COMMUNICATION FROM THE COMMISSION - BENCHMARKING THE COMPETITIVENESS OF EUROPEAN INDUSTRY
Date: 1996-10-09
Institutions: European Commission
Subjects: European industrial area, competitiveness, economic analysis, productivity

COMMISSION  OF THE  EUROPEAN  COMMUNITIES 

it 
•tt 

* 
« 

Brussels,  09.10.1996 
C( )Mc%) 463  final 

COMMUNICATION  FROM  THE COMMISSION 

BENCHMARKING THE COMPETITIVENESS OF EUROPEAN 
INDUSTRY 

TABLE OF  CONTENTS 

I. INTRODUCTION 

II. COMPETITIVE PERFORMANCE OF EUROPEAN INDUSTRY 

1. The general context 

2. Growth of Industry 

3. Cost of key inputs 

4. Investment in industry 

III. DETERMINANTS  OF COMPETITIVE  PERFORMANCE 

1. Functioning of Markets 

2. Innovation 

IV. BENCHMARKING 

1. Enterprise benchmarking 

2. Benchmarking of sectors 

3. Benchmarking framework  conditions 

V. CONCLUSIONS 

1 

3 

3 

5 

6 

8 

8 

8 

12 

15 

16 

16 

17 

18 

/)é\ 

INTRODUCTION 

The Communication takes as its starting point the Commission's  proposals for  a  Confidence 
Pact  for  Employment!.  That  document  begins  by  pointing  out  that  the  rate  of  structural 
unemployment  is  increasing  regularly;  at  the  end  of  each  recession  the  level  is  higher. 
Ensuring  a sufficient  rate of  net job  creation  to  reverse  this tendency  and  to  ensure that  all 
those  willing  and  able  to  contribute  to  well-being  in  the  Union  through  productive 
employment have the opportunity to do so constitutes the major  challenge for  Europe today. 
As pointed out in the White Paper on  "Growth, Competitiveness  and Employment"2  and the 
Communication  on  "An  Industrial  Competitiveness  policy  for  the  European  Union"3, 
improved  competitiveness  of  the  European  economy  constitutes  an  important  means  to 
achieve  that  goal.  These  three  documents,  along  with  other  Commission  proposals,  set  out 
the  agenda  which  must  be  met  for  competitiveness  to  improve.  Many  of  these  actions 
concern Member  States. 

The  purpose  of  this  Communication  is  to  provide  an  updated  analysis  of  the  present 
situation  of  European  industrial  competitiveness.  In  order  to  assist  prioritisation,  a  limited 
number  of  key  areas  for  improving  competitiveness  are  identified  in  the  light  of  the 
preceding  analysis.  The  Commission  calls  attention  to  benchmarking  not  as  a  new  policy 
initiative  but  as  a  tool  to  promote  better  implementation  of  measures  in  key  areas  for 
competitiveness  by focusing  on factors  and conditions that determine  superior  performance 
and exchange of information  on best practices. 

In this Communication, whilst the analysis of competitiveness  mainly relates to industry,  it 
also  sheds light on some of the underlying  factors  explaining the  outcome  of the  economy 
of the whole in terms of growth, productivity  and employment.  Indeed, no discussion  of the 
competitiveness  of European  manufacturing  industry would be complete without that of the 
competitiveness of a certain number of services. 

Competitiveness Advisory  Group 
appointed by President  Santer 

The  first  report  of  the  Group  took  a  broad  view  of  competitiveness,  stressing  that 
competitiveness  implies  elements  of productivity,  efficiency  and  profitability,  and that  it  is 
not  an  end  in  itself.  It  is  a  powerful  means  to  achieve  rising  standards  of  living  and 
increasing  social  welfare.  For  this  reason,  at  the  level  of  the  economy  the  most  important 
indicators  of competitiveness  concern  growth,  productivity  and  employment  along with  the 
factors  that  can  explain  a given  outcome.  At the  level  of the  major  sectors  of the  economy 
indicators  of 
or 
competitiveness  can  be  used.  Market  share  and  profitability  also  constitute  important 
indicators, which  provide a link with the competitiveness  of firms. The various  indicators of 
competitiveness  are  connected,  since  ultimately  it  is  enterprises  that  provide  the  growth 
which  creates  jobs  and  raises  productivity.  How  competitiveness  at  different  levels  are 
interlinked to provide a given outcome  is a significant  issue, addressed  below. 

industry  and  services,  many  of  the  same 

individual  sectors  of 

Action for  Employment  in Europe. A  Confidence  Pact, SEC  (96) 1093 of 6.5.1996 
Growth,  Competitiveness  and Employment  (COM (93)  700, December  1993 
COM  (94) 319  of14.9.1994 

A 

Structural  factors  affecting  competitiveness  are the  focus  of this  Communication.  But of 
course  the  macro-economic  environment  has  a  very  important  effect.  However,  the 
Commission  does  report  regularly  on  these  aspects  in  the  annual  economic  report  and 
monitors  progress  towards  meeting  macro-economic  objectives  through  its examination  of 
economic  convergence.  The  Maastricht  criteria,  by  putting  targets  for  economic  and 
monetary  union, represent a form  of benchmarking  in the policy area, which  has proved  its 
usefulness  in promoting convergence and which can serve as a model  for the application  of 
benchmarking to other areas of importance for competitiveness. 

EMU and  Competitiveness 

The transition  to the Economic and Monetary  Union  (EMU) will  have  important  beneficial 
effects  on competitiveness both as regard  internal and external aspects. 

Internally,  EMU  will  eliminate  transaction  costs  of  cross  border  payments.  In  addition,  it 
will  foster  competitiveness  through 
increasing  transparency.  SMEs  whose  costs  in 
participating  in international trade are at present relatively  high, will  particularly  benefit,  as 
EMU will enable them to increase their efficiency  by entering into all European markets. 

Furthermore, EMU will contribute significantly  to exploit the full  advantages of the internal 
market.  The  past  four  years  have witnessed  that  currency  fluctuations  have  led  to  a  sub-
optimal  allocation  of  production  factors,  jeopardising  the  beneficial  effects  of  economic 
integration and slowing down growth in Europe. 

Externally,  given  the  importance  of  the  European  Union  in  international  trade,  financial 
markets may grant to the Euro a status of international  currency,  similar to that enjoyed  by 
the Dollar. European  companies will  progressively  be able to sell  in Euro on third  markets 
and will thus be safeguarded  from  the effects  of currency changes on sales prices. 

Finally,  macro-economic  policies  play  a  central  rôle  for  competitiveness.  In  particular, 
public  deficits  which  are  too  high  absorb  a  considerable' share  of  private  savings  (nearly 
35%  in  1993)  to  the  detriment  of  productive  investments  and  push  interest  rates  higher. 
Policies  oriented  towards  budgetary  stability  allow  the  macro-economic  framework  to  be 
improved.  Indeed,  general  government  net  borrowing  decreased  from  6.3%  in  1993  in  the 
EU  to  5.1%  in  1995  and  4.4%  in  1996  (forecasts).  Real  short  term  interest  rates  have 
followed  a similar  path,  falling  from  6.7%  in  1992  to 4.9% in  1993 and  3.9  in  1995. This 
development  is reinforced  by progress towards Economic and Monetary Union. 

The  primary  responsibility  for  ensuring  that  enterprises  remain  competitive"  lies  with 
firms  themselves. They maintain competitiveness through the efficiency  and the  flexibility 
with which they satisfy  existing market needs and through their ability to adjust to structural 
change,  to  create  new  markets  and  to  meet  new  needs.  The  quality  of  management 
determines  to  a  large  degree  the  extent  to which  enterprises  are  successful  in  these  tasks. 
Public  authorities  sustain  competitiveness  by  putting  in  place  the  appropriate  framework 
conditions  under  which  enterprises  operate.  This  takes  the  form  of  providing  necessary 
infrastructure,  putting  in  place  an  appropriate  regulatory  environment  and  specific 
initiatives,  particularly  in  the  areas  of  innovation,  quality,  the  business  environment  for 
small  and  medium  sized  enterprises  and  economic  cohesion  (Commission  Green  Paper  on 
Innovation, working document on quality and Multi-annual programme for SMEs). 

This  Communication  presents  the  diversity  of  and  inter-relations  between  the  factors 
influencing  the  competitiveness  of enterprises,  and,  as  a result,  the  necessity  to  develop  a 

coherent  approach  concentrating  on  those  factors  in  the  business  environment  which  are 
determining for enterprises. The urgency of this procedure derives from  the globalisation  of 
markets, and the  risk  that a lack of competitiveness  on such  markets  holds  for  employment 
and  living  standards.  In order to assist  enterprises  and  public  authorities  in the  adaptations 
required  to  meet  greater 
international  competition,  the  Commission  proposes  that 
benchmarking be promoted  in partenariat with  industry and public administrations. 

The  present  Communication  does not  seek  to examine  all  those  framework  conditions  that 
affect  competitiveness,  but  only  a  limited  range.  Some  elements  of  taxation,  social  policy 
and  the efficiency  of public  administration  are examined  in so far  as they  are  identified  as 
factors  underlying  competitiveness  so  are  the  regulatory  environment,  the  burden  of 
administrative  procedures  and the  adequacy  of public  infrastructure.  The  Commission  will 
continue to examine how public policies can support competitiveness. 

II.  COMPETITIVE PERFORMANCE OF EUROPEAN INDUSTRY 

The general  context 

A  strong  economy  is an  economy  that  is capable  of  high  productive  efficiency,  creating 
jobs  in  order  to  raise  living  standards.  Living  standards  must  be  defined  broadly  to 
include  elements  that  are  difficult  to  quantify,  such  as  a  high  degree  of  environmental 
protection  or a low level of crime. They include aspirations to a reasonable  level of security 
against  illness  and  destitution  that  has  come  to  be  known  as  the  European  social  model. 
Maintaining  and  improving  the  quality  of  life  in  Europe  requires  that  expectations  and 
possibilities  are  matched  and that  the  productive  base  is  capable  of  delivering  the  desired 
outcome. 

Gross  domestic  product  represents  an  imperfect  measure  of  living  standards.  However, 
certain  less quantifiable  elements of living standards may be less incompatible with  raising 
gross domestic product than may at first appear. For instance, a high  level of environmental 
protection can, under certain conditions, support competitiveness^. Improving the  efficiency 
with  which  the  economy  transforms  energy  and  materials  into  goods  and  services 
constitutes  both  a  key  element  for  reaching  sustainable  development  and  a  significant 
means for improving competitiveness. 

Commission Communication on Industrial Competitiveness and Protection of the Environment 
SEC(92)  1986 

The  C o m p e t i t i v e n e ss  Pyramid 

[Standard  of Living| 

J 

Employment  1 
1 

Rate 

l 
ctivity  1 
1 Produ 

Participation 
Rate 

Job 
Creation 

Market 
Performance 

Financial 
Performance 

Demo 
graphics 
1 
Ageing 
of the 
Population 

Labour 
Markets 

~ " r 

Internal & 
External 
Flexibility 

Intangible 
Investments 
1" 
Skills 
Formation  , 

i 
Intangible 
-  Investments 
1 
Research 
and 
Development 

i 
Innovation 

f 
Organisation, 
Quality, 
Diffusion 

| Fixed 
Investments 
j 
Financing of 
Investments 

i 
Public 
Infrastructures 
~  T~ 
Taxation 

• 

in 

living  standards.  Increases 

High  productivity  provides  the  basis  for  raising 
the 
productivity  of  labour  should  not  be  achieved  at  the  expense  of job  creation.  The  ability  to 
achieve  high  rates  of  employment  affects  living  standards  directly  by  generating  income 
from  a  larger  proportion  of  the  population.  When  both  productivity  and  employment  are 
rising  together,  strong  growth  can  ensue.  At  the  level  of  the  economy,  productivity  and 
employment  constitute  the  principal  benchmarks  of  competitiveness.  Unlike  the  Maastricht 
criteria,  they  can  not  directly  be  translated  directly  into  policy  actions.  The  structural 
conditions  that  underlie  superior  performance  are  more  susceptible  to  be  translated  into 
policy  actions  through  individual  framework  conditions  that  affect  competitiveness.  The 
different  relationships  that  determine  strong  economic  performance  can  be  illustrated  by  the 
competitiveness  pyramid. 

Europe  continues  to  lag  significantly  behind  the  United  States  in  terms  of  both  labour 
productivity  and  the  proportion  of  the  working  age  population  that  is  employed  (the 
employment  rate).  It  also  lags  behind  the  Japanese  employment  rate.  The  result  is  a  level 
of  GDP  per  capita  nearly  one  third  below  that  of  the  United  States  and  one  sixth  below  that 
of  Japan.  Such  a  result  is  by  no  means  inevitable  and  should  not  be  considered  as 
infrastructure  and  the  size  and 
acceptable.  Europe's  human  resources,  capital  base, 
development  of  its  home  market  provide  the  foundation  for  both  high  productivity  and  high 
employment  rates.  Within  the  existing  technological  frontier,  considerable  unexploited 
potential  remains.  Further  gains  are  possible  beyond  the  existing  frontier  by  speeding  up 
innovation. 

Although  difficult  to  interpret,  the  rapid  increase  in the  capital  stock  in the  European  Union 
and  Japan  contributed  significantly  to the  increase  in  labour  productivity  in these  countries, 
but to  an  important  extent this was at the expense  of falling  productivity  of capital.  In  both 
the  European  Union  and  in Japan the  substitution  of  labour  by  capital  has  been  significant  at 
the  same  time  as capital  intensity  increased  substantially. 

The  record  of  employment  creation  remains  disappointing.  Since  1960,  the  European 
Unioa  has  managed  to  create  10 million  net  new jobs  or half those  of  Japan  and  less thar.  -
fifth  of those  in  the United  States, essentially  because  of  a very  high  rate  of  gross 
osses. 
At the  same  time, the  number  of new  entrants to the  labour  market  was  one  and , 
•*;merj 
greater  in  the  United  States  than  in  Europe,  but  lower  in  Japan,  The  high  rats  of  net 
ioh 
creation  in  the  United  States  enabled  it  to  increase  its  ernploy^ien'.  rate  F 
wcujii v 
between  1960  and  1995,  when  it  approached  the  consistently  high  Japanese  rate.  In  the 
European  Union,  the  employment  rate  declined  over  the  same  period.  The  fact  that  certain 

countries  in  Europe  reach  or  even  surpass  US and  Japanese  rates  would  seem  to  indicate 
that low European  employment rates are not inevitable. 

EMPLOYMENT RATE 

1960 

67% 

63% 

74% 

1995 

60% 

72% 

74% 

European Union 

United States 

Japan 

• 

The  main  reasons  for  Europe's  disappointing  performance  can  be  identified.  Of 
particular  importance  for  productivity  levels  and  growth  can  be  mentioned  intangible 
investments,  innovation,  and  fixed  investments  in  plant  and  equipment.  On  the  side  of 
employment,  in addition  to  investments  in human  resources, the  functioning  of the  labour 
markets  and  demographic  developments,  particularly  the  numbers  of  new  entrants  to  the 
labour  market  and the dependency  ratio of old and  young  people,  are  important  factors.  In 
turn, these  issues give rise to specific  areas of concern  such as the ageing of the population, 
internal  and  external  flexibility  of  labour,  skills  formation,  research  and  development, 
organisational  issues, financing of investments and  levels and structure of taxation. 

Public  investment  supports  competitiveness  when  it  develops  Europe's  infrastructure, 
encourages  intangible  investment  in  skills  and  technology  and  assists  the  development  of 
lagging  regions.  It  appears  that  the  European  economy  increasingly  faces  problems 
resulting  form  infrastructural  bottlenecks,  both  in  the  area  of  physical  capacities  and  in 
relation  to  the  way  facilities  are  operated.  As  a  result,  the  infrastructural  costs  of,  e.g. 
transport  operations,  are  in  Europe  considerably  higher  than  in  the  United  States,  thus 
weakening the competitive position of enterprises  located  in Europe. 

A social safety  net is required to ensure that the benefits of growth are equitably  distributed 
and  to  combat  social  exclusion.  However,  social  protection  needs  to  equip  recipients  with 
the necessary  skills and to encourage mobility  for them  to occupy  productive jobs  in order 
to promote competitiveness  of the economy. Consumption  driven  public deficits  ultimately 
reduce productive potential by depressing  investment. 

Directly or indirectly, taxation,  in particular of labour, represents a cost to enterprises. The 
share of taxation  in GDP rose from  34% to 43% in the European  Union  between  1970 and 
1995.  In  addition,  the  very  high  fiscal  deficits,  driven  essentially  by the  growth  in  public 
transfers,  mean that domestic  savings are being  used to finance deficits  rather than  provide 
investment.  Trends  in  the  structure  of  taxation  show  that,  over  the  period  1980-94,  the 
European average of the effective  tax rate on employed labour increased  steadily from  34% 
to 40%, whereas the effective  tax rate on other factors of production decreased from  44% to 
35%. 

It  should  be stressed  that the  functioning  of the  economic  system  depends  not  only  on  the 
availability  and  quality  of any single aspect  related  to competitiveness,  but  much  more on 
the  interaction  between  different  elements.  The  ways  in  which  the  different  elements 
interact either sustain or hinder economic  performance. 

2.  Growth of Industry 

D 

In  spite  of  much  improved  economic  fundamentals,  European  industry  has  not  been 
performing  as well  as  it might. In most manufacturing  sectors, the United  States  continues 
to  lead  European  productivity.  High  Japanese  productivity  is  concentrated  in  a  limited 
number of export oriented  sectors. 

The European  Union  share in OECD export  markets (excluding  intra-EU  trade) has been 
declining  since  1987.  This  loss  in  market  share  can  be  attributed  essentially  to  an 
insufficient  presence  on  markets  with  strong  growth  rather  than  to  exchange  rate  or  other 
price  developments.  A  similar  absence  of  specialisation  on  growth  markets  can  also  be 
observed  for  European  direct  investment  in third  countries. The  European  Union's  external 
trade  and  investment  has been  concentrated  on  mature  markets, eastern  Europe  and  on the 
Mediterranean  rather  than  the  high  growth  markets  of  east  Asia  and  certain  parts  of  Latin 
America.  Since  1993, there  are  encouraging  signs  of  improved  European  performance  in 
growth  markets  for  both  exports  and  foreign  investment.  In  order to  maintain  and  develop 
their  position  on  world  markets,  it  is  imperative  that  European  enterprises  have  access  to 
third  country  markets,  both  on  equivalent  terms  to  those  of  its  main  competitors  and 
compared to those of domestic competitors.^ 

Net profit  margins and  return on investment for European  enterprises began to improve in 
1994. Nevertheless, compared with the cost of capital, returns remain  inadequate (7%) since 
they are even lower than the rate of interest on long term public debt (8%). 

•  Over  the  last  ten  years,  industrial  value  added  increased  by  2.4%  per  annum  in  the 
European  Union  compared  with  3%  in  the  United  States  and  3.8%  in  Japan.  The  overall 
result  is  also  reflected  at  the  individual  sectoral  level.  Of  the  manufacturing  sectors,  only 
food,  drink, and tobacco and wood  and furniture  grew faster  in the  European  Union than  in 
the United  States and Japan between  1985 and  1995. 

All the sectors for which growth  in value added  in Europe was equivalent to or above that in 
the  United  States  or  Japan  realised  productivity  gains  equivalent  to  or  above  those  of  its 
main  competitors.  In  all  those  sectors  which  grew  more  slowly  in  Europe,  productivity 
gains  were  lower.  Equally,  European  sectors  with  average  or  good  relative  growth 
performance  also maintained  higher investment rates than their competitors. 

3. 

Cost of key inputs 

In  order  for  enterprises  to  remain  competitive,  they  must  control  unit  costs  either  by 
increasing efficiency  or by controlling costs of inputs to production  or by a combination  of 
both. Individual  items of cost appear differently  from  the point of view of the enterprise  in 
manufacturing  than  from  that  of  the  economy  as  a  whole.  For  the  individual  industrial 
enterprise,  purchases  of  goods  and  services  make  up  sixty  percent  of  costs,  followed  by 
labour  with  thirty  percent  of  costs  (and  seventy  percent  of  value  added)  and  finance  the 
remainder. 

Since  purchases  of  goods  and  services  make  up  such  a  large  share  of  costs,  access  to 
efficient  suppliers  represents  a  key  condition  for  competitiveness.  Energy,  water  and 
producer  services  (communications,  transport,  financial  and  business  services)  account 
directly  or  indirectly  for  over  one  fifth  of  manufacturing  costs.  Prices  for  key  service 
inputs  m  Europe  have  remained  Hgher  than  those  of  major  competitors,  and  with  the 
progress  of  liberalisation  elsewhere  the  gap  between  Europe  and  major  competitors  has 
been  widening.,  In  telecommunications,  after  the  introduction  of  competition  the  price  of 

Commission Communication on Market Access of 14.2.1996,  COM(96)53 

long  distance  calls  declined  between  18%  and  35%  over  the  period  1990-1994.  In  the 
absence  of  competition  prices  fell  by  between  12% and  16%.  In  energy,  gas  prices  have 
fallen  in  parallel  to  oil  prices,  but,  on  average,  remain  30%  higher  than  US  prices.  For 
electricity, the difference  is bigger. 

Large  firms  have  access  to  a  deep  pool  of  international  savings  and  complex  financial 
instruments along with sophisticated treasuries. They can finance investments on  favourable 
terms. Most small firms remain  unquoted, often  locally oriented  and rely on very traditional 
sources  of  finance  for  investment.  Overwhelmingly,  they  rely  on  retained  earnings,  which 
attract  a high tax penalty, and  bank  loans. Since  1980, average  nominal  long term  interest 
rates in Europe have remained  between one and two percentage points higher than those in 
the  United  States,  and  about  four  percentage  points  higher  than  those  in  Japan.  Cost  of 
capital  estimates  also point to higher financing costs  in Europe, and  especially  amongst  the 
smaller Member States. Amongst the factors  which have contributed  to high capital  costs in 
Europe  can  be  mentioned  inflationary  expectations,  high  public  sector  deficits,  lack  of 
competition between financial institutions and limitations on cross-border  investments. 

The  third  element  of  industry's  cost  base  is  that  of  labour.  Developments  in  the  cost  of 
labour  are  closely  tied  up  with  the  overall  macro-economic  situation.  Over  the  past  two 
decades, the EU economy has undergone a difficult  process of adjustment,  not just  in terms 
of structural change, but in order to bring inflationary  pressures and costs under control, and 
in  order  to  restore  the  profitability  of  capital  investments.  During  the  1970's  inflation 
exceeded  10%,  coming  down  to  5%  by  the  beginning  of  the  1990s  and  to  3%  today. 
Inflationary  expectations  had  a  significant  effect  on the  context  in  which  wage  bargaining 
took  place.  Today,  the  Union  enjoys  favourable  economic  fundamentals.  Inflation  is 
historically  low and  still  declining, exchange  rate tensions  have progressively  eased,  world 
trade 
improving. 
Nevertheless, it is clear that the European economy still retains certain cost and  productivity 
problems. 

is  expanding  at  a  healthy  pace,  and 

investment  profitability 

is 

From  the  point  of  view  of  competitiveness,  it  is  necessary  to  take  all  of  the  charges  an 
employer  faces  in  employing  labour  and  then  adjust  total  labour  cost  for  productivity  to 
establish  unit  labour  costs".  Unit  labour  costs  in  practice  are  difficult  to  calculate  and  for 
this reason  there  are  relatively  few  robust  estimates  of  unit  labour  cost  available.  Over the 
past decades, the European  Union  has gradually  brought  its inflation  problem  under  control 
and  reduced  the  share  of  wages  in  GDP to  a  level  comparable  with  the  United  States  and 
Japan. It has also continued to improve its level of productivity  relative to the United States. 
In consequence,  EU real unit labour costs have been progressively reduced  since  1980. 

In  the  manufacturing  sector,  the  situation  is  less  clear  and  probably  less  favourable.  Over 
the past years, for example, while real unit labour costs in the EU economy as a whole have 
fallen  by  5% relative to the United  States, indications  suggest that  real  unit  labour  costs  in 
manufacturing  have risen by  1-2%  in total. 

A  key  difference  in  the  structure  of  labour  costs  between  the  European  Union  and  the 
United  States  concerns  non-wage  costs  and  taxes,  reflecting  the  extent  to  which  certain 
services  -  health,  pensions  etc.  -  are  funded  through  taxation  or  take  home  pay.  One 
particular  issue  of  concern  for  the  European  Union  expressed  in  the  White  Paper  is  the 
way that  non-wage  costs bear  particularly  heavily  at the  low  end  of the  scale.  Demand  for 
unskilled  labour  has  been  declining  relative  to  skilled  labour  and  employment  problems 
are  particularly  severe  for  the  unskilled.  Diminishirig  the  level  of  non-wage  costs  relative 
to those up the scale could help to make employing unskilled  labour more  attractive. 

6 Total labour cost is composed of social security and taxation in addition to wages and salaries. It should 
not be confused with income. Unit labour costs combine productivity with total labour costs to yield the 
labour cost content per unit of output. High productivity can compensate for high labour costs. 

Growth  in  wage  costs  is  now  relatively  moderate.  The  reform  of  tax< :  m  and  social 
security  systems,  already  underway,  should  contribute  to  containing  labour  costs  although 
the  main  scope  for  keeping  unit  costs  low  will  lie,  as  in  the  past,  in  the  active  pursuit  of 
productivity  improvements  in the context of a high  income, high skill  economy. 

8 

4. 

Investment in industry 

To  a  large  extent  productivity  improvements  depend  on  investment,  both  tangible  and 
intangible. Investment in plant and equipment not only  increases productive capacity  but 
also incorporates technical progress. The investment effort  by Japan  in plant and  equipment 
has  been  particularly  noteworthy  rising  at  its peak  at  the  beginning  of the  decade  to  three 
times  the  level  of  the  early  1970s  before  falling  back  during  the  current  recession.  Up  to 
1990,  investment  in  equipment  in  the  United  States  and  Europe  followed  a  parallel  path 
when US investment began to rise very fast. 

In  the  field  of  intangible  investments,  more  specifically  relating  to  the  importance  of 
quality management  for the competitiveness of industry, the World Competitiveness  Report 
presents  information  related  to  the  different  elements  of  the  competitive  situation  of 
countries  all  around  the  world.  Trends  over  recent  years  show that  changes  in the  level  of 
quality is mirrored  by implementation  of quality management  strategies. The United  States 
is even  in the  process  of  overtaking  Japan  in terms  of  degree  of  quality,  for  the  first  time 
since the mid  seventies. These trends are confirmed  in the areas of the  degree  of  customer 
satisfaction  as well as of workforce  motivation and the quality of industrial relations. 

Research  and  development  represents  another  significant  form  of  intangible  investment 
for which European performance  is  insufficient. 

TOTAL R&D SPENDING 
as % of GDP 

R&D SPENDING BY INDUSTRY 
as % of GDP 

European Union 

United States 

Japan 

1.9% 

2.5% 

3.0% 

1.0% 

1.6% 

2.2% 

i n.  DETERMINANTS OF COMPETITIVE  PERFORMANCE 

Two  main  causes  for  the  poor  competitive  performance  of  European  industry  can  be 
identified:  the  functioning  of  markets  and  innovation.  The  essential  complementarity 
between efficient  markets and high rates of innovation and  intangible investment need to be 
stressed. Removing  barriers to access  in key product  markets  and  ensuring that capital  and 
labour markets  are able to meet the  needs  of new forms  of  investment  and  organisation  of 
work  is  critical  to  innovation.  Without  a  sufficient  degree  of  market  liberalisation,  the 
benefits  from 
investment,  which  must  constitute  the  basis  of  Europe's 
competitive  advantage, will  not materialise.  Equally, efficient  markets  are not  sufficient  to 
ensure  the  high  level  of  intangible  investment  required  to  make  further  gains  in  living 
standards  possible  and  to  ensure that  growth  is driven  in a skills  and  knowledge  intensive 
way. 

intangible 

1.  Functioning  of  Markets 

Restrictions  on  access  to  markets  lead  to  inefficiency,  stifle  innovation  and  growth. 
Recognition  of the high  cost of market  access  restrictions  has  led to a clear trend  amongst 
developed  countries  towards  liberalisation  of  markets.  In  the  European  Union, the  Single 
Market  programme,  in  conjunction  with  competition  and  trade  policies,  has  led  to  a 
significant  opening of access to markets particularly for manufactured  products. 

Product Markets 

The  Single  Market  has  led to the removal  of barriers to trade and  facilitated  market access. 
However,  in  certain  key  markets  effects  have  been  more  limited.  Areas  in  which  least 
progress  has  been  made  in  removing  barriers  to  access,  whether  in  the  enhancement  of 
bilateral  economic  relations  or through  international  trade  negotiations  under  the  Uruguay 
Round,  under  the  Single  Market  programme  or  under  national  programmes,  include  those 
that supply government  markets (public procurement), public utilities and  many services. It 
should  be  stressed  that  many  restrictions  on  market  access, particularly  in services, are the 
result  of  the  actions  of  national  governments.  Areas  under  which  national  restrictions 
continue  to  apply  include  business  services,  construction  and  distribution.  Altogether, 
sectors  for  which  more  or  less  serious  access  restrictions  remain  make  up  around  half  of 
gross domestic product. 

The  Commission  Communication  on  Services  of  General  Interest6  in  Europe  sets  out  a 
certain number of principles which guide policy  in this area. As regards  services of general 
economic  interest they refer to market services which the Member  States subject to  specific 
obligations  by  virtue  of  a  general  interest  criterion,  covering  such  things  as  transport 
networks,  energy  and  communications.  For this  reason,  the  introduction  of  competition  in 
these  sectors  is  accompanied  by  public  service  obligations  including  the  provision  of 
universal  service  which  is  to  ensure  access  for  all  citizens  to  quality  service  at  prices 
that everyone can afford. 

that 

is  the  single  most 

infrastructure  quality 

For  its part, the  second  report  of the Competitiveness  Advisory  Group  has highlighted  the 
influencing 
fact 
multinational  investment.  According  to  the  group,  introducing  competitive  forces  in  the 
sector of public  utilities  has proved  to be a win-win  situation  for the  State (positive  impact 
on  the  public  borrowing  requirement),  for  industry  (utilities  which  are  more  responsive  to 
needs) and  for  the  consumer  (competitive  pricing  and  service  and  greater  choice).  In their 
conclusions,  the  group  states  that  the  Commission  should  stimulate  the  exchange  of  best 
practice  by  monitoring  and  publicising  on  an  annual  basis  a  benchmark  report  on  the  best 
public-sector reform  practices and competitiveness  improvements achieved  in the European 
Union as compared with the USA and Japan. 

important  factor 

D  Evidence  from  those  countries  that  have  liberalised  key  services  shows  that  considerable 
scope  for  growth  and  employment  in  addition  to the  beneficial  effects  of  lower  price  and 
better service can be obtained: 

-  Telecommunications  are  a  case  in  point  since  many  innovative  services  depend  on 
open cost-efficient  telecommunications  networks  for  their development.  For  example, 
in the United  States the price of long distance and  international  calls and of leased  lines 
is  substantially 
in  Europe,  giving  enterprises  relying  heavily  on 
communications  a competitive advantage. Furthermore, unlimited  local calls are usually 
included  in the fixed telephone  line rental  fee; this has provided  a powerful  stimulus  for 
services  on  the  Internet.  In  Europe,  Internet  connections  are  paid  for  at  local  rates  and 
according to duration. Closed networks have also stifled  the development of  information 
that  can  be  provided. 
limiting  the  range  of  services 
technology  services  by 

lower 

than 

Commission Communication on Services of General Interest in Europe of 11.9.1996 COM (96) 443 

6 
final 

10 

Uncompetitive  telecommunications  services constitute  a factor  that  is slowing down  the 
development  of  the  Information  Society  in  Europe.  Where  markets  have  been  opened, 
(including 
the 
significant  employment  creation 
equipment)  has  ensued.  For  instance,  in  Finland,  employment  in  telecommunications 
increased 20% faster than employment  in general after  liberalisation. 

telecommunications  cluster 

in 

-  Liberalisation  of  the  conditions  for  access  to  transport  markets  is  improving  the 
competitiveness  of  the  road  haulage,  aviation  and  maritime  sectors,  generating 
significant  cost savings. Further  improvements  can  be expected  as market  structures  are 
adapted to the more liberal regulatory environment. For air transport, which constitutes a 
major  means  of  communications  for  business  users,  a  history  of  bilateral  cooperative 
arrangements  between  national  flag  carriers  in  the  past  appears  to  have  undermined 
some of the benefits  that could have been expected to flow  from  liberalisation.  Effective 
liberalisation  of  access  to  rail  services,is  less  advanced  than  other  forms  of  transport 
despite its high strategic importance for easing road congestion. 

-  Energy  is  another  area  where  liberalisation  will  bring  benefits  to  industry  once  the 
Single  Market  is  achieved  in  practice.  Some  progress  is  being  made  in  the  electricity 
context. 

-  Notwithstanding  Single  Market  legislation,  financial  services  remain  fragmented  with 
little cross-border  competition. To the extent that competition  has  increased  in banking, 
it  can  be  attributed  essentially  to  technological  developments  such  as  tele-banking, 
which enables banks to offer  services at much  lower cost. 

-  Least  progress  in  removing  limitations  to  market  access  has  been  made  in  the  field  of 
business  services.  Marketing  remains  an  area  for  which  a  multitude  of  national 
restrictions  inhibit  industry's  ability  to  develop  co-ordinated  marketing  programmes 
across borders. The recent Commission  Green Paper on Commercial Communications in 
the Single Market describes the situation  in more detail7-  Professional  services remain  a 
fortress  into  which  competition  has  yet  to  enter.  Putting  into  place  the  requisite 
legislation  for  liberalisation  and,  once  it  is  in  place,  ensuring  coherence  between 
different  policies  to  ensure  that  benefits  can  be  reaped  remain  areas  in  which  the 
European Union  must improve  its performance  if industry  is not to suffer  from  a serious 
competitive handicap. 

Competitive  intensity  on  markets  can  also  be  undermined  by  continued  subsidisation  of 
enterprises.  In the  face  of market  failures,  certain  subsidies can  have a positive  impact on 
competitiveness  (for  example  subsidies  to  R&D or  small  and  medium  sized  enterprises  or 
for  the  creation  of  enterprises)  or  may  be  required  to  meet  certain  Community  objectives 
such  as  economic  and  social  cohesion  (regional  aid  and  aid  for  training).  Nevertheless,, 
state aids remain  a significant  problem  in Europe, with  state aids to manufacturing  industry 
alone totalling  34 billion  ECU  in  1992, equivalent to  1,200  ECU  for every employee  in the 
industrial  sector.  Although  state  aids  are  concentrated  in  manufacturing,  they  also  pose  a 
problem  in certain  specific  services  undergoing  liberalisation.  For  instance,  in the  field  of 
air  transport,  high  levels  of  subsidisation  can  undermine  efforts  to  introduce  more 
competition by liberalisation of markets. This situation has led the Commission to introduce 
a specific  aid regime in the domain of air transport. 

COM (96)  192 final of 8.5.1996 

Capital  market 

11 

Liberalisation  of movements of capital has been  a major  achievement of the  Single  Market 
programme. However, a number of imperfections  and restrictions remain on capital  markets 
which  limit  the  possibilities  of  European  firms  to  raise  equity  for  investment.  In the 
field  of  mortgage  credit,  there  is  unequal  access  to  capital  markets  for  the  purpose  of 
refinancing.  There  are  problems  too  in  some  bond  markets.  Differences  in  taxation  of 
investment  income  continue  to  perpetuate  distortions  in  capital  movements  between 
Member  States.  Insurance  companies  are often  restricted  as to the type  of  investment and 
country  in  which  they  hold  their  reserves.  In  many  Member  States,  the  pan-European 
activities  of  pension  funds  are  seriously  hampered.  The  relatively  large  share  of  foreign 
assets for funds  based  in the United  Kingdom  and the Netherlands  stems from  the fact  that 
these  are the only  two countries, together  with  Ireland,  where  pension  fund  investment  is 
unrestricted. 

Labour market 

A  better  functioning  labour  market  is generally  acknowledged  to be a vital  factor  for the 
competitiveness  of European  industry, just as the competitiveness of industry  is, in itself, a 
determining factor for the level of employment. 

More  fundamentally,  there  is  a  need  for  a  radical  rethink  of  all  relevant  labour  market 
systems - employment protection, working time, social  protection and health and safety  - to 
adapt them  to a world of work which  will  be organised  differently,  in particular one where 
the boundaries  between  work and leisure, work  and learning, employee  and  self-employed 
are,  or  may  become,  less  well-defined.  The  concept  of  security  for  workers  has  to  be 
reformulated,  focusing  more  on  security  based  on  employability  and  the  labour  market 
rather than  security based on the individual  work place. It should be focused  on security in 
change, not security against change. 

Over the last decade, substantial changes have been made by Member States to introduce 
greater  flexibility  into  the  labour  market  through  changes  to  the  regulatory  framework 
governing  employment.  Virtually  all  Member  States  have  seen  a  significant  reduction  in 
working time  regulations  and rules  relating to taking on and laying off workers  have  been 
reviewed  and  restrictions  eased  in  a  third  of  Member  States.  It  has  become  easier  for 
employers to take on part-time  as well as temporary  workers, and the possibilities  for  self-
employment  have  increased  considerably.  Member  States  have  focused  changes  on 
measures  which  have actually  inhibited  employment  prospects  of the weaker  groups,  such 
as the unskilled young and/or other workers with  little experience. 

Lack  of  flexibility  on the labour  market  arises  for  a  number  of reasons,  which  are not 
necessarily  linked  to  the  rules  and  conditions  governing  employment.  For  instance, 
company  pension  schemes  can  impose  a  substantial  penalty  for  those  that  change  jobs 
because  entitlement  to  benefits  can rise  very  steeply  in the  final  years  before  retirement. 
Housing  markets  in  Europe  also  discourage  geographic  mobility  in  several  European 
countries. Not only major  differences  in house prices between  high and low unemployment 
regions,  but  also  the  lack  of  rented  accommodation  as  a  result  of  restrictive  tenancy 
provisions, may make it very difficult  to change regions. 

a  Deficiencies  in  the  functioning  of  labour  markets  in  Member  States  are  partly  due to 
inappropriate, or outdated, systems or labour market regulations, which can restrict  internal 
and  external  flexibility  and the capacity  of  firms  to  create jobs.  Levels  of  labour  market 
regulation  vary  considerably  within  the  European  Union.  Evidence  suggests  that,  while 
employment  performance  is primarily  determined  by the performance  of the economy  as a 
whole,  labour  market  regulations  may affect  the level  of employment  creation  or, at  least, 
the  speed  with  which  firms  adjust  their  labour  force  in response to change. Restrictions on 

12 

the capacity of enterprises to adjust  their labour forces  in the form  of regulations or in terms 
of  the  cost  of  taking  on  and  laying  off  workers  are  likely,  when  excessive  or  outdated,  to 
affect  economic  performance  of  companies,  although,  in  practice,  enterprises  often  find 
ways to circumvent  some of these  effects  through  an  increased  use of temporary  and  other 
a-typical working arrangements. 

- 

It should be emphasised that increased flexibility needs to be combined  with a  sufficient 
level  of  stability  and  employment  security  in  order  for  the  full  benefits  to  be  reaped. 
Effective  use  of  human  resources  remains  a  key  element  for  gains  in  productivity  and 
also  for  internal  flexibility.  An  increasing  volatility  of  employment  bears  the  risk  that 
the investment  in human capital, notably through training, required for  long-term  growth 
and  competitiveness  will  not take  place. Training and  continuous  upgrading  of  skills  is 
(and  in future  will become even  more so) intangible  investment with  real and  increasing 
benefit  for  industry  and  employees  alike.  A  high  skill,  high  quality,  high  productivity 
industry's  competitiveness  and  employees' 
industrial 
employability  as explained below. 

strategy  will  enhance 

-  Sector-wide  wage  bargaining  has  been  the  prevailing  mode  of  bargaining  in  Europe, 
whilst  plant-level  bargaining  is usual  in the  United  States  and  Japan. The  level  of wage 
bargaining  is usually set by the social  partners, and they need to agree on any changes to 
existing  arrangements.  Different  forms  of  wage  bargaining  each  have  their  advantages 
and  disadvantages  and  it  is  not  possible  to  conclude  at  the  present  time  that  any 
particular  form  is  inherently  superior  to  another.  On  the  one  hand,  for  instance, 
centralised  or  sector-wide  bargaining  has  been  used  to  introduce  successfully  wage 
moderation  in certain  countries, with  significant  impact  on  inflation  as well  as  costs. It 
also  contributes  to  transparency  of  wages  and  to  social  and  regional  cohesion  On  the 
other  hand,  however,  sector  bargaining  also  leads  to  comparable  rates  of  pay  between 
enterprises  irrespective  of  levels of productivity  and  across regions  in the  same  country 
irrespective of differences  in availability of labour. 

-  Working hours are governed  by collective agreements or by legislation. Restrictions on 
working  hours  set  by  Member  States  unrelated  to  the  minimum  standards  set  by 
European  legislation, which allow considerable flexibility  for  implementation  at national 
level,  affect  the time when work  is carried out. In this way, the ability to run plant  in the 
optimal  fashion  to make best use of existing or future  investments may be impeded. The 
level of capital  utilisation  is thereby reduced. Certain  services, such as the possibility  for 
shops  to  stay  open  to  meet  the  requirements  of those  at  work  during  normal  hours, are 
also  prevented  from  developing  as they might. Innovative  uses of flexible  working time 
arrangements can also lead to the significant  creation of new jobs. 

Well  functioning  labour  markets  are  responsive  to  global  competition  and  technological 
developments  which,  by  truncating  time,  are  increasing  the  speed  with  which  structural 
change is taking place. 

Europe  (and  the  world)  is  evolving  towards  a  more  knowledge-based  economy  where 
information  and  technology  play  a  crucial  rôle,  reshaping  company  structures  and 
organisational  competence.  Industry's  success  in  meeting  the  challenge  of  such  changes 
will  depend  on  how  well  skills  can  be  upgraded.  Each  year  at  least  10%  of  all  jobs 
disappear  and  are  replaced  by  new  ones,  different  jobs,  in  new  processes,  in  new 
enterprises,  requiring  higher  or  broader  skills.  But  these  changes  have  not  been 
accompanied  by  adequate  measures  to  develop  and  improve  the  skills  of the  labour  force, 
and have led to a skills gap and mismatch. 

13 

2. 

D 

Innovation 

Intangible  factors  play a predominant  rôle  in the ability of companies to  innovate and  their 
competitiveness. They enable knowledge  intensive economics to maintain  their  competitive 
position  compared to resource or  labour  intensive economies and to continue to raise  living 
standards  in  an  environmentally  sustainable  manner.  Dematerialisation  of  the  economy 
involves  investing  to  an  ever  high  extent  in  intangibles.  Intangible  investment  and 
innovation  are  inseparable.  A  high  level  of  skills  promotes  adaptability  and  ensures  that 
ever  more  technologically  advanced  processes  can  be  implemented.  Intellectual  property 
constitutes  the  basis  on  which  enterprises  exploit  their  technological  superiority  for 
commercial  success. The Green Paper on Innovation constitutes an opportunity to review all 
of  the  different  obstacles  to  innovation  and  to  develop  a  common  approach  to  their 
removal**. 

Skills 

In  spite  of  the  lack  of  comparable  data,  an  examination  of  educational  and  training 
systems  yields  some  important  information  about  current  requirements  for  human 
resources. The much faster  rate of change and the necessity for an individual to change jobs 
several times  in the course of a working  life  requires a soundly  based  general  education  on 
which  to  build  subsequent  skill  development.  Education  and  initial  training  systems, 
therefore,  provide  an  essential  foundation  for  participation  in  further  training.  Systems 
providing  access  to  qualifications  -  particularly  acquired  through  apprenticeships  enabling 
someone to qualify  in a trade or craft  - later in working life, taking account of their  previous 
work experience are not well developed. This limits the scope for changing jobs and  careers 
throughout  working  life.  It  also  limits job  prospects  and  undermines  the  efficiency  of  the 
labour market. 

The  skills  required  for  the  effective  functioning  of  enterprises  today  go  well  beyond 
technical  skills  associated  with  a  particular  task  or  function.  In  particular,  the  ability  to 
operate  in teams, to adjust  rapidly to changing circumstances  and to take  responsibility  are 
as  important  as  more  formal  grounding  in  specific  aspects  of  the  production  process.  The 
implementation  of  quality  management  strategies  designed  to  manage  constant  change  in 
modern  industry,  has  influenced  fundamentally  the  importance  and  contents  of  vocational 
training  and  professional  education,  as  everyone  in  such  cases  is  an  integral  part  of  the 
quality. 

The  active 
involvement  of  industry  is  essential  to  the  effectiveness  of  the  vocational 
education  and training systems. However, when the investment can be lost for the  enterprise 
in question, it may fail to invest in training. The area in which  skills development appears to 
be least well assured  is that of initial  vocational training for transferable  skills of a technical 
character.  A  market  failure  in  the  provision  of  training  for  transferable  skills  can  be 
observed and requires correction. 

•  A key weakness  of training  systems remains the lack of transparency  and  recognitioK  of 
qualifications  between  Member  States. An approach  inspired  by product  standards may  be 
required if mutual recognition  is to become effective  as a means of improving the levels s>nd 
acceptability  of qualifications.  Systems to ensure that training  systems  and  provision  are  of 
a  high  standard  need  to  be  developed.  An  approach  similar  to  that  of  quality  and  or 
environmental  standards,  backed  by  certification,  may  be  an  appropriate  route  to  achieve 
quality  control  of training.  In  this  context,  the  work  already  carried  out  by  bodies  such  as 
the  European  Organisation  for  Quality (EOQ), which  has developed  a harmonised  scheme, 
at  European  level,  for  qualification  of  quality  professionals  (quality  engineers,  managers 

8 

COM (95) 688 final 20.12.1995 

and  auditors),  could  be  of  exemplary  value.  The  development  of  such  assessment 
techniques lay the foundation  for successful  benchmarking of skills. 

14 

Technology 

Europe has not been  using its advanced  base  in science  in technology  to the best  advantage 
and  indeed  the  European  research  base does appear to be less  market oriented  than  that 
of its major  competitors. In addition  fewer  human  resources are devoted  to R&D.  Scientific 
research  personnel  represent  only  0.47%  of  the  labour  force,  compared  to  0.74%  in  the 
United  States and 0.80%  in Japan. The Community  Innovation  Survey  indicates that  firms 
that  engaged  in  technical  cooperation  agreements  usually  have  a  substantially  larger 
proportion  of new or  improved  products  in their total  sales. The value, therefore,  of  linking 
public  support  of  R&D to cooperation,  as  is the  case  for  European  Union  programmes  for 
R&D, should be stressed. 

Between  1984  and  1993, the  European  Union  lost  share  in  patents, the  principal  indicator 
of  innovating  capacity,  for  all  sectors  except  aerospace  and transport  equipment.  The  most 
significant  loss  took  place  in  electronics,  a  sector  for  which  R&D  is  highly  intensive  and 
in  the  rest  of  industry  through 
which  exerts  considerable  influence  on  innovation 
technology embedded  in investment goods. 

Adaptive  organisations  have become a prerequisite  for  innovation.  Such organisations  use 
multi-skilled  employees,  decentralisation  of  responsibility  and  teamwork  to  achieve  the 
integration  of different  functions  within the firm from  research, engineering, and production 
to  marketing  and  distribution,  based  on  a  project  approach.  Faster  new  product 
development  depends on the successful  integration  of functions.  Increasingly,  suppliers are 
brought  into the development  process. Changes  in management  practices are also central  to 
the 
including  total  quality  management, 
continuous  incremental  improvement (kaizen) and just-in-time production  systems. 

introduction  of  lean  production  processes 

Quality 

A number of surveys carried out by Eurobarometer at the request of the Commission, on the 
effect  of  quality  systems  on  the  commercial  results  of  companies,  indicate  that  the 
implementation  of quality  management  strategies  generate  significant  improvements  in the 
companies'  performance.  If  Europe  has  increasingly  been  assimilating  best  organisational 
practice  developed  elsewhere,  there  are  few  signs  that  significant  improvements  to  best 
practice have been made in Europe. 

In  order  to  be  effective,  efforts  to  promote  quality  will  need  to  be  integrated  into  a 
framework  for  the  continued  reinforcement  of  the  technical  quality  infrastructures  for 
industrial  and  economic  initiatives.  By  giving  a  European  tone,  framework  and  sense  of 
direction  to  the  various  initiatives  in  the  Community,  the  Commission  can  help  to  bring 
awareness to  industry  and  public  authorities  alike. The  Commission  can  also help, through 
the  implementation  of  the  Quality  Promotion  Policy,  to  deploy  the  quality  message  in  its 
various  policies  by  ensuring  coherence  and  integration  of  the  different  measures  at  its 
disposal (e.g. environment, social policy, regional policy,...). 

European  Quality  Promotion  Policy  has the  primary  ambition  of  constituting  above  all  an 
awareness  policy,  to  give  political  visibility  and  support  to  a  European-wide  range  of 
quality  instruments  and  actions.  No  public  authorities,  either  national  or  European,  can 
oblige  the  market  place  to  adopt  quality  strategies,  but  they  can,  by  their  public 
commitment  and  by  wide  dissemination  of  information  and  messages,  influence  the 
environment  in  which  management  establish  their  strategies.  A  clear  political  signal  can 
heavily  influence  industrial  investment. 

15 

Diffusion 

important 
Everywhere,  affiliated  or  partner  companies,  clients  and  suppliers  are 
mechanisms  for. the  diffusion  of  innovation.  Differences  appear  however  in  the  linkages 
and  interchange  between  industry  and  the  research  system.  The  German  infrastructure,  in 
particular  the  Fraunhofer  centres,  is  often  considered  exemplary  in  respect  of  fostering 
innovation  diffusion. 

Innovation  systems  remain  essentially  national.  Diversity  should  be  seen  as  a  source  of 
enrichment  in the  innovation  process. However,  fragmentation  of effort  should  be seen  as a 
disadvantage.  The  successful  development  of  the  Information  Society  depends  on  a  much 
faster  rate  of  adoption  of  new  technologies.  Even  though  at  the  present  time  diffusion  of 
innovation  remains  primarily  a  national  responsibility,  cross  border  cooperation  can 
contribute 
interaction  and  exchange.  Technical  cooperation 
agreements  both  between  firms  operating  in  Europe  and  between  these  firms  and  those  in 
third countries remain the most effective  instrument for developing cross-border  diffusion. 

to  mutually  beneficial 

Financing of innovation 

In  addition  to  diffusion,  financing  of  innovatory  and  high-technology  firms  remains & 
major  problem  in  Europe,  particularly  for  small  and  medium  sized  firms.  Innovatory 
projects  require  considerable  funding  even  before  the  start  of  commercial  activities,  at  the 
research phase, the prototype phase, and, in particular, for the start of production.  Financing 
is thus  required  at  a stage when  potential  returns  are  remote  and  technological  uncertainty 
high.  Venture  capital  in  Europe  has  always  neglected  the  seed  capital  area,  investing  only 
7%  of  total  funding  in  this  area.  This  weakness  weighs  particularly  on  the  creation  of 
innovative  and  technological  firms,  which  are  required  to  ensure  a  renewal  of  the 
productive base and European  presence on markets of the  future. 

European venture capital  industry 

Some  of  the  weaknesses  in  the  European  venture  capital  industry  result  from 
the 
underdeveloped  nature  of  pension  funds,  which  are  major  investors  in  the  United  States. 
Another  significant  weakness  lies  in  the  fragmented  nature  of  the  market.  Investors  will 
take  positions  in  high  risk  projects  provided  that  there  are  sufficient  of  them  to  diversify 
risk. Equally, suitable exit routes for  investors must exist. The lack in Europe of an  efficient 
low cost financial market for  growth  stocks similar to the NASDAQ over-the-counter  stock 
exchange  in  the  United  States  means  that  innovative  firms  in  Europe  with  strong  growth 
potential  are  denied  access  to  suitable  finance,  since  national  markets  are  incapable  of 
providing  sufficient  depth  of  projects  to  diversify  risk.  A  number  of  recent  initiatives 
attempt to address this  shortcoming.  The EASDAQ  market  has already  begun  trading,  and 
the  Paris and  Frankfurt  new markets  and  London  AIM  market  all  cater  in varying  ways  to 
the needs of companies which are not covered by existing stock markets. 

IV.  BENCHMARKING 

' 

16 

The  previous  sections  have set out key areas  in which  European  industry  is not  performing 
satisfactorily  and  some  of  the  reasons  for  this  situation.  As  stated  in  the  Introduction,  the 
Commission  believes that  it has already  identified  and  proposed  the  key actions  which  are 
required  to  address  the  current  competitive  situation  both  at  European  Union  and  Member 
State  level.  However,  progress  has  been  slow  in  implementing  those  measures  and  the 
results  have  yet  to  be  reaped  in  the  form  of  faster  growth,  more  employment  and  higher 
productivity.  A  tool  to  monitor  progress  on  an  on-going  basis  and  assess  the  situation 
against  continuously  improving  best  practice  world-wide,  could  provide  the  European 
Union  with  a  powerful  instrument  to  strengthen  competitiveness.  Benchmarking  can 
constitute  a  tool  for  promoting  convergence  towards  best  practice,  providing  that  it  is 
clearly related to the essential factors of competitiveness. 

BENCHMARKING  FOR  COMPETITIVENESS 

identifies  gaps 

Competitive  analysis 
in  performance  on  key  dimensions  such  as 
productivity, growth, costs, investment and  innovation. However, competitive analysis does 
little  to  explain  why  these  differences  of  performance  have  occurred  and,  in  some  cases, 
remain for many years in spite of widespread access to new technologies, capital and skilled 
human  resources  amongst  developed  countries.  Benchmarking  goes  beyond  competitive 
analysis by providing an understanding of the processes that create superior performance.  It 
first  identifies  the  key  areas  that  need  to  be  benchmarked  and  the  appropriate  criteria  on 
which  to  evaluate  that  area.  It  then  sets  out  to  identify  best  practice  world-wide  and  to 
measure how those results have been achieved. 

The  potential  range  of  benchmarking  is  very  wide.  In  this  Communication  a  number  of 
different  possible  applications  of  benchmarking  are  presented.  In  each  case,  the  type  of 
benchmarking  undertaken  will  depend  on the  use to which  the results of the exercise  are to 
be put. Benchmarking  for  competitiveness  has for  object  to help enterprises,  industries and 
public  authorities 
that  affect 
competitiveness. 

their  performance  on  critical  dimensions 

improve 

/.  Enterprise  benchmarking 

Benchmarking at enterprise  level can offer  a key instrument for  improving competitiveness. 
It remains the primary  responsibility of  industry to implement  such  benchmarking  and  it is 
not the  intention  of the European  Commission  to become  involved  in the  benchmarking  of 
individual  enterprises.  However,  a  number  of  schemes,  both  public  and  private,  seek  to 
promote  benchmarking  of  enterprises  to  a  wider  audience,  particularly  to  small  and 
medium  sized  enterprises  that  do  not  have  the  resources  or  the  experience  to  undertake 
benchmarking on their own. 

National Programmes  for  Benchmarking  Enterprises 

The  Department  of  Trade  and  Industry  In the  United  Kingdom  has  established  a National 
Benchmarking  Scheme  to  enable  sharing  of  statistical  data  and  identification  of  national 
best  practice.  Member  States  and  private  organisations  have  cso  ^ a ^d  b*"ogr -r  *ies  to 
facilitate  the  diffusion  of  environmental  b>s>:  practices  (e _ 
technology Best Practice Programme), 

*  UK  c, <*  *~  i "  rfa! 

17 

The  disparate  nature  and  the  diverse  techniques  and  processes  employed  in  benchmarking 
for enterprises do not contribute to the proper promotion  of the usefulness  and  effectiveness 
of  such  quality  techniques.  Industrial  co-operation  and  networking,  which  are  inherent  to 
benchmarking,  can  be strong  instruments  for  the development  of a  European  way  of  doing 
things,  for  the  real  development  of  a  European  quality  culture  which  can  strengthen 
European  industry internally and help it face  up to its external  competitors. 

The Commission  therefore  suggests that Community  institutions should  recognise the value 
of benchmarking  of enterprises  in the  furtherance  of an  integrated  and  competitive  market 
and  invite  all  concerned  to  bring  their  experiences  together  into  a  truly  European  system 
with  clearly  visible  European  processes. This  will  entail, through  co-operation,  developing 
European  processes  out of the various  existing  ones, comparing  practices,  setting  common 
rules  and  a  common  calibration  system.  It  will  also  entail  developing  common 
indicators/criteria and a European information  network and management system  for data. 

2.  Benchmarking  of  sectors 

Benchmarking  can also be applied to sectors, for which a significant  amount of expertise  is 
beginning to emerge. This constitutes  a natural extension  of enterprise  benchmarking  in 
that  many  of the  same  principles  can  be applied  to that  set  of  enterprises  that  make  up an 
industry  and  for  which  similar  types  of  best  practice  are  fundamental  for  competitiveness. 
The Commission  has already  underlined the significance  of benchmarking  for  sectors  in its 
recent  Communications  on  the  automobile  and  chemical  industries.  Benchmarking  of 
sectors  enables  the  Commission  to  monitor  on  a  continuing  basis  the  ability  of  European 
industries  to  respond  to  international  competition.  When  applied  to  the  key  locational 
factors  it provides a lead in to the necessary benchmarking of framework  conditions. 

Benchmarking of sectors by the Commission 

The  pilot  programme  for  component  suppliers  to  the  consumer  electronics  run  in 
conjunction  with  MITI  and  industry  aims  to  improve  the  quality  of  European  based 
suppliers of components through a process of benchmarking against Japanese best practice. 

In  its Communication  on the European  Union Chemical  Industry (COM (96)  187 final), the 
Commission  states  that  it  "will  implement,  in  cooperation  with  representatives  from  the 
European  chemical  industry a structural  follow-up  programme, and will closely monitor the 
evolution  of the international  competitiveness  of this sector and the adoption  of the various 
measures proposed  in the Communication". 

The  Commission  has begun  to benchmark  the competitiveness  of European  manufacturing 
locations  for  the automotive  industry.  Information  technology  is another  area  in which  the 
Commission  intends to develop benchmarking. 

3.  Benchmarking  framework 

conditions 

Thirdly,  benchmarks  can  be  developed  to  appraise  the  performance  of  key  elements  of 
framework  conditions  for  industry.  These  enable  an  evaluation  to  be  made  of  the 
attractiveness of Europe as a place to do business. The Dutch  Ministry of Economic  Affairs 
has  published  a  report  "Benchmarking  the  Netherlands:  Test  of  Dutch  Competitiveness" 
which demonstrates some of the ways in which benchmarking for framework  conditions can 
be undertaken. 

18 

The present Communication  has identified  a number of key priority  areas  for  performance, 
which may be suitable for benchmarking: 

-  Concerning  costs,  unit  labour  costs,  costs  of  finance,  levels  and  structure  of  public 

expenditure, taxation and deficits  constitute key elements. 

-  Benchmarking  can  be  applied  to  key  inputs  for  industrial  competitiveness  as 
requested  by  the  Competitiveness  Advisory  Group.  The  Australian  Bureau  of  Industry 
Economics  has  undertaken  pioneering  work  on  benchmarking  infrastructure  services. It 
has demonstrated  the feasibility  of benchmarking such  inputs and also of identifying  key 
reasons for less than adequate performance,  some of which depend on the regulatory and 
business  framework.  Key  areas  to  be  benchmarked 
include  price,  quality  and 
accessibility of service and number of innovatory services provided. Productivity of both 
capital  and  labour  need  to  be  measured  in  order  to  establish  the  underlying  causes  of 
unsatisfactory  performance.  As  identified  above, telecommunications,  energy,  transport 
and  business and financial services are the principal  services for  which  benchmarking  is 
required. Closely  linked to benchmarking the quality of services  is that of  infrastructure. 
This is particularly  important for transport where much of the efficiency  of the service is 
determined  by the quality of the infrastructure,  whether that be ports, roads, airports and 
traffic  control  or  the  rail  network.  Investment  in  plant  and  equipment  and  intangible 
investment both  in education and training and in research will be also be required. 

-  One area for  benchmarking  concerns skills.  In the context  of  its on-going  evaluation  of 
competitiveness,  the  United  Kingdom  has  recently  published  a  skills  audit  which 
represents an approach to benchmarking  in this area. The audit is based on  qualifications 
rather than  skills  although  coverage  is also devoted  to the  acquisition  of basic  skills. In 
order  to  benchmark  skills  adequately,  it  is  necessary  to  benchmark  the  skills  actually 
acquired  rather  than  qualifications  delivered.  It  is  also  necessary  to  benchmark  the 
capacity of education and training systems to deliver a prescribed  set of skills. 

- 

Innovation  also  represents  an  area  for  which  benchmarking  would  be  useful.  In  the 
context  of  its  policy  on  innovation,  the  Commission  intends  to  establish  a  permanent 
monitoring  of  innovation  in  Europe  and  in  the  world.  Benchmarking  research,  in 
particular research financed by industry  itself is an area for  which the Union has already 
developed  suitable  indicators. Research  represents  an  input to innovation  rather than  an 
output  and  can  provide  only  a partial  view  of the  extent to  which  European  innovation 
systems  are  sufficiently  competitive.  Intellectual  property  can  be  benchmarked  to  a 
certain  extent  through  patent  applications  and  trade  marks. Organisational  and  product 
innovation  as  well  as  the  capacity  of  national  systems  to  diffuse  innovation  are  more 
difficult  to  benchmark.  Technology  licensing,  adoption  rates  of  generic  technologies, 
speed  to  market,  and  the  degree  of  application  of  total  quality  concepts  represent 
examples of indicators that might be used to benchmark  innovation. 

-  Benchmarking  of  environmental  efficiency  will  be  required  to  ensure  that  efforts  to 
improve  competitiveness  are  not  made  at  the  expense  of  sustainability.  Key  criteria 
relate  to  the  capacity  of  the  economy  to  efficiently  transform  flows  of  materials  into 
goods  and  services.  Suitable  indicators  in  the  field  of  energy  efficiency  already  exist. 
However,  benchmarks  for  other  material  flows,  such  as  the  use  of  water,  which  is 
becoming  an  increasingly  rare  resource,  will  need  to  be  developed.  Criteria  such  as 
recycling  rates  of  water  can  help  to  measure  the  efficiency  with  which  the  European 
economy  in general  and European  industry  in particular  is using resources. 

~-  Many  policy  areas  affecting  competitiveness  are  either  the  exclusive  or  principal 
responsibility  of  the  Member  States.  A  number  of  product  markets,  including 
distribution,  and  labour  and  capital  markets  fall  under  this  category.  Benchmarking  in 
these  areas  will  need  to  be  developed  in  close  cooperation  with  Member  States.  The 

Commission  is  already  actively  working  with  Member  States  on  th-.:  use  of  criticn1 
indicators  in employment  policy. Of particular  importance  in this context  will  indicators 
for  monitoring  progress  in  promoting  positive  flexibility  both  internally  within  firms 
and externally; 

-  Fostering  an  administrative  environment  favourable  to  enterprise  is  a  prerequisite  for 
business  competitiveness.  Some  Member  States  have  developed  bold  strategies  of 
administrative simplification.  Under the Integrated  Programme for  SMEs and the  Craft 
Sector9,  the  Commission  and  the  Member  States  will  develop  concerted  actions  where 
benchmarking  will  play  a  valuable  rôle  in  promoting  best  practice  in  the  area  of 
administrative  simplification. 

There  are  a  number  of  reasons  why  the  European  Union  should  become  involved  in 
benchmarking.  First, there are a number of policies developed  at Union  level  that  influence 
competitiveness,  and  it  is  important  that  their  impact  should  have  as  positive  effect  as 
possible.  Regular  monitoring  and  evaluation  against  world  best  practice  and  not  merely 
against that  in Member  States  is required  to ensure that these  policies  are  indeed  providing 
the  necessary  benefits.  Secondly,  many  policies  are  the  responsibilities  of  Member  States 
and  their  ability  to  benchmark  both  against  each  other  and  with  regard  to  best  practice 
world-wide  should  be  encouraged.  Collection  of  data  is  both  an  expensive  and  time 
consuming process. By pooling their efforts,  the Commission  and Member  States can make 
substantial savings in the benchmarking process. 

The  Commission's  efforts  will  be  devoted  initially  to  bringing  together  all  the  different 
actors to  identify  which  actions  are already  being  undertaken  and  which  need  to  be treated 
on  a  priority  basis.  Based  on  partenariat  between  industry,  Member  States  and  the 
Commission, a work  programme will need to be drawn  up in the course of  1997. This work 
programme  should  include  a  certain  number  of  pilot  projects  to  test  the  validity  and 
feasibility  of  the  application  of  benchmarking  at  European  Union  level.  It  should  further 
specify  how  to  manage  benchmarking  on  an  on-going  basis  and  how  to  ensure  the  best 
exploitation of results. 

V.  CONCLUSIONS 

The  analysis  developed  in  this  Communication  reveals  the  urgency  of  action  to  promote 
industrial  competitiveness  and  the  necessity  of  a  global  approach  concerning  all  those 
factors  in the business environment which are determining for enterprises. 

1.  The  Commission  invites  the  Council  and  the European  Parliament  to  endorse,  the 

Commission's  analysis  of competitiveness, 

the main points  of  which  are: 

-  while  the  situation  of  the  European  economy  presents  a  number  of  areas  of  strength,  the 
European  Union  is not exploiting  its full  potential  or meeting the performance  of  its  major 
competitors  in terms of  living standards, productivity  and employment  creation,  leading  to 
idle resources and high rates of unemployment; 

- 

inadequate  performance  is  also  reflected  by  weak  growth  in  industrial  value  added,  low 
profitability  and falling share of exports from  developed countries; 

-  high  costs  and  low  investment,  especially  intangible  investment,  combine  to  depress 

industrial  performance; 

9 COM(96) 329 final of 10.07.1996 

20 

public  deficits  remain  too  high  and  expenditure  too  concentrated  on  transfers  and 
consumption  with  insufficient 
levels  of  public  investment  in  both  infrastructure  and 
intangible  investment.  The  level  of  public  deficits  exerts  pressure  on  interest  rates  and 
siphons off available savings; 

continue to control state aids with the objective of reducing overall  levels of state aid and 
reliance by firms on public support; 

in  spite  of  some  very  well  functioning  education  and  training  systems  in  Europe,  lifelong 
learning  and permanent  upgrading of human  resources  still  has some way to go  in order to 
reach the highest levels in most Member States; 

Europe's research  base  is insufficiently  market oriented  and  close  integration  with  industry 
is needed  at the  same time  as  spending  on  research  is  insufficient  and  the take  up  of  new 
technologies is slow; 

the adoption of new technologies remains too slow, particularly  in areas relating to the 
Information  Society; 

financing  of innovation  remains a specific problem  in Europe; 

quality  in all  its aspects  represents an essential  element  for  improving  competitiveness  and 
adaptive organisations  are required  in order to  introduce quality  management  and  speed  up 
the process of innovation. 

2.  The  Commission  proposes  that  the  Council  and  the European  Parliament  support: 

- 

the  value  of  benchmarking  as  a  tool  for  identifying  the  underlying  reasons  behind  poor 
the 
competitive  performance  and 
in  addressing 
Commission's 
intention  over  the  coming  year  to  bring  forward  a  programme  of 
benchmarking  on the basis of close consultation  with  industry  and  Member  States  in order 
to track progress in improving competitiveness  in key areas. 

these  weaknesses  and 

to  assist 

-  a  European  Quality  Promotion  policy  which  will  contribute 

the 
competitiveness  of  European  enterprises  by  drawing  up  a  multi-annual  European  Quality 
Promotion  programme  of  actions,  centring  in  particular  on  the  promotion  of  self 
assessment,  benchmarking,  networking  of  information  and  the  development  of  European 
quality training programmes and techniques for measuring progress. 

to  reinforcing 

ISSN 0254-1475 

COM(96) 463 final 

DOCUMENTS 

EN 

10  17 

Catalogue number  : CB-CO-96-501-EN-C 

ISBN 92-78-09915-5 

Office  for Official  Publications of the European Communities 

L-2985 Luxembourg