs, especially as regards labour costs. Energy costs, especially higher gas cost prices, seem to be more difficult to offset than higher input prices.

The crisis had different impacts on TFP across Member States. Today still more than half of EU Member States have not yet managed to recover their pre-crisis levels (i.e. they are in the left half of the figure), with Greece, Italy, Luxemburg and Cyprus being at or below their 2000 level. For Spain, Italy and Luxembourg, TFP started to decline or stagnated long before the crisis. In the case of Spain the positive development after the crisis could only just offset pre-crisis losses in productivity with regard to 2000. On the other end of the spectrum, some Member States have recorded considerable gains even during the crisis, such as Slovakia, Poland, the Baltic countries, Ireland and Denmark. Overall, the crisis did not interrupt their longer-term TFP performance. Romania stands out with large TFP gains relative to 2000, but the crisis seems to have put it on halt.

Figure 2.20 analyses in more details changes of TFP for the EU Member States and the US. The US has improved its TFP both with respect to 2000 and since the beginning of the crisis. This hints to a stronger resilience of the US economy as compared to Europe. A wide majority of the European Member States performs better compared to their 2000 level of productivity. This is particularly true for some of the new Member States (represented by blue circles), which is an evidence for convergence, in some cases from low starting levels. Yet, the convergence trend seems to be weaker since the beginning of the crisis.

Total factor productivity (TFP) captures changes in productivity which are not accounted for by the changes in the quantities of capital and labour inputs, but rather by the way they are combined, i.e. the degree of their utilisation and the technology or organisation employed in the production. Figure 2.19 shows the evolution of TFP from 2005 to 2014 for the EU-28 against that of some major competitors. During the crisis and in its immediate aftermath, TFP decreased everywhere, reaching its lowest level in 2009. This may be the effect of short run excess capacity due to the drop of demand following the crisis. The crisis hit overall EU TFP severely. The EU lost more than the US by 2009, and the US recovered much faster their pre-crisis levels and continued to grow. Japan – where the damage was similar to that of the EU – also managed to recover faster and to follow a recovery path similar to that of the US.

The above mentioned research also finds that even if the most advanced national firms have high levels of productivity, they may fail to significantly impact aggregate productivity due to their relative small size. A more efficient allocation of resources towards most productive firms would help them grow and thus boost productivity growth.

Recent OECD research shows that there is a rising gap in productivity growth between different types of firms. Productivity growth of the globally most productive firms has remained strong, while that of the rest of firms has slowed. This performance is stronger in the services sector than in manufacturing. Effective measures facilitating the diffusion and adoption of technologies across firms could therefore boost productivity.

The process of convergence of productivity at regional level seems to have stalled given the wide dispersion in growth rates (Figure 2.18). Indeed divergence has been a stronger force than convergence in the last few years. Resuming the convergence process could produce huge economic gains. A recent study suggests there are three main ways to improve the competitiveness of underperforming regions without hampering that of the best performing: internal and external R&D collaboration; investment in human capital, knowledge, R&D and innovation; and regional absorptive capacity. These areas could therefore be the focus of any regional cluster policies and smart specialisation strategies that need to also consider the strength and bottlenecks of their specific regional economic structure.

Labour productivity growth took place mainly in regions of Bulgaria, Spain, Portugal, Ireland, Sweden, Poland, Slovakia and the Baltic States. In the central European Member States as well as in Finland, the UK, Greece and Cyprus, most regions experienced falling labour productivity. In many cases, this was due to output cuts greater than labour cuts. In other cases, output grew but not as much as the number of persons employed.

While in most countries there were regions with increasing as well as regions with decreasing labour productivity from 2008 to 2012, in some Member States there was positive or negative labour productivity growth in all regions: Bulgaria, Ireland, Slovakia and Sweden (positive growth in all regions); Hungary, Italy and Slovenia (negative growth in all regions). Whilst this may generate convergence at the national level, it adds to the divergence between Member States.

There is a wide dispersion between and within Member States as regards regional labour productivity growth from 2008 to 2012 (Figure 2.18). Within Member States, the range from lowest to highest labour productivity change was particularly wide in Greece, Poland and Romania, indicating growing internal competitiveness differentials and divergence.

The productivity growth of an economy depends on the productivity of each sector but also on whether the resources are allocated to those sectors with higher productivity growth. However, policy measures can alter that process and lead to the allocation of resources to less productive sectors, thus hampering economic growth. The analysis referred to above suggests that the payoffs from improving factor allocation across sectors are potentially large. Productivity gains from a better allocation within countries could already reach more than 10 % in some cases, boosting economic growth.

The productivity losses generated by policy distortions in the service sector are among the biggest. Indeed, the heaviest drags on productivity growth have come from service sectors which are often closed to competition, such as non-market, personal and business services. The liberalisation of regulated services sectors could thus be an important source of job creation and output growth.

To a certain extent, these productivity gaps can be anticipated due to factors such as sectoral R&D intensity or agglomeration spillovers (e.g. manufacturing in Germany). However, the above mentioned analysis suggests that policy distortions are playing a significant role. For instance, regulatory or tax exemptions, subsidies, size-dependent policies, labour and product market rigidities, may all lead firms to make inefficient choices and investment decisions. These policy distortions generate massive losses due to lost productivity gains. If they are tackled, productivity and thus economic growth would be boosted. The wide variation in the regulation of each sector across Member States seems to confirm this result. Fostering Single Market integration would decrease regulatory dispersion and contribute to reduce productivity gaps.

It should be noted that the ICT sector appears to offer the larger margin of improvement. Only Sweden is leading in this sector, with all other Member States showing a laggard performance.

In the services sector, we encounter a similar situation (Figure 2.17). Only the Netherlands appears among the leaders in all subsectors analysed. Yet, even in this case, there are areas with margin for improvement such as renting of machinery and equipment, and other business activities. Overall, the analysed Member States outperform in finance and business services, but underperform in distribution services, particularly on transport and storage.

Netherlands, which is leading on: food, beverages, tobacco; textiles, leather, footwear; chemicals; and basic, fabricated metals. Yet it is largely lagging on wood and cork; transport equipment, and recycling. Overall, there appears to be a larger margin for improvement in the following industries: rubber and plastics, transport equipment; and recycling.

There are also large differences across subsectors within the same sector. For instance, in manufacturing, the Member States analysed are simultaneously leaders and laggards in different industries (Figure 2.16). A clear example is the

There are huge differences in the productivity within the same sector across Member States (see introductory chapter). A recent IMF staff research on productivity trends confirmed that even the most technologically advanced countries are lagging in certain sectors and could thus reap large gains from adopting existing best practices. For instance, Member States with leading performances in manufacturing such as Germany and Sweden are lagging in ICT and personal services respectively.

In general, the within sector improvements explain most of the changes in labour productivity. This is probably due to the fact that we consider very large sectoral aggregations. But there are interesting exceptions, like Lithuania in the period 2002-2007, during which the static shift was positive and very large. This can be explained by a sharp decrease of the share of employment in the primary sector, matched by an increase both in industry and in trade, transport, accommodation and food service activities.

The same analysis can be repeated for individual Member States. For the period 2002-2007, most of the top performers in terms of total productivity changes are CEE Member States (Estonia, Latvia and Slovakia). But only Latvia managed to keep the same standard for the following period. For the period 2008-2013, one notable case is Ireland, whose performance was excellent. While most countries experienced improvements in labour productivity in the period 2002-2007, the crisis had negative consequences in the subsequent time frame, especially for countries like Greece, Finland and the United Kingdom.

Figure 2.15 shows the evolution of labour productivity across different sectors. The productivity growth due to changes in labour shares across sectors with different productivity growth (dynamic shift) is negative for both periods considered, but the effect is small in magnitude. This suggests that a small extra fraction of workers have been employed by sectors with declining productivity, in particular professional, scientific and technical activities (which includes also administrative and support service activities).

At the same time, the productivity growth due to changes in labour shares across sectors with different levels of productivity (static shift) remained more stable in absolute value, slightly decreasing from a value of 1.21 % in 2002-2007 to 0.78 % in 2008-2013, but increasing substantially in terms of share (from 13 % to 21 %). This suggests an ongoing structural change in the European economy, for which a larger share of workers is employed in more productive sectors. Data suggests an outflow of employment from agriculture, forestry and fishing and industry to sectors with higher productivity, such as information and communication, finance and insurance, and services in general.

Figure 2.14 shows the result of a shift share analysis examining the changes in labour productivity. It shows that in the period 2002-07, labour productivity increased significantly more than in the period 2008-13 (8.75 % vs. 3.61 %). This is not surprising given that the latter period was characterised by the financial crisis and the subsequent recession. Interestingly, most of the change can be explained by a sharp reduction in the contribution of each sector (within effect) in the second period, which dropped from 7.92 to 2.93. In the period 2002-2007, the within effect accounted for 86 % of the total variation (in absolute value), while only 78 % in 2008-2013. This dynamic is mainly explained by the drop of productivity caused by the financial and economic crisis in sectors such as: industry; trade; transport; accommodation services; professional scientific, technical activities; and financial and insurance.

There is also a productivity gap between the retail sector and other sectors of the European economy. For example, the r