COMMISSION STAFF WORKING DOCUMENT European Competitiveness Report 2010  Accompanying document to the  COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS  An integrated Industrial Policy for the Globalisation Era Putting Competitiveness and Sustainability at Front Stage   {COM(2010) 614} {SEC(2010) 1272}
Date: 2010-10-28
Institutions: European Commission
Subjects: competition, industrial policy, intellectual property, single market, sustainable development

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EUROPEAN COMMISSION 

Brussels, 28.10.2010 
SEC(2010) 1276 final 
VOLUME I 

COMMISSION STAFF WORKING DOCUMENT 

European Competitiveness Report 2010 

Accompanying document to the 

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

An integrated Industrial Policy for the Globalisation Era 
Putting Competitiveness and Sustainability at Front Stage 

{COM(2010) 614} 
{SEC(2010) 1272} 

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COMMISSION STAFF WORKING DOCUMENT 

European Competitiveness Report 2010 

Table of Contents 

EXECUTIVE SUMMARY .............................................................................................................. 3 
1. Introduction ........................................................................................................................ 3 
2. Overall competitiveness performance................................................................................ 3 
3. Trade in intermediate products and EU manufacturing supply chains .............................. 4 
4. Foreign corporate R&D and innovation in the European Union ....................................... 6 
5. European competitiveness in key enabling technologies................................................... 9 
6. Innovation and competitiveness of the creative industries in the EU .............................. 11 
7. Conclusions ...................................................................................................................... 13 
INTRODUCTION ........................................................................................................................ 15 
1.  GROWING IMBALANCES AND EUROPEAN INDUSTRY ...................................................... 17 
1.1  The crisis as a major adjustment ................................................................................. 17 
1.1.1  A big recession ..................................................................................................... 17 
1.1.2  Sudden drop and slow recovery in the labour market.......................................... 18 
1.2  The years before the crisis........................................................................................... 20 
1.2.1  Aggregate trends and the crisis ............................................................................ 20 
1.2.2 
Industrial trends.................................................................................................... 23 
1.2.3  R&D in EU industries .......................................................................................... 24 
1.3  Growing imbalances and external competitiveness .................................................... 26 
1.3.1  Soaring asset prices .............................................................................................. 26 
1.3.2  Growing distortions and external competitiveness .............................................. 31 
1.3.3  Rising unit labour costs, cause or consequence?.................................................. 33 
1.3.4  World market shares............................................................................................. 36 
1.3.5  Summarizing ........................................................................................................ 41 
1.4  The impact of the boom on industry and competitiveness.......................................... 41 
1.4.1  Has the housing bubble crowded out productive investment?............................. 41 
1.4.2  Employment growth in construction and real estate services .............................. 45 
1.4.3  The allocation of productive investment.............................................................. 50 
1.4.4  Summarizing ........................................................................................................ 51 
1.5.  The impact of the crisis on industry ........................................................................... 51 
1.5.1  Output................................................................................................................... 53 
1.5.2  Employment ......................................................................................................... 55 
1.6  Conclusions ................................................................................................................. 57 

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EXECUTIVE SUMMARY 

1. Introduction 

The  European  Union  and  the  world  economy  went  through  a  deep  financial  and  economic 
crisis in 2008 and 2009. The first signs of recovery were visible in 2009 and were confirmed 
in the first half of 2010. These developments and the quickly evolving world market situation 
are a compelling call for the importance of remaining competitive. 

This  year’s  edition  of  the  annual  European  Competitiveness  Report  looks  first  at  the 
implications of the economic downturn for productivity — the key factor for competitiveness 
in  the  long  run  —  and  at  some  of  the  main  future  determinants  of  EU  competitiveness  on 
world  markets:  in  the  changing  pattern  of  trade  in  intermediate  products  and  EU 
manufacturing  supply  chains;  foreign  corporate  R&D  and  innovation  activities  in  the  EU; 
European competitiveness in key enabling technologies; and innovation and competitiveness 
in the creative industries. 

2. Overall competitiveness performance  

With the exception of the 2001 slowdown, the period 1995-2006 has been one of remarkable 
stability for industrialised countries. In the EU in particular, it has been a period of sustained 
growth, increasing participation in employment and increasing income per capita. In the US 
and  some  European  countries,  however,  this  stability  was  hiding  the  accumulation  of 
significant imbalances that ultimately led to a downturn of a severity unseen since the early 
1970s’ oil shocks. In the EU, with the only exception of Poland, all Member States saw a drop 
in their production in 2009: from around 3 per cent in Belgium or France to double digit drops 
for Ireland and the Baltic republics. Even if some individual countries had experienced similar 
recessions in the recent past, this recession is unusual for its combination of a large drop in 
economic activity and its scope: synchronized global downturn with all advanced economies 
in nose-dive. 

Beyond the issue of recovery, it is legitimate to ask what could be the impact of the crisis on 
economic  performance  in  the  medium  to  long  term.  The  European  Competitiveness  Report 
2009  examined  the  potential  impact  of  the  recession  on  competitiveness.  All  in  all,  the 
conclusion  was  that  the  recession  need  not  have  a  negative  impact  on  the  rate  of  technical 
change  in  the  years  to  come;  for  a  recession  includes  two  types  of  mechanisms:  those  that 
impinge negatively on economic efficiency, but also those that improve our ability to increase 
productivity in the future. Furthermore, understanding those mechanisms makes it possible to 
design economic policies to tone down the negative effects and amplify the positive ones in 
order to speed recovery and boost future growth. 

The  first  chapter  of  the  present  edition  of  the  Report  examines  the  potential  impact  of  the 
boom  years  2000-07  on  competitiveness.  The  above-mentioned  accumulation  of  large 
imbalances  has  the  potential  to  distort  significantly  the  allocation  of  resources  among  and 
within our economies.  

Seen  in  retrospective,  the  boom  period  2000-07  was  also  a  period  of  growing  imbalances, 
notably  in  the  housing  sector  in  the  US  but  also  in  Europe:  some  Member  States  saw 
investment  in  dwellings  increase  by  the  order  of  magnitude  of  several  percentage  points  of 

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GDP. For a decade or more, in some countries, particularly in the UK, Denmark, Ireland and 
Spain, the prices of dwellings increased over their fundamental value. The distortion did not 
affect all countries, but in those affected it was not a minor one. In countries like Spain, for 
instance, at the height of the boom (around 2005-06) housing prices were increasing by 15 % 
annually.  For  years  millions  of  agents  in  the  private  sector,  notably  households,  made 
consumption-saving  decisions  counting  on  house  prices  increasing  in  a  way  that  ex-post 
appeared not to be sustainable. Indeed, in countries affected, the fast growth of housing prices 
led  households  to  overinvest  in  housing  and  to  overstate  their  wealth,  pulling  down  their 
saving rate. If houses constituted an attractive investment for locals, so they did for foreigners 
as well, directly or indirectly. 

The period 2000-06 witnessed as well a substantial change in the lending/borrowing position 
of  many  European  countries.  In  those  with  a  housing  bubble,  the  demand  for  credit  fuelled 
capital  inflows.  When  the  boom  came  to  an  end,  the  magnitude  of  the  adjustment  was 
proportional  to  the  magnitude  of  the  accumulated  distortions.  Once  the  value  of  houses 
dropped  ―  or  was  believed  to  drop  in  the  future  ―  a  large  portion  of  perceived  wealth 
vanished  leading  to  a  major  adjustment  of  consumption  and  saving  patterns.  Consumption 
dropped  and  saving  increased  to  recompose  the  latter.  Hence,  countries  affected  by  bubbles 
found  themselves  in  a  classical  demand-side  recession  caused  by  the  consumption-saving 
adjustments  performed  by  households.  Other  countries,  not  necessarily  affected  by  these 
imbalances, were affected through a drop in external demand. 

The  European  Competitiveness  Report  2009  examined  the  potential  impact  of  the  recession 
itself on competitiveness. The European Competitiveness Report 2010 examines the potential 
impact of the boom years; in particular, whether these growing imbalances had an impact on 
competitiveness via the distortion of prices, wages or the allocation of investment. 

For instance, during the boom some countries experienced large increases in unit labour costs, 
a measure of the nominal cost of labour. However, it does not seem that the evolution of unit 
labour  costs  has  had  a  significant  effect  beyond  coming  along  with  the  corresponding 
increases  in  the  general  level  of  prices.  In  principle  raising  the  nominal  cost  of  labour  may 
affect the competitive position of domestic firms in international markets. However, when the 
international  market  shares  are  compared  to  the  evolution  of  unit  labour  costs,  there  is  no 
obvious relation. Part of the explanation to this apparent paradox may lie in the fact that wage 
inflation takes place mostly in non-tradable sectors, notably services and, in particular, in the 
construction sector.  

In  short,  if  the  boom  years  have  affected  competitiveness,  that  is,  the  ability  to  increase 
productivity in the forthcoming years, the evidence remains elusive. Nevertheless, this is not 
to say that exiting the crisis may not be a slow adjustment process in some EU countries. For 
instance, it is possible that a part of those large capital inflows has not been used productively 
in some of the so-called deficit countries, therefore hampering the ability of these countries to 
generate income in the future while at the same time increasing the interest burden on these 
economies. 

3. Trade in intermediate products and EU manufacturing supply chains 

A  large  and  growing  number  of  products,  especially  in  the  high-tech  area,  consist  of  many 
different  components  that  are  manufactured  in  various  parts  of  the  world.  Manufacturing 
production processes also require many kinds of services from different parts of the world if 
firms are to develop, produce and market their products.  

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However,  this  multi-country  nature  of  products  is  no  longer  typical  only  for  complex  high-
tech  goods.  Components  and  services  are  purchased  abroad  for  many  products.  This  is  the 
case  for  direct  inputs  when  firms  purchase  both  domestically  and  foreign  produced 
intermediate  inputs,  but  also  in  an  indirect  way:  components  imported  from  a  particular 
country might already include inputs from other countries, which are then used indirectly in 
the final product. 

A prominent feature of the globalisation of today’s economy is the increasing adjustment and 
adaptation of production structures to more international sourcing structures and cross-border 
production networks. Firms distribute their production activities and develop supply chains in 
different geographical locations according to the comparative advantages of the locations. So 
these developments can be said to have led to increased trade in intermediate goods.  

Important  shifts  in  the  composition  of  EU-27  intermediate  trade  have  taken  place 
during the last decade 

Trade in intermediates accounts for the largest part of overall trade, with an average share of 
about 50% of both imports and exports. There are, however, big differences across countries. 
This  share  has  increased  little  over  the  last  decade  or  so  and,  has  been  driven  mostly  by 
industry specialisation. The shift towards more knowledge-intensive sectors in the EU has led 
to an increasing role of imported intermediates.  

Large  shifts  have  taken  place  in  the  geographical  structure  of  trade  in  intermediates  for  the 
EU-27  countries.  BRICs (Brazil, Russia, India and  China)  have  become  more  important  for 
EU exports and imports. They increased their share in EU-27 imports by 5 percentage points 
during  the  last  decade.  Gains  of  market  shares  can  in  general  be  related  to  relative  price 
changes or increased product quality. Product quality upgrading also explains part of the EU-
121 market share increase within the EU. 

A large part of trade in intermediates consists of two-way trade, i.e. most countries are both 
exporters  and  importers  of  intermediates,  which  blurs  the  common  perception  of  certain 
countries being predominantly outsourcing or target countries. Smaller emerging economies, 
including most of EU-12, are more specialised in trade in intermediates as compared to larger 
ones,  both  in  imports  and  exports.  This  raises  the  more  general  question  whether  trade  in 
intermediates might help countries to integrate into the world economy and how this shapes 
patterns of specialisation in both production and trade.  

Increasing sourcing of inputs, trade of intermediates and inter-industry linkages 

The  growing  trade  in  intermediates  means  that  inter-industry  linkages  across  borders  have 
increased  over  time.  For  instance,  when  demand  for  cars  increases  in  a  particular  country, 
more  intermediate  goods  have  to  be  imported  than  was  the  case  a  few  years  ago.  Between 
1995 and 2005 imports of intermediate goods increased in all manufacturing industries and in 
almost all EU countries. During the same period of time, the share of imported intermediates 
in total intermediates has also grown indicating an increasing role of imported intermediates 
in  final  products.  There  are,  however,  some  distinct  industry  differences  in  the  use  of 
imported  intermediates.  High-technology  industries  import  more  intermediate  goods  than 
other industries: imported intermediates accounted for 55% of total inputs in high-technology 
manufacturing  industries  in  2005.  On  the  other  hand,  foreign  trade  plays  a  smaller  role  in 
service  industries  than  in  manufacturing.  Among  service  industries,  the  largest  share  of 
imported intermediate goods in 2005 (26%) was in transport services.  

1   EU-12 are the 12 countries which joined the European Union in 2004 and 2007. 

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Detailed information from a leading European mobile phone producer on supply chains shows 
that Europe captures 55% of a particular phone’s total value added. The phone was assembled 
both  in  Europe  and  China.  When  it  was  assembled  and  sold  in  Europe,  the  European  share 
accounted  for  68%.  But  even  when  it  was  assembled  in  China  and  sold  on  the  US  market, 
Europe still captured as much as 51% of the value. This shows that the final assembly, though 
important, represents only a fraction of the overall value added of a high-tech product like a 
mobile  phone.  The  value  is  largely  detached  from  the  physical  flows  of  goods  within  the 
supply  chain.  The  major  parts  of  the  value  are attributed  to  design,  R&D,  brand,  marketing 
and distribution, and management of these activities. 

The financial crisis hit intermediate trade relatively harder and disrupted supply chains 

There is a risk that the economic crisis of 2008-2009, characterised by trade flows collapsing 
by more than the drop in GDP growth rates, might have changed sourcing patterns and firms’ 
supply chains. Trade in intermediates, and especially in parts and components, was hit harder 
by the crisis than other types of goods. Trading volumes of parts and components slumped by 
some 38% percent compared to pre-crisis levels. As a result, the relative importance of parts 
and components in EU-27 trade declined both in EU-27 trade overall and in almost all sectors 
in which vertical supply chains play a major role. These vertical supply chains are important 
especially for the industries producing electrical machinery, mechanical equipment and motor 
vehicles. 

The automotive industry has one of the highest shares of parts and components trade. During 
the  recent  recession  its  exports  and  imports  registered  the  biggest  falls,  of  some  45% 
compared  to  before  the  crisis.  Such  disruptions  to  international  supply  chains  might  have 
resulted from changes in the sourcing strategies of multinational corporations, such as shifting 
to domestic suppliers. Inventory adjustments have also contributed to the decline. An upturn in 
EU-27  trade  can  be  expected  if  the  marked  decline  in  parts  and  components  trade  is  primarily 
driven by the inventory cycle, as empty stocks have to be replenished. However, the recovery may 
be  delayed  if  there  is  a  reversal  of  the  trend  towards  ever  more  complex  international  vertical 
supply chains.  

Globalisation and localisation of the value chain 

Trade in intermediates constitutes only one of many business activities in the value chain. As 
the  mobile  phone  example  shows,  large  parts  are  attributed  to  more  knowledge-intensive 
activities,  like  management,  design  and  R&D.  These  are  especially  important  for  high-tech 
industries,  which  tend  to  locate  them  close  to  the  firm's  headquarters,  where  it  is  easier  to 
control and manage them. So EU firms’ R&D and innovation activities are still predominantly 
domestic,  though  they  are  becoming  increasingly  internationalised  as  adapting  products  to 
foreign  markets  necessitates  the  presence  of  product  development  close  to  those  markets. 
Firms  also  seek  to  ensure  access  to  scientific  and  technological  capabilities,  human  capital 
and  other  resources,  which  is  another  motive  for  the  foreign  location  of  R&D  activities. 
Localisation  decisions  are  not  based  on  local  preferences  but  on  strategic  considerations 
concerning the provision of strategic resources. 

4. Foreign corporate R&D and innovation in the European Union 

Corporate research, development and innovation (R&D&I) activities were long seen as one of 
the  few  business  areas  still  relatively  insulated  from  offshoring  and  globalisation.  This 
perception  has  lately  been  changing  rapidly.  Over  the  last  thirty  years,  globalisation  has 
changed international trade and foreign direct investment flows  considerably, reshaping and 

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transforming R&D&I processes and the knowledge and skills that enable firms to compete in 
domestic and international markets. As a result, a growing number of firms, in particular large 
multinational enterprises, started locating R&D&I activities outside their home countries. 

Firms  decide  to  (re-)locate  R&D&I  activities  abroad  by  weighing  a  number  of  important 
considerations against each other. Potential benefits include local development and design of 
new products and services to capture new markets and growth opportunities; gaining access to 
new  sources  of  scientific  and  technological  capabilities,  skills  and  talent;  and  reducing 
R&D&I  capacity  bottlenecks.  Potential  costs  include  foregone  benefits  of  R&D&I 
centralisation,  including  economies  of  scale  and  scope,  the  need  for  more  coordination  and 
complexities  in  the  transfer  of  knowledge,  given  its  often  "tacit",  cumulative,  localised  and 
context-related nature.  

The  European  Union  has  been  an  important  player  in  this  emerging  internationalisation  of 
R&D&I,  as  documented  by  a  number  of  datasets  (patents,  R&D  expenditure  of  foreign 
affiliates  and  various  surveys).  The  analysis  points  to  some  important  differences  across 
countries,  sectors,  technologies  and  firms,  as  well  as  to  some  of  the  likely  effects  of  the 
increasing and uneven degree of internationalisation on productivity and employment in the 
European Union. 

EU performance in the emerging internationalisation of R&D&I 

In a global perspective, the EU is still in a position of strength, but the global competition to 
attract R&D&I flows is set to continue rising. R&D&I internationalisation is predominantly a 
matter  for  the  triad  US,  EU  and  Japan,  with  smaller  roles  for  countries  like  Canada, 
Switzerland,  Korea  and  Israel.  The  bilateral  flows  between  the  EU  and  the  US  clearly  take 
prominence  on  a  global  scale.  For  instance,  from  2001  to  2007,  US  multinational  firms 
significantly increased their R&D expenditure in the EU, still the main location for their R&D 
(the EU single market attracted more than 60 % of all US overseas R&D expenditure in this 
period).  The  EU,  however,  is  facing  growing  global  competition  in  this  field,  from  both 
developed and emerging economies. R&D expenditure of US subsidiaries in the BRICs is still 
relatively  low  (altogether  representing  about  one  tenth  of  the  value  for  the  EU-27  in  2007), 
but is growing fast. 

The  considerable  increase  in  R&D&I  cross-border  links  is  evident  at  extra-EU  and  in 
particular  intra-EU  levels,  as  further  documented  by  the  locations  of  patent  applicants  and 
inventors.  For  instance,  some  17 %  of  all  European  Patent  Office  patents  resulting  from 
inventions  made  in  the  EU  were  foreign-owned  (9 %  by  non-EU  and  8 %  by  EU-based 
organisations); in 1990, only 10 % of such patents had foreign owners (6 % non-EU and 4 % 
EU-based organisations). Moreover, the last two decades have seen an increase in the number 
of both domestic and foreign-owned patents resulting from inventions made in the EU, which 
suggests  that  the  internationalisation  of  R&D&I  did  not  squeeze  out  domestically  owned 
patenting. 

Altogether, the various sources of evidence confirm the rise of R&D&I cross-border links and 
flows,  indicating  at  the  same  time  a  possible  slowdown  in  recent  years  and  showing  that 
domestic activities still account for the bulk of R&D&I, particularly in the large countries. 

Uneven levels and trends across EU countries, sectors, technologies and firms 

Cross-border R&D&I links between the EU-15 countries tend to be relatively strong, but are 
often limited to the large and medium-sized R&D-intensive Member States. In contrast, links 

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between the EU-12 and the EU-15 countries, and in particular within the EU-12, tend to be 
rare. 

Medium-sized  or  small  Member  States  tend  to  have  a  higher  degree  of  internationalisation 
and in some cases relatively higher R&D&I inflows than large countries. Patent data suggest 
that  strong  country  links  in  terms  of  R&D&I  often  appear  to  be  explained  by  a  common 
language, geographical proximity or a long history of economic integration. Key examples are 
the links between the Nordic countries, and the links between a large country and a smaller 
neighbour, such as Germany and Austria, UK and Ireland, or France and Belgium. There are 
at  least  five  countries  in  the  EU  (Austria,  Czech  Republic,  Hungary,  Ireland,  and  Slovakia) 
where foreign-owned firms currently account for more than 50 % of total R&D expenditure in 
manufacturing. 

Services tend to be less internationalised than manufacturing, but their share of total overseas 
R&D  expenditure  is  rising.  Also,  different  sectors  and  technologies  present  different 
internationalisation  levels  and  dynamics.  For  instance,  a  high  and  increasing  level  of 
internationalisation  is  generally  found  in  technology-intensive  sectors,  such  as  information 
technologies, telecommunications and pharmaceuticals (characterised by high R&D intensity 
and  fast  rates  of  technological  change).  A  high,  but  more  or  less  stable  internationalisation 
level is found, for instance, in the food industry, possibly reflecting the presence of a number 
of  large  multinational  enterprises  and  a  high  degree  of  product  variation  and  innovation  in 
response to differing consumer tastes.  

Internationalisation  is  mainly  pursued  by  a  small  number  of  large,  R&D-intensive  firms. 
Typically,  firms  move  R&D&I  to  high-income  countries  to  access  knowledge,  while 
relocation to low-income countries is driven by the quest for new markets. 

EU firms are increasing their R&D&I outside the EU 

EU firms are increasingly seizing opportunities to start or expand R&D&I abroad (extra-EU), 
particularly  in  the  US.  The  outward  internationalisation  of  EU  firms  has  increased 
considerably  over  the  last  two  decades  and  is  catching  up  with  the  top  levels  of  R&D&I 
internationalisation that US firms overall still tend to hold. For instance, between the periods 
1991-1995  and  2001-2005,  the  share  of  all  EU  patent  applications  (in  the  OECD  triadic 
database)  resulting  from  inventions  made  outside  the  EU  increased  from  4%  to  11 %.  It  is 
worth  comparing  the  outward  internationalisation  dynamics  among  the  triad  (US,  EU  and 
Japan): the  EU more  or  less caught  up with the US (11 % share of patent applications  from 
inventions made abroad in the period 2001-2005), leaving Japan well behind (3 % in the same 
period).  

Patent  data  and  R&D  expenditure  surveys  both  indicate  that  the  US  is  by  far  the  preferred 
location  for  overseas  R&D&I  of  EU-27  —  as  a  whole  and  across  countries,  sectors  and 
(such  as 
technologies.  R&D-intensive  European 
pharmaceuticals,  cosmetics  or  semiconductors)  tend  to  have  a  somewhat  higher  level  of 
outward internationalisation. 

firms,  sectors  and 

technologies 

Foreign-owned  firms 
companies...  

innovate  differently 

in  the  EU  than  domestically  owned 

Foreign-owned firms tend to have lower innovation input intensities than domestically owned 
companies, but achieve similar innovation outputs. This suggests that the innovation efforts of 
foreign-owned  firms  are  based  to  a  considerable  degree  on  knowledge  and  technologies 
received from the group or parent company. Many of the differences between foreign-owned 
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and domestically owned firms can  be explained by related  firm characteristics, e.g. foreign-
owned  firms  are  larger,  have  higher  absorptive  capacities,  or  operate  more  often  in 
technology-intensive sectors. 

Cooperation with domestic partners, in particular domestic research organisations (including 
universities),  is  common  among  foreign-owned  firms,  a  sign  of  their  embeddedness  in  the 
host countries’ innovation systems and of potential spillover effects. Foreign-owned firms can 
act as agents of international technology diffusion and as links between organisations in the 
host country and foreign sources of knowledge. 

…but both groups of firms contribute to productivity growth and employment creation 

Foreign-owned  firms  have  significantly  higher  productivity  levels  (measured  by  sales  per 
employee) than domestically owned companies. They also show higher levels of productivity 
growth, though differences in relation to domestically owned firms are considerably smaller 
and less significant here. Productivity growth of foreign-owned companies is mainly related 
to  output  growth  of  old  products  and  the  effects  of  product  innovation,  but  not  process 
innovation.  There  are  no  major  differences  between  foreign-owned  firms,  domestic  group 
enterprises and domestic unaffiliated firms in the way innovation affects productivity levels. 

Foreign-owned  companies  also  differ  from  domestically  owned  firms  in  the  way  they 
transform  new  technologies  into  employment  growth.  General  productivity  increases  as  a 
result of job cuts are on average compensated by the employment-creating effects of higher 
sales  from  old  products  and  product  innovation  in  the  foreign-owned  firms.  Together,  these 
effects result in net employment growth in foreign-owned companies. 

5. European competitiveness in key enabling technologies 

Because  they  can  generate  new  growth,  spur  innovation,  increase  productivity,  help  tackle 
environmental  and  climate  challenges,  and  give  rise  to  new  applications,  key  enabling 
technologies  are  attracting  growing  interest,  and  the  importance  of  staying  competitive  in 
these technologies cannot be overstated. 

in  six  key  enabling 

Trends 
technologies  (KETs)  —  nanotechnology,  micro  and 
nanoelectronics  (including  semiconductors),  industrial  biotechnology,  photonics,  advanced 
materials,  and  advanced  manufacturing  technologies  —  are  reviewed  from  a  variety  of 
perspectives: (i) state of development, (ii) existing and future applications, (iii) current market 
volume  and  future  potential,  and  (iv)  European  competitiveness  in  comparison  with  North 
America, East Asia and the rest of the world. 

There  is  considerable  uncertainty  about  how  fast  the  markets  for  applications  of  the  six 
technologies  —  nanotechnology  in  particular  —  will  grow  in  the  medium  term.  A 
contributing  factor  to  the  uncertainty  is  that there  are  no  agreed  definitions  of  key  enabling 
technologies. A broad definition is likely to lead to a more optimistic assessment of potential 
market  volume  than  a  more  narrowly  defined  technology.  With  this  in  mind  it  is  hardly 
surprising  that  the  potential  market  for  key  enabling  technology  applications  in  2015  (as 
reflected in the literature) covers a very wide range. 

Most  applications  of  key  enabling  technologies  are  still  at  a  conceptual  or  pre-competitive 
stage, and it is not possible to use market data to assess how competitive Europe is compared 
with the rest of the world. Instead, patent data analysis and a number of case studies are used 
to analyse Europe’s competitiveness in these areas. 

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Strong  European  position  in  advanced  manufacturing  technologies  and  industrial 
biotechnology 

The  overall  conclusion  is  that  European  producers  of  KETs  are  well  placed  in  all  six 
technologies,  representing  between  a  quarter  and  half  of  all  patent  applications  analysed. 
Europe is the world leader in advanced manufacturing technologies and shares the lead with 
North  America  in  industrial  biotechnology.  In  photonics,  nanotechnology  and  micro  and 
nanoelectronics, Europe contributes less to total output than North America and East Asia. 

Europe  is  in  principle  holding  its  position  in  all  six  technologies.  In  recent  decades  it  has 
neither lost nor gained ground, despite increasing competition from  East Asia, which in  the 
past  decade  has  made  great  strides  in  most  of  the  technologies.  At  the  same  time  the 
contribution  of  North  America  to  global  technology  output  has  gradually  diminished. 
Germany  is  the  main  producer  of  key  enabling  technology  patents  in  the  EU,  followed  by 
France and the United Kingdom. 

Importance of skills, venture capital and of maintaining a manufacturing base 

Maintaining a strong European manufacturing base in each key enabling technology is critical 
if  the  EU  is  to  benefit  fully  from  productivity  and  innovation  effects.  Direct  interaction 
between research and development, manufacture and application in user industries is needed 
if new fields of application are to emerge and good facilities for new technologies are to be 
developed. 

KET  research  is  often  at  the  cutting  edge  of  technology.  Complex  technologies  and  new 
technological challenges have to be addressed. In such a context progress depends on bringing 
together  different  scientific  disciplines  and  fields  of  technology  in  a  joint  endeavour.  More 
coordination  is  needed  between  research  and  industry,  going  beyond  any  coordination  by 
market mechanisms. Providing incentives for networking and clustering can help to achieve 
this.  In  some  areas  global  networks  of  the  leading  organisations  from  research  and  industry 
are ideal; elsewhere regional networks (clusters) can spur technology development. Clusters 
can be particularly helpful in linking research and commercial applications. Best practices for 
facilitating  the  flow  of  knowhow,  ideas  and  personnel  between  industry  and  research 
institutions should be circulated between and within Member States. 

With  Europe  facing  a  likely  shortage  of  skilled  labour,  promoting  higher  education  and 
training  in  KETs  will  be  essential.  Strengthening  cross-disciplinary  education  is  a  main 
challenge in that context. Higher education institutions need to offer curricula that are better 
geared  to  meeting  the  specific  demands  of  KETs.  Students  need  to  be  made  aware  of  the 
career  opportunities  offered  by  cross-disciplinary  studies.  Education  and  training  may  be 
complemented by immigration policies to address the shortage of skilled personnel. 

Venture capital markets are important for commercialising research results in KETs through 
spin-offs and other types of start-ups. To work, venture capital needs a supportive regulatory 
environment, and public programmes may need to step in to address any failures by European 
private  venture  capital  markets  to  provide  sufficient  funds  for  start-up  and  early-stage 
financing. 

The role of regulation 

In some KETs there is a particular focus on health, environment and safety issues. Cases in 
point  are  nanotechnology,  industrial  biotechnology  and  advanced  materials.  Procedures, 
standards and implementation tools (e.g. test methods and guidance documents) are needed to 
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deal  with  health,  safety  and  environmental  issues  and  to  provide  incentives  for  further 
technological  advances  and  innovative  dynamics.  Legislation  has  to  be  flexible  enough  to 
adjust to technological progress within each KET. 

Industrial  standardisation,  intellectual  property  rights,  and  enabling  and  promoting  spin-offs 
are  of  critical  importance  to  the  transfer  of  technology.  All  in  all,  an  integrated,  coherent 
policy approach is required if KETs are to increase productivity and wealth. This should bring 
in  regional,  national  and  international  levels  and  the  various  policy  domains,  including 
research, innovation, education, competition, industry, taxation, health and environment. 

6. Innovation and competitiveness of the creative industries in the EU 

The  creative  industries  have  large  growth  potential.  A  survey  in  the  EU  Member  States  in 
early  2010  found  that  more  than  97 %  of  respondents  thought  the  creative  industries  were 
‘important’  or  ‘very  important’  in  supporting  innovative  activities,  encouraging  economic 
growth and creating new jobs. Creative industries are at the crossroads between arts, business 
and  technology.  They  range  from  information  services,  such  as  publishing  or  software,  to 
professional  services  like  architecture,  advertising  or  design2.  Creative  industries  are  among 
the  fastest  growing  sectors  in  the  EU,  creating  new  jobs,  playing  key  roles  in  global  value 
chains, and spurring innovation.  

Creative industries are increasingly a source of growth in the EU 

Creative  industries  account  for  3.3 %  of  total  EU  GDP  and  3 %  of  employment,  and  are 
among the most dynamic sectors in the EU. Though employment growth was uneven across 
subsectors, overall employment in the creative industries increased by an average of 3.5 % a 
year  in  2000-2007,  compared  to  1.0 %  a  year  for  the  EU  economy  as  a  whole.  Software 
consulting accounted for more than half of creative industries’ employment growth in the EU-
27 in 2000–2007. Indeed, the employment growth rate for software consultancy in the EU-27 
was  about  5.2 %  per  year  on  average  in  2000-2007.  Within  software  publishing,  the  video 
games industry is one of the fastest growing industries worldwide. The Baltic states and other 
new  Member  States  have  the  highest  annual  employment  growth  rates  in  the  creative 
industries.  Among  the  EU-15  countries,  Portugal  and  Ireland  report  a  higher  than  average 
increase. The fast growth of the creative industries in the EU is partly due to catching up in 
the  less  developed  EU  countries.  Demand  factors  and  a  strong  entrepreneurial  culture  are 
further  job  creation  factors.  Creative  industries  are  dominated  by  micro-firms  (95 %  have 
fewer  than  ten  employees)  co-existing  with  very  large  corporations.  They  typically  include 
large shares of self-employed and highly skilled professionals.  

The increasing importance of skills and creativity in the EU job market is clearer when one 
looks  at  professions  that  are  ‘creative’  in  essence,  regardless  of  whether  they  belong  to  the 
‘creative  industries’  proper  or  to  more  traditional  activities.  Occupations  considered  as 
‘creative’  include  for  example  professions  such  as  mathematicians  or  engineers,  along  with 
writers, creative and performing artists and artistic or entertainment professions. What they all 
have  in  common  is  that  they  produce  intangible  assets  such  as  ideas,  knowledge  and 
information  that  increase  firms’  value  added.  In  the  EU-15,  creative  occupations  grew  at 
around 3 % per year on average between 2002 and 2008, with the highest growth for artistic, 

2   The concept of creative industries is very close to another concept of creative and cultural industries used in 
industries’: 

the 
http://ec.europa.eu/culture/our-policy-development/doc2577_en.htm. 

paper  —  Unlocking 

potential 

creative 

cultural 

‘Green 

and 

the 

of 

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entertainment  occupations  (5.7 %),  followed  by  social  science  and  related  professionals 
(5.0 %),  and  architects,  engineers  and  computing  professionals  (each  3.2 %).  Creative 
occupations are growing within and outside the creative industries, indicating that creativity is 
spreading to other sectors. Similar trends can be observed for the new Member States (though 
fewer data are available here). 

New empirical evidence is given on how the creative industries strengthen regional growth. 
Recent findings at the regional level for ten EU countries show that the creative industries had 
a  positive  and  significant  effect  on  the  growth  rate  of  local  GDP  per  capita  in  2002-2007. 
However, in terms of  the  related  but  different concept of ‘creative occupations’, there is no 
consensus on the impact of the creative workforce on regional growth.  

Though there are not many tradable creative services, the EU’s position on the global markets 
is  bolstered  by  the  most  tradable  parts  of  the  creative  sectors.  Europe  is  one  of  the  world's 
leading  exporters  of  creative  industries  products.  There  was  an  increase  in  the  revealed 
comparative advantage of the EU in publishing, music records, audiovisuals (film), and most 
notably in the new media (digital records) — with strong growth in video games.  

Creative industries stand out because of their propensity for innovation 

Some creative industries are among the most potentially innovative of all EU sectors. Firms in 
software  consultancy  and  supply  are  the  most  innovative  of  the  service  industries.  The 
architecture and advertising industries have a higher than usual share of firms introducing new 
or significantly improved services.  

Creative industries are not only innovators themselves but have also been an important driver 
for innovation. As far as supply chain relationships are concerned, they account for increasing 
inputs  in  the  development  of  other  sectors.  A  creative  industry  like  industrial  design 
contributes substantially to the production process and product design innovations of several 
manufacturing  industries,  such  as  chemicals  and  pharmaceuticals,  minerals,  glass  and 
ceramics, motor vehicles and tobacco. Conversely, some creative industries are major users of 
new technologies, playing a key role in stepping up the spread of technological innovations. 
Outside the ICT sector itself, publishing and software firms were among the earliest users of 
the internet and e-business practices.  

Reinforcing the growth and innovation potential of creative industries: action needed! 

Creative industries tend to be small-scale organisations, which makes them natural candidates 
for  small-business  policies.  They  tend  to  be  more  prone  to  rationing  of  funding,  and  many 
sub-markets of the creative industries urge the authorities to provide for a level playing-field 
of  competition.  Certain  creative  sectors  may  justify  consideration  for  targeted  approaches 
because  of  their  public  utility  aspect.  They  do  a  lot  to  generate  innovation  and  build 
knowledge. Under-investment must therefore be avoided. Appropriate education and training 
are also essential to provide the sector with the skills it needs to grow.  

More coordination, networking and sharing of best practices will enable all creative industries 
and occupations to optimise their growth prospects and contribute to the economy as a whole. 
EU policies can help in the dissemination of best practice. 

Ultimately, the impact of the creative industries is not only economic and thus calls for more 
than national or local action. While the welfare effects are difficult to quantify, it is clear that 
some of the creative industries facilitate structural adjustment in declining regions. They can 
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boost  social  cohesion  and  get  the  less  well-off  more  involved  in  cultural  activities.  Where 
concerted and coordinated action would increase the economic and social impact of creative 
industries, the EU can play a role. EU prerogative areas such as intellectual property rights or 
the  single  market  for  services  are  the  bedrock  of  creative  industries.  A  recent  Amsterdam 
declaration on the ‘European Creative Industries Alliance’ and a Green Paper3 on cultural and 
creative industries are some recent initiatives on competitiveness and innovation in this sector. 

7. Conclusions 

The  present  edition  of  the  European  Competitiveness  Report  2010  examines  the  potential 
impact of the boom years on competitiveness. The accumulation of large imbalances has the 
potential  to  distort  significantly  the  allocation  of  resources  in  our  economies.  However,  a 
glance at the evidence shows that exports performance does not seem to have been severely 
affected  by  these  developments.  As  for  productivity  growth,  construction  and  real  estate 
activities have attracted much investment in countries affected by housing bubbles; there is no 
obvious  impact  on  aggregate  productivity  so  far  but  these  distorted  investments  have  the 
potential  to  hamper  the  ability  of  affected  countries  to  generate  income  in  the  future  to 
compensate the interest burden. 

Nonetheless,  the  financial  and  economic  crisis  hit  international  trade  in  intermediate  goods 
(especially  parts  and  components)  quite  hard,  accounting  for  something  like  50%  of  all 
international trade. It also disrupted some of the established international supply chains (e.g. 
in  the  automotive  industry)  and  resulted  in  some  changes  to  multinational  corporations' 
sourcing strategies, such as shifting to domestic suppliers. If confirmed, this may have longer-
term  consequences  —  by  at  least  temporarily  restricting  the  internationalisation  of  certain 
companies’ activities, and perhaps by delaying the recovery in some industries.  

EU  firms’  R&D  and  innovation  activities,  especially  in  high-tech  industries,  are  still 
predominantly domestic, but are becoming increasingly internationalised, as the need to adapt 
products  to  foreign  markets  brings  product  development  closer  to  local  markets.  Firms' 
location decisions are also increasingly based on the provision of strategic resources, such as 
ensuring access to scientific  and  technological capabilities and to human capital. A detailed 
analysis of a specific high-tech product) shows that the value captured has little to do with the 
physical  flows  of  goods  within  the  supply  chain:  major  parts  of  the  value  are  attributed  to 
design, R&D, brand, marketing, distribution and management. This shows how important it is 
to keep a strong grip on these activities. 
Maintaining  and  developing  a  position  of  maximum  strength  for  the  EU  and  the  Member 
States  in  the  inward  and  outward  cross-border  flows  of  R&D&I  is  crucial  to  keep  the  EU 
economies competitive and dynamic in the medium and long term. Inward foreign research, 
development and innovation offer great potential for the transfer and diffusion of knowledge 
and  innovation  across  all  business  sectors.  They  can  complement  EU  homegrown  activities 
and help to catch up R&D&I in certain sectors and technologies; they can help achieving a 
critical  mass  and  agglomeration  of  these  capacities  in  certain  areas  and  countries;  and  they 
may help to smooth and sustain a steady R&D&I effort in times of crisis. Key policies and 
measures  for  maintaining  and  attracting  new  R&D&I  )  include:  enhancing  the  quality  of 
Science  and  Technology  (S&T)  bases  and  the  mobility  of  researchers  and  S&T  personnel; 
widening  the  scope  and  tightening  up  the  enforcement  of  Intellectual  Property  Rights, 
including  the  competitiveness  and  efficiency  of  the  patenting  system;  promoting  R&D&I 

3  

‘Green paper — Unlocking the potential of cultural and creative industries’: http://ec.europa.eu/culture/our-
policy-development/doc2577_en.htm. 

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partnerships  and  consortiums — open to foreign (intra and extra-EU) business  and research 
organisations  —  fostering  competition  and  cooperation,  integration  and  spillovers  into  EU 
innovation systems; promoting an international regulatory dialogue and a level playing-field 
in public R&D&I support measures; and adopting proactive standards and public procurement 
policies  with  a  view  to  developing  a  dynamic  single  market  for  research,  development  and 
innovation in the EU. There may well be considerable benefits for firms, the EU’s innovation 
systems and the economy as a whole from outward R&D&I flows by EU firms, in particular 
SMEs.  Potential  benefits  include  opening  up  and  seizing  opportunities  in  new  and  fast 
growing  markets,  adapting  innovative  products  to  local  requirements  and  preferences,  and 
gaining access to foreign sources of knowledge which are of strategic importance for certain 
businesses. 
The  European  producers  of  key  enabling  technologies  seem  to  be  well  placed  in  the 
international arena, and Europe is in principle in a strong position in all six identified KETs. 
KET  research  is  often  at  the  technological  frontier.  However,  more  coordination  between 
research  and  industry  is  needed,  over  and  above  the  coordinating  effect  of  market 
mechanisms. Incentives for networking and clustering can be helpful. Best practices should be 
disseminated between and within the Member States. Promoting higher education and training 
will be essential to secure a supply of skilled personnel. In addition, venture capital markets 
are  needed  to  commercialise  the  results  of  KETs,  and  they  in  turn  need  a  supportive 
regulatory  environment.  Public  programmes  may  be  needed  to  provide  additional  funds  for 
start-up and early-stage financing. 

Creative  industries  have  great  potential  for  reinforcing  economic  growth  and  creating  new 
jobs. They have long been among the fastest growing sectors in the EU; they play a key role 
in global value chains, and they spur innovation. Moreover, creative occupations are growing 
within  and  outside  the  creative  industries,  i.e.  creative  professions  are  spreading  to  other 
sectors. The EU is one of the world's leading exporters of creative industries’ products. Their 
importance,  however,  is  not  purely  economic  —  they  can  facilitate  structural  adjustment  in 
declining  regions  and  do  a  lot  to  enhance  social  cohesion  and  inclusion.  EU  policies  can 
therefore  play  a  role  in  strengthening  intellectual  property  rights  and  the  single  market  for 
services. The creative industries must be brought into the scope of SME policies; they need 
access to proper financing facilities and creative companies need to be helped to grow. 

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INTRODUCTION 

This is the thirteenth edition of the Commission’s European Competitiveness Report since the 
1994  Industry  Council  Resolution,  which  called  on  the  Commission  to  report  annually. 
Competitiveness is taken here to mean a sustained rise in the standard of living of a nation or 
region and as low a level of involuntary unemployment as possible. For an industrial sector, 
the  main  competitiveness  criterion  is  maintaining  and  improving  its  position  in  the  global 
market. 

As in previous years, the Report approaches the issues using insights from economic theory 
and  empirical  research,  and  its  ambition  is  to  contribute  to  policy-making  by  drawing 
attention  to  trends  and  developments  and  by  discussing  policy  options.  Its  main  subjects 
continue  to  be  related  to  productivity,  this  being  the  most  reliable  indicator  for 
competitiveness over the longer term, and other microeconomic issues underpinning the EU’s 
future economic developments, in particular its Europe 2020 strategy. 

Chapter 1 presents a snapshot of recent economic developments in a period of financial and 
economic  crisis  and  the  beginning  of  recovery.  In  addition,  the  boom  period  2000-07  is 
explored in order to analyse its likely impact on European competitiveness.  

Chapter 2 analyses trade in intermediate products and EU manufacturing supply chains with a 
view to shedding light on the relative importance of trade in intermediates in overall EU-27 
trade and in individual countries. The questions addressed in this chapter include: what is the 
share  of  these  products  in  overall  trade  in  exports  and  imports,  what  are  the  changes  over 
time,  and  what  factors  are  driving  these  changes  and  the  geographical  structure  of  trade  in 
intermediate goods? There is also a case study from the high-tech area, which addresses the 
issue of who 'captures' the value of the production process. Finally it examines the extent to 
which  trade  in  intermediaries  has  been  affected  by  the  economic  crisis  (including  a 
comparison with other product categories) and how the crisis has affected EU manufacturing 
supply chains. 

The issue of foreign corporate research and development and its impact on innovation in the 
European  Union  is  addressed  in  chapter  3.  The  aim  is  to  study  why  firms  internationalise 
R&D and innovation; analyse R&D&I activities of foreign-owned firms in the EU by sector, 
country and technology; and examine the activities of EU firms outside the European Union. 
The chapter also investigates whether — and how — foreign-owned and domestically owned 
firms differ in their innovation behaviour and how they transform innovation into productivity 
and employment growth. 

Chapter 4 on key enabling technologies (KETs) discusses their role in increasing wealth by 
boosting innovation and raising productivity, and the performance of Europe (firms as well as 
public  institutions)  in  producing  new  technology  compared  to  the  main  competing  regions 
(North  America  and  East  Asia).  The  analysis  looks  at  the  industrial  sectors  and  fields  of 
application that are most affected by different KETs, what their likely medium-term growth 
potential is, and which factors are likely to drive technological and commercial success. 

The  main  objective  of  chapter  5  is  to  give  a  comprehensive  picture  of  the  innovation 
performance and competitiveness of the creative industries, along with their relative size and 
economic  performance  in  the  EU-27  countries.  It  explores  what  drives  creative  industries 
growth  and  their  impact  in  the  wider  economy  in  different  forms:  direct  contribution  to  the 
economy  (employment  and  some  output  measures);  spillovers  into  the  wider  economy;  the 
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direct,  but  less  quantifiable,  contributions  of  the  creative  industries  to  innovation;  and  their 
role in improving the quality of life. The scope and opportunities for policy intervention are 
then explored. 

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1. 

GROWING IMBALANCES AND EUROPEAN INDUSTRY 

1.1  The crisis as a major adjustment 

With  the  exception  of  the  2001  slowdown,  the  period  1995-2006  was  one  of  remarkable 
stability for the industrialised countries. In the EU in particular, it was a period of sustained 
growth,  more  people  in  employment,  and  higher  income  per  capita.  In  some  countries, 
though, stability concealed the accumulation of significant disequilibria that in 2008 brought 
on a global recession of a severity unseen since the Oil Shocks in the 1970s. 

1.1.1  A big recession 

Individual countries had experienced similar recessions in the recent past but this recession is 
unusual  for  its  combination  of  a  big  drop  in  economic  activity  and  its  global  nature:  most 
countries in the world were touched in one way or another. In the EU, with the sole exception 
of  Poland,  all  Member  States  saw  their  production  fall:  from  around  3%  in  Belgium  and 
France to double-digit drops for Ireland and the Baltic republics. Latvia suffered the biggest 
contraction: 26% drop in GDP compared with its peak value in 2007. 

Figure 1.1. The magnitude of the contraction: real GDP current (bars) 

and maximum (dots) drop with respect to peak* 

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Source: Eurostat, Quarterly National Accounts. 

While  most  countries  emerged  from  the  trough  in  2010,  none  of  them,  again  with  the 
exception of Poland, recovered to the level of real GDP they had in 2007. The varied picture 
showed in Figure 1.1 reflects differing patterns during the boom period 2000-07. As will be 
discussed below, several Member States were affected by large speculative bubbles and were 
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afterwards  hit  hard  by  the  ensuing  readjustment;  countries  not  suffering  from  these  asset 
pricing  distortions  were  quickly  affected  by  contagion  —  through  international  trade  and 
through  problems  in  the  international  supply  chain;  this  is  particularly  true  of  many  of  the 
new Member States. 

1.1.2  Sudden drop and slow recovery in the labour market 

With  a  few  exceptions,  in  the  boom  years,  i.e.  the  period  from  2000  to  2007,  the 
unemployment  rate  fell  in  most  European  countries.  For  some,  however,  the  crisis  reversed 
the  situation  within  a  few  quarters,  and  they  now  have  significantly  higher  unemployment 
rates. The experience of previous recessions is that employment takes something like two to 
four times the length of the recession to return to its earlier level4. So with this rule of thumb, 
employment is expected to remain below its peak level for one to four years in the EU. 

Figure 1.2. Breakdown of unemployment in 2009 

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The  lower  value  indicates  the  lowest  rate  of  unemployment  (civilian  labour  force)  in  2007  or  2008;  the 
stacked bar is the rise over this initial low value up to 2009. 

Source: AMECO database, European Commission.  

Needless  to  say,  the  experience  across  Member  States  is  quite  uneven,  and  depends  on 
institutional arrangements that vary considerably across the EU. Not surprisingly, the scale of 
job cuts and the increase in unemployment was particularly sizeable in the countries hardest 
hit (e.g. the Baltic republics, Ireland and Spain). Given the magnitude of the recession, other 
countries, notably Germany, experienced only modest losses in employment. The unevenness 
of performance reflects the nature of the recession as well as labour market institutions. For 
instance,  when  employers  regard  demand  shocks  as  temporary,  they  tend  to  smooth  their 
labour responses5; this appears to be the case with Germany, which was affected primarily by 
the collapse in global trade. In contrast, large labour changes and reorganisations are the best 
response to permanent demand shocks that involve large sectoral restructuring; this appears to 

4   See  the  discussion  in  section  1.2  in  European  Competitiveness  Report  2009  or  European  Commission 
(2009a). 
5   Section 1.4 in European Competitiveness Report 2009. 
18

EN 

EN 

 
 
 
 
 
 
 
                                                 
be  the  case  in,  say,  Spain  and  Ireland,  both  of  which  had  major  problems  with  a  housing 
bubble.  

In  the  midst  of  such  a  crisis,  and  over  and  above  the  issue  of  recovery,  it  is  reasonable  to 
wonder  about  the  impact  on  economic  performance  in  the  medium  to  long  term.  The 
European  Competitiveness  Report  2009  examined  the  potential  impact  of  the  recession  on 
long-term productivity growth; all in all, the conclusion was that the recession need not have a 
negative impact on the rate of technical change in the years to come; for a recession includes 
two  types  of  mechanisms:  those  that  impinge  negatively  on  economic  efficiency,  but  also 
those  that  improve  our  ability  to  increase  productivity  in  the  future.  Furthermore, 
understanding those mechanisms make it possible to design economic policies to tone down 
the negative and amplify the positive effects6 in order to avoid a slow recovery followed by an 
era of sluggish growth7.  

Figure 1.3. GDP, employment and productivity growth rates in the EU-27 

GDP

Employment

Productivity

e

t

t

a
r
h
w
o
r
g
%

r
a
e
y
-
o

t
-
r
a
e
y

6

5

4

3

2

1

0

-1

-2

-3

-4

-5

-6

1
Q
0
0
0
2

2
Q
0
0
0
2

3
Q
0
0
0
2

4
Q
0
0
0
2

1
Q
1
0
0
2

2
Q
1
0
0
2

3
Q
1
0
0
2

4
Q
1
0
0
2

1
Q
2
0
0
2

2
Q
2
0
0
2

3
Q
2
0
0
2

4
Q
2
0
0
2

1
Q
3
0
0
2

2
Q
3
0
0
2

3
Q
3
0
0
2

4
Q
3
0
0
2

1
Q
4
0
0
2

2
Q
4
0
0
2

3
Q
4
0
0
2

4
Q
4
0
0
2

1
Q
5
0
0
2

2
Q
5
0
0
2

3
Q
5
0
0
2

4
Q
5
0
0
2

1
Q
6
0
0
2

2
Q
6
0
0
2

3
Q
6
0
0
2

4
Q
6
0
0
2

1
Q
7
0
0
2

2
Q
7
0
0
2

3
Q
7
0
0
2

4
Q
7
0
0
2

1
Q
8
0
0
2

2
Q
8
0
0
2

3
Q
8
0
0
2

4
Q
8
0
0
2

1
Q
9
0
0
2

2
Q
9
0
0
2

3
Q
9
0
0
2

4
Q
9
0
0
2

1
Q
0
1
0
2

Source: Eurostat. 

The present edition of the European Competitiveness Report examines the potential impact of 
the boom years on competitiveness. The abovementioned accumulation of serious imbalances 
has a potential to significantly distort the way resources are used in our economies, and hence 
on productivity growth in the years to come. 

6   For  instance,  the  Product  Market  Review  2009  (European  Commission  (2009b))  examines  the  negative 
impact of the crisis on R&D (section 4.1) and, accordingly, discusses policy measures that attempt to tone down 
the potentially negative impact (section 4.2).  
7   European Commission (2009a) discusses the possible impact of the crisis on potential output and a scenario 
with lower permanent growth rates is not ruled out. 

EN 

19

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Box 1.1. Competitiveness and external competitiveness 
Competitiveness  refers  to  the  overall  economic  performance  of  a  nation  measured  in 
terms of its ability to provide its citizens with growing living standards on a sustainable 
basis and broad access to jobs for those willing to work. In short, competitiveness refers 
to  the  institutional  and  policy  arrangements  that  create  the  conditions  under  which 
productivity  can  grow  sustainably  (productivity  growth  is  the  only  source  of  sustained 
income growth, in turn the backbone of growing living standards). 

to 

international 

When  applied 
trade,  however,  competitiveness,  or  external 
competitiveness,  may  convey  a  different  more  specific  meaning.  Unless  otherwise 
stated, in this chapter external competitiveness refers to the ability to export goods and 
services  in  order  to  afford  imports,  and  hence  it  will  be  summarized  by  world  market 
shares (the share of exports in total exports). 

1.2  The years before the crisis 

The period preceding the crisis was characterised by remarkable stability: steady income 
growth, low inflation, and growing employment. 

1.2.1  Aggregate trends and the crisis 

Table  1.1  sets  out  average  annual  growth  rates  for  the  five-year  intervals  1996-2000  and 
2001-2005, and for the years 2006, 2007, 2008 and 2009. As mentioned, the unprecedented 
fall  in  GDP  per  capita  in  2009  was  somewhat  uneven,  but  all  EU  countries  were  affected, 
reflecting the severity and dire consequences of the economic and financial crisis. The GDP 
per  capita  fall  was  particularly  sizeable  in  some  of  the  EU-12  countries  (particularly  in  the 
Baltic republics, ranging from -13.6 % in Estonia to -17.5 % in Latvia and Lithuania, but also 
in  Hungary,  Romania  and  Slovenia,  at  -6 %  to  -9 %),  thus  wiping  out  part  of  their  previous 
performance and catching-up achievements within the EU. Some of the EU-15 countries were 
also  severely  hit,  such  as  Ireland  and  Finland  (with  a  GDP  per  capita  fall  of  8 %  and  7.3 % 
respectively. 

EN 

20

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Table 1.1. Real GDP per capita growth and GDP level in PPS 

Annual growth rate of GDP per capita1) 

1996-20002) 
2.64 
-0.21 
1.60 
2.44 
1.88 
7.19 
8.44 
2.91 
3.65 
2.36 
1.87 
2.49 
6.34 
5.20 
4.70 
4.25 
3.88 
3.43 
2.82 
5.42 
3.68 
-1.00 
4.35 
3.25 
4.54 
3.23 
3.13 
2.57 
2.70 
3.15 

2001-20052) 
1.14 
6.66 
3.82 
0.95 
0.53 
8.32 
3.64 
3.72 
1.73 
0.93 
0.31 
1.42 
8.86 
8.32 
2.37 
4.49 
0.33 
0.82 
1.04 
3.13 
0.25 
6.50 
3.57 
4.97 
2.24 
2.19 
2.03 
1.12 
1.43 
1.45 

2006 
2.10 
6.59 
6.47 
3.00 
3.29 
10.18 
2.76 
4.10 
2.44 
1.53 
1.46 
2.15 
12.85 
8.49 
3.92 
4.13 
2.65 
3.24 
2.85 
6.31 
1.03 
8.07 
5.44 
8.42 
4.50 
3.66 
2.26 
2.43 
2.77 
1.72 

2007 
2.18 
6.17 
5.55 
1.22 
2.59 
7.39 
3.50 
4.06 
1.70 
1.72 
0.82 
2.93 
10.55 
10.44 
4.83 
1.12 
3.10 
3.38 
3.13 
6.83 
1.64 
6.55 
6.22 
10.31 
3.76 
1.81 
1.91 
2.03 
2.39 
1.15 

BE 
BG 
CZ 
DK 
DE 
EE 
IE 
EL 
ES 
FR 
IT 
CY 
LV 
LT 
LU 
HU 
MT 
NL 
AT 
PL 
PT 
RO 
SI 
SK 
FI 
SE 
UK 
EU-15 
EU-27 
US 

2008 
1.04 
6.01 
1.41 
-1.78 
1.43 
-3.47 
-4.91 
1.61 
-0.73 
-0.14 
-1.80 
2.65 
-4.13 
3.30 
-1.73 
0.82 
1.61 
1.61 
1.70 
5.00 
-0.17 
6.45 
2.39 
6.14 
0.58 
-0.92 
-0.06 
-0.02 
0.32 
-0.50 

2009 
-3.58 
-5.40 
-5.46 
-4.72 
-4.88 
-13.62 
-7.96 
-1.54 
-4.92 
-2.65 
-5.20 
-1.67 
-17.57 
-17.54 
-4.85 
-6.38 
-2.97 
-4.93 
-4.03 
1.21 
-3.07 
-7.79 
-7.04 
-5.90 
-7.27 
-5.05 
-5.21 
-4.56 
-4.46 
-3.34 

2009 GDP per 
capita 
(in pps; EU-
27=100)3) 

114.9 
41.2 
80.5 
117.4 
116.2 
62.0 
131.1 
94.8 
103.3 
107.4 
101.7 
98.3 
48.6 
53.2 
268.0 
63.0 
77.6 
129.9 
123.6 
60.8 
78.3 
45.3 
86.1 
71.6 
110.5 
120.4 
116.4 
110.6 
100.0 
147.3 

1) GDP per capita is measured in 2000 prices; 2) Geometric Average; 3) PPS stands for Purchasing Power 
Standards. 

Source: AMECO database, European Commission. 

Table 1.1 shows that in 2009 employment contracted less in the EU-27 (-2 %) than in the US 
(-3.5 %),  reflecting  the  lower  responsiveness  of  EU  labour  markets.  The  crisis  also  has  the 
potential to affect labour supply in the short and  medium  term,  by  changing  either  the  total 
population (e.g. via reduction of immigration flows) or the participation rates. On one hand, 
recessions  tend  to  discourage  labour  entry  (e.g.  young  people  may  decide  to  stay  longer  in 
full-time  education)  and  encourage  exit  (early  retirement  for  older  workers).  On  the  other 
hand,  households  affected  by  significant  income  reductions  may  delay  retirement  decisions, 
and  formerly  inactive  household  members  may  seek  to  enter  the  labour  force,  particularly 
when  labour  markets  are  flexible  and  the  recovery  starts  to  generate  new  job  opportunities. 
The participation rate in the EU-27 has indeed fallen from 65.9% in 2008 to 64.6% in 2009 

EN 

21

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(roughly  the  level  attained  in  2006  and  2007).  The  participation  of  young  workers  (15-24) 
appears to have accentuated its declining trend in 20098.  

Table 1.2. Annual growth rate of employment1) 

1996-2000 

2001-2005 

2006 

2007 

2008 

BE 
BG 
CZ 
DK 
DE 
EE 
IE 
EL 
ES 
FR 
IT 
CY 
LV 
LT 
LU 
HU 
MT 
NL 
AT 
PL 
PT 
RO 
SI 
SK 
FI 
SE 
UK 
EU-15 
EU-27 
US 

1.22 
-0.26 
-0.82 
1.02 
0.81 
-2.03 
5.72 
0.55 
3.88 
1.40 
0.98 
1.24 
-0.54 
-1.12 
4.13 
1.26 
0.75 
2.55 
0.92 
-0.37 
2.11 
-1.89 
-0.29 
-0.79 
2.27 
0.82 
1.26 
1.47 
1.01 
1.78 

0.71 
1.53 
0.21 
0.05 
-0.16 
1.10 
2.91 
1.35 
3.26 
0.64 
1.25 
3.08 
1.66 
0.86 
3.13 
0.23 
0.83 
0.33 
0.68 
-0.61 
0.28 
-1.35 
0.36 
0.58 
0.86 
0.22 
0.93 
0.86 
0.65 
0.68 

1.19 
3.34 
1.94 
1.99 
0.62 
5.38 
4.30 
2.03 
3.92 
0.98 
1.96 
1.76 
4.70 
1.83 
3.64 
0.73 
1.31 
1.70 
1.40 
3.21 
0.51 
0.69 
1.50 
2.29 
1.76 
1.69 
0.87 
1.49 
1.63 
1.87 

1.63 
2.82 
2.66 
2.69 
1.66 
0.75 
3.56 
1.36 
3.02 
1.35 
1.24 
3.25 
3.58 
2.78 
4.42 
-0.10 
3.18 
2.60 
1.80 
4.43 
-0.03 
0.36 
2.98 
2.12 
2.21 
2.16 
0.68 
1.60 
1.78 
1.10 

1.88 
3.27 
1.55 
0.83 
1.40 
0.17 
-0.82 
0.11 
-0.61 
0.53 
0.32 
2.63 
0.74 
-0.48 
4.71 
-1.19 
2.42 
1.44 
1.76 
3.78 
0.44 
0.28 
2.87 
2.94 
1.61 
0.91 
0.73 
0.70 
0.95 
-0.44 

2009 

-0.84 
-2.03 
-2.03 
-2.61 
-0.30 
-8.98 
-7.79 
-0.91 
-6.63 
-1.77 
-1.13 
-0.35 
-11.86 
-8.25 
1.09 
-2.99 
-0.61 
-0.11 
-1.47 
-0.70 
-2.29 
-3.28 
-2.59 
-2.04 
-2.87 
-2.22 
-1.97 
-1.92 
-2.03 
-3.53 

1) Employment in persons; all domestic industries (National accounts); 2) Geometric Average. 

Source: AMECO database, European Commission. 

Labour productivity in the EU-27 appears to be recovering faster than GDP (see Figure 1.3) 
due  to  the  adjustment  lags  of  employment.  Table  1.3  shows  a  substantial  variation  in 
measured labour productivity across countries, reflecting the patchy nature and the magnitude 
of economic shocks, flexibility and response in labour and market  adjustments, the stage in 
the business cycle, the strength of the recovery, etc.  

8   For details, see chapter 3 ‘Youth and Segmentation in EU labour markets’ in Employment in Europe 2010 
(forthcoming). 

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Table 1.3. Annual growth rate of real labour productivity(1) 

1996-20002) 

2001-20052)  2006 

BE 
BG 
CZ 
DK 
DE 
EE 
IE 
EL 
ES 
FR 
IT 
CY 
LV 
LT 
LU 
HU 
MT 
NL 
AT 
PL 
PT 
RO 
SI 
SK 
FI 
SE 
UK 
EU-15 
EU-27 
US 

2.17 
1.68 
1.94 
1.08 
2.01 
 N/A 
5.15 
2.86 
0.25 
2.13 
0.89 
2.08 
 N/A 
4.29 
2.61 
2.53 
 N/A 
1.75 
1.79 
6.17 
3.41 
 N/A 
 N/A 
4.93 
2.81 
2.48 
2.52 
1.77 
 N/A 
2.38 

0.65 
3.68 
4.47 
1.18 
1.30 
6.50 
3.08 
3.06 
0.75 
1.44 
0.11 
0.96 
6.95 
6.59 
1.34 
3.21 
0.85 
1.58 
1.16 
3.75 
0.93 
8.95 
N/A 
4.87 
2.08 
2.80 
1.99 
1.23 
N/A 
2.49 

1.29 
3.17 
5.03 
0.81 
2.86 
4.82 
1.44 
-0.53 
0.84 
2.72 
0.29 
1.46 
7.96 
6.77 
2.29 
3.81 
3.95 
1.58 
2.56 
2.94 
1.40 
6.20 
6.03 
6.84 
3.45 
2.88 
2.27 
1.80 
1.77 
0.82 

2007 

 1.52 
 2.78 
 4.04 
-0.38 
 0.69 
 6.53 
 3.19 
 4.64 
 1.69 
-0.14 
 0.21 
 1.47 
 7.53 
 5.70 
 1.44 
 1.34 
-0.44 
 1.56 
 2.24 
 2.28 
 2.78 
 5.43 
 4.54 
 8.26 
 2.13 
-0.59 
 1.75 
 1.09 
 1.09 
 1.46 

2008 

2009 

-1.09 
 2.69 
 0.51 
-2.31 
-0.04 
-2.26 
-0.17 
 1.88 
 0.82 
-0.24 
-0.94 
0.92 
-1.21 
 1.61 
-4.23 
 1.88 
-0.79 
 0.87 
 0.31 
 1.57 
-0.40 
 6.45 
-1.20 
 2.56 
-0.34 
-1.69 
 1.03 
 0.07 
 0.01 
 1.36 

-0.97 
-2.94 
-0.06 
-0.85 
-2.27 
 3.04 
 1.45 
-0.13 
 4.92 
-0.87 
-1.66 
 1.26 
-2.22 
-10.90 
-1.57 
-3.98 
-1.41 
-3.50 
-2.38 
 5.75 
-0.96 
  N/A 
-5.53 
 0.77 
-1.02 
-1.70 
-1.95 
-0.96 
  N/A 
  N/A 

1) GDP at 2000 prices over total hours worked; 2) Geometric Average. 

Source: AMECO database, European Commission. 

1.2.2 

Industrial trends 

At the sectoral level, the years preceding the crisis confirmed historical trends like the faster 
productivity growth of manufactures compared with services (see Table 1.4), notably in high-
tech  sectors  like  chemicals  and  pharmaceuticals.  This  is  also  true  for  'Electrical  and  optical 
equipment,  including  ICT  manufacturing',  as  well  as  the  associated  service  industry 
'Transport,  storage  and  communication',  which  includes  ICT  services.  The  highest 
productivity  and  value  added  growth  rate  was  in  a  different  high-tech  sector:  Electrical  and 
optical equipment. Within services, value added growth was higher for 'Transport, storage and 
communication' and 'Financial intermediation'; the latter was an exception in the sense that it 
is the only services sector with higher productivity growth than the average of manufactures. 
Labour-intensive  services  like  'Construction  and  real  estate'  display  negative  productivity 
growth  due  to  relatively  higher  employment  growth,  probably  associated  with  the  boom 
described in section 1.3 below.  

EN 

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Table 1.4. Sectoral labour productivity in the EU-27; annual average % change 1995-
2008 

NACE - 31 
sector 
classification 

Sector 

Labour 
productivity

Value 
added 

Employment

A 
B 
C 
D 
DA 
DB 
DC 
DD 

DE 

DF 

DG 

DH 
DI 
DJ 
DK 
DL 
DM 
DN 
E 
F 

G 

H 
I 
J 
K 
L 
M 
N 

O 

Agriculture 
Fishing 
Mining and quarrying 
Manufacturing 
Food products, beverages and tobacco 
Textiles and textiles products 
Leather and leather products 
Wood and wood products 
Pulp, paper paper products; publishing and 
printing 
Coke, refined petroleum products and nuclear 
fuel 
Chemicals, chemical products and man-made 
fibres 
Rubber and plastic products 
Other non-metallic mineral products 
Basic metals and fabricated metal products 
Machinery and equipment n.e.c. 
Electrical and optical equipment 
Transport equipment 
Manufacturing n.e.c. 
Electricity, gas and water supply 
Construction 
Wholesale and retail trade; repair of motor 
vehicles 
Hotels and restaurants 
Transport, storage and communication 
Financial intermediation 
Real estate, renting and business activities 
Public administration and defence 
Education 
Health and social work 
Other community, social, personal service 
activities 

TOTAL 

Source: Eurostat. 

1.2.3  R&D in EU industries 

3,2 
0,0 
1,1 
2,6 
0,4 
1,4 
-0,8 
1,6 

1,9 

2,8 

4,1 
1,5 
2,1 
2,3 
3,0 
6,3 
1,8 
0,3 
2,3 
-0,4 

1,3 
-0,4 
3,0 
2,9 
-1,0 
0,5 
0,0 
0,5 

-0,1 
1,3 

1,0 
-1,7 
-1,7 
2,1 
0,4 
-1,8 
-3,9 
0,6 

1,0 

-0,1 

3,3 
2,3 
1,2 
2,1 
2,2 
5,9 
2,7 
0,9 
1,5 
1,1 

2,6 
2,1 
3,8 
3,4 
3,4 
1,0 
0,9 
2,2 

2,1 
2,4 

-2,2 
-1,7 
-2,8 
-0,6 
0,0 
-3,2 
-3,1 
-1,0 

-0,9 

-2,9 

-0,8 
0,8 
-1,0 
-0,2 
-0,8 
-0,3 
0,9 
0,6 
-0,8 
1,5 

1,3 
2,4 
0,8 
0,5 
4,4 
0,5 
1,0 
1,7 

2,3 
1,0 

Before the crisis the US spent significantly more on R&D that the EU, both in absolute terms 
and as a percentage of GDP; the widest gap is in business enterprise R&D expenditure. The 
distribution  of  total  manufacturing  R&D  expenditure  shows  a  relatively  similar  pattern 
between  the  EU-14  and  the  US9,10.  However,  when  looking  at  the  relative  effort,  R&D 
expenditure as a percentage of value added (see Figure 1.4), it transpires that US businesses 

9   EU-14  stands  for  the  EU-15  minus  Luxembourg.  No  data  for  the  EU-27  was  available  at  this  level  of 
disaggregation. 
10   The lion’s share goes to C23T25 Chemical, rubber, plastics and fuel products, which accounts for roughly 
27 % of total manufacturing R&D expenditure on either side of the Atlantic. In the EU-14 C34 Motor vehicles 
sector stands out, accounting for 20 % of total manufacturing R&D, contrasting with only 10 % in the US. 

EN 

24

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make  a  significantly  higher  effort  than  their  EU  counterparts,  particularly  in  sectors 
considered  to  be  high-technology.  For  instance,  C33  Medical  precision  and  optical 
instruments devotes close to half of its value added to R&D in the US, compared with barely 
12 % in the EU. In short, the EU does not invest enough in R&D, neither in absolute nor in 
relative  terms,  and  a  look  at  the  sectoral  distribution  of  R&D  intensity  in  manufacturing 
clearly  shows  that  it  is  the  high-tech  sectors  that  underperform  compared  to  their  American 
counterparts11. 

Figure 1.4 – Sectoral R&D intensity 

    C36T37 Manufacturing n.e.c. and
recycling

      C35 Other transport equipment

      C34 Motor vehicles, trailers and
semi-trailers

        C33 Medical, precision and
optical instruments

        C32 Radio, television and
communication equipment

        C31 Electrical machinery and
apparatus, n.e.c.

        C30 Office, accounting and
computing machinery

      C29 Machinery and equipment,
n.e.c.

      C28 Fabricated metal products,
except machinery and equipment

      C27 Basic metals

    C26 Other non-metallic mineral
products

    C23T25 Chemical, rubber,
plastics and fuel products

    C21T22 Pulp, paper, paper
products, printing and publishing

    C20 Wood and products of wood
and cork

    C17T19 Textiles, textile products,
leather and footwear

    C15T16 Food products,
beverages and tobacco

  C15T37 MANUFACTURING

EU-14

US

0

5

10

15

20

25

30

35

40

45

50

% of value added

Notes:  Sector  classification  is  ISIC  Rev.3.1;  R&D  expenditure  is  ANBERD,  i.e.  it  includes  R&D  activities 
carried out in the business enterprise sector, regardless of the origin of funding; data for EU-14 is 2005, for 
the  US  2006;  the  EU-14  is  the  EU-15  minus  Luxembourg;  no  data  for  EU-12  countries  is  available  at  this 
level of disaggregation. 

Source: OECD STAN indicators, ed.2009. 

11   Even if it can be argued whether these R&D expenditures are cost efficient, or what is the sense of seeking 
causality between R&D and performance, these differences undoubtedly reflect a thriving and innovative market 
economy in the US compared to the EU. 

EN 

25

EN 

 
 
 
                                                 
1.3  Growing imbalances and external competitiveness 

This  period  of  relative  stability,  with  the  exception  of  the  slowdown  in  2001,  came  to  an 
abrupt  end  in  2007  when  signs  of  unrest  in  the  US  subprime  mortgage  market  and  of  a 
slowdown started to become apparent. 

1.3.1  Soaring asset prices 

Seen in retrospect, the 2000-07 period can be seen as an incubation period; it was the boom 
years, notably in the housing sector in the US, but also in Europe: some Member States saw 
investment in dwellings ― that is, housing excluding non-residential and civil engineering ― 
increase  by  several  points  of  GDP  (see  Box  1.2).  In  line  with  previous  major  recessions 
combined  with  a  banking  crisis,  ‘[t]he  crisis  was  preceded  by  a  long  period  of  rapid  credit 
growth, low risk premiums, abundant availability of liquidity, strong leveraging, soaring asset 
prices and the development of bubbles in the real estate sector’12. 

The present chapter examines the potential impact of the boom years on competitiveness. The 
accumulation  of  large  distortions  has  the  potential  to  significantly  distort  the  way  resources 
are allocated in European economies. The following sections examine this possibility. 

Figure 1.5 - The rise in investment in dwellings 

P
D
G

f
o

e
g
a
t
n
e
c
r
e
P

14

12

10

8

6

4

2

0

Belgium

Germany

Spain

France

United Kingdom

Ireland

United States

5
9
9
1

6
9
9
1

7
9
9
1

8
9
9
1

9
9
9
1

0
0
0
2

1
0
0
2

2
0
0
2

3
0
0
2

4
0
0
2

5
0
0
2

6
0
0
2

7
0
0
2

8
0
0
2

9
0
0
2

Note: Investment in dwellings does not comprise non-residential construction and civil engineering. 

Source: AMECO database, European Commission.  

12   From the introduction to European Commission (2009c); see chapters 1 ‘Root causes of the crisis’ and 2 ‘The 
crisis from a historical perspective’. See also European Commission (2010b), ‘Surveillance of Intra-Euro-Area 
Competitiveness and Imbalances’. 

EN 

26

EN 

 
 
 
 
 
 
 
 
                                                 
Box 1.2. Accumulated distortions 

For a decade or more in some countries, notably the UK, Denmark, Ireland and Spain, 
house prices increased over their fundamental value. Prices went up because economic 
players  expected  them  to  increase  in  a  speculative  spiral  that  made  investment  in 
dwellings  attractive  to  households  compared  to  other  forms  of  investment.  The 
distortion  did  not  affect  all  countries,  but  where  it  did  it  was  not  a  minor  one.  In 
countries  like  Spain,  for  instance,  at  the  height  of  the  boom  period,  around  2005-06, 
house prices increased by 15% a year13.  

This  means  that  for  years  millions  of  households  and  firms  made  consumption-saving 
decisions  counting  on  trends  in  the  price  of  houses  that  subsequently  proved  to  be 
unsustainable. Households invest most of their savings in property. Large and sustained 
increases in the price of houses led them to overinvest in housing and to overstate their 
wealth, pulling down their savings rate. If houses constituted an attractive investment for 
locals, the same was true for foreigners, directly or indirectly. In 2000-06, on average, 
countries  with  a  large  housing  boom  also  experienced  a  substantial  change  in  their 
lending/borrowing position. In some cases it was a dramatic change; Spain for instance 
was  a  net  lender  by  the  end  of  the  1990s  and  was  borrowing  almost  10%  of  its  GDP 
annually  in  2007.  To  see  this  graphically,  the  housing  bubble  can  be  linked  to  the 
increase in investment in dwellings, measured in percentage points of GDP, during the 
boom period: Figure 1.6 relates the housing bubble during 2000-06 to the change in the 
net lending/borrowing position in the same period. In regard of this figure, it looks like 
countries like Germany and Austria became lenders to countries like Spain, Ireland and 
Estonia14. 

These  flows  of  capital  further  fuelled  the  behaviour  of  households,  misguided  by  the 
trend in housing prices. The rising consumption rate financed by these incoming flows 
of capital induced a deterioration of the commercial balance with the rest of the world 
(see Figure 1.7 and Figure 1.8). 

When the boom came to an end, accumulated distortions gave way to the corresponding 
adjustment process. Once the value of houses drop ― or is thought to be going to drop 
in  the  future  ―  a  large  portion  of  perceived  wealth  vanishes,  leading  to  a  major 
adjustment  of  consumption  and  saving.  Consumption  drops  and  saving  increases  to 
rebuild  net  wealth.  Moreover,  if  liabilities  are  substantial  with  respect  to  assets,  the 
saving rate will grow further in an effort to deleverage. In the countries most affected by 
the  housing  bubble  the  increase  in  the  savings  rate  in  2007-09  range  from  three 
percentage points of disposable income in the UK to eleven points in Spain. That these 
increases are related to the previous intensity in investment in dwellings is illustrated in 
Figure 1.915. 

Likewise, the countries that  accumulated a  sizeable deterioration  of net exports during 
the boom years (Figure 1.7) were those that suffered most from the subsequent collapse 

13   For Spain and Ireland see, for instance, Ahearne et al (2008) or Díaz and Raya (2009). For an overview of 
EU countries see Setzer, van den Noord and Wolff (2010). 
14  This  is  further  clarified  by  the  examination  of  the  Bank  of  International  Settlements  consolidated  bank 
statistics; see pages 18 to 21 in the BIS Quarterly Review, June 2010. 
15   For a description of the mechanics and magnitude of the adjustment in the US, see Robert A. Solow (2009), 
‘How  to  Understand  the  Disaster’,  New  York  Review  of  Books,  56(8).  Retrieved  20  May  2010  from 
http://www.nybooks.com/articles/22655. 

EN 

27

EN 

 
 
 
 
 
 
                                                 
of private consumption at the outbreak of the crisis (see Figure 1.9 and Figure 1.10). 

Figure 1.6. Investment in dwellings and net lending/borrowing 

)

P
D
G
%

(

6
0
-
0
0
0
2

n

i

)
-
(

i

g
n
w
o
r
r
o
b

/

)
+
(

i

g
n
d
n
e

l

t
e
n

n

i

e
g
n
a
h
C

10

8

6

4

2

0

-2

-4

-6

-8

-10

-12

-14

-16

-18

DE

AT

PL

CZ

JP

LU

NL

HU
SI

PT

MA

DK

EL

SE

BE

UK

IT
FI
LT

FR
US

RO

CY

ES

EE

IE

-2

-1

0

LV

1

2

3

4

5

6

Increase in % points of GDP in investment in dwellings from 2000 to 2006.

Source: AMECO database, European Commission.  

Figure 1.7. Changes in net exports 2000-06 

L U

C Z

D E

P T

A T

P L

M A

H U

N L

S V

E L

S E

B E

D K

E S

I E

C Y

E E

U K

F R

I T

F I

L T

R O

L V

1 5

1 0

5

0

- 5

- 1 0

- 1 5

)

P
D
G

f
o

i

s
t
n
o
p
%

(

7
0
-
0
0
0
2

s
t
r
o
p
x
e

t
e
n

n

i

e
g
n
a
h
C

- 2

-1

0

1

2

3

4

5

6

7

R is e   i n   i n v e s t m e n t   in   d w e l lin g s   2 0 0 0 - 2 0 0 6   ( in  %   p o i n t s   o f   G D P )

Source: AMECO database, European Commission.  

EN 

28

EN 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Figure 1.8. Changes in saving rates and net exports 2000-06 

)

P
D
G

f
o

i

s
t
n
o
p
%
n
i
(
7
0
-
0
0
0
2

s
t
r
o
p
x
e

t
e
n

f
o

e
g
n
a
h
C

15. 00

10. 00

5. 00

0. 00

-5. 00

- 10. 00

- 15. 00

LU

M A

C Z

H U

P T

P L

A T
N L

B E

EL

S K SI

D E

S E

IT

F R

D K

F I

U K

IE

L T

R O

C Y

ES

EE

LV

-1 0.00

-8 .00

-6 .00

-4 .00

-2 .00

0. 00

2. 00

4.0 0

6.0 0

C ha n g e  in  p rivate  sa vin g  2 0 0 0 -0 7  (%  p o ints o f G N D I)

Source: AMECO database, European Commission.  

Figure 1.9. The rise in the private saving rate 2007-09 

19

14

9

LV

RO

LT

ES

CY

EE

PT

4

PL

CZ

AT

-3

-2

SK

-1
DE

-1

0

EL
DK

HU

UK

BE

FR

IE

SV

NL

IT

1
FI

SE

2

3

4

5

6

LU

-6

MA

Rise in investment in dwellings 2000-2006 (in % points of GDP)

9
0
-
7
0
0
2
e

t

a
r
g
n
v
a
s

i

e

t

a
v
i
r
p

n

i

e
g
n
a
h
C

Source: AMECO database, European Commission.  

EN 

29

EN 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Figure 1.10. The fall in private consumption 2007-09 

9
0
-
7
0
0
2
n
o
i
t
p
m
u
s
n
o
c

e
t
a
v
i
r
p

l

a
e
r

n

i

e
g
n
a
h
c
%

.
x
a
m

2

-3

-8

-13

-18

-23

PL

CZ
LU

DE

AT

PT

MA

FR

SV

NL

BE

FI
IT

SE

EL

UK

DK

CY

ES

HU

IE

RO

LT

-2

-1

0

1

2

3

4

5

6

Rise in investment in dwellings 2000-2006 (in % points of GDP)

EE

Source: AMECO database, European Commission.  

EN 

30

EN 

 
 
 
 
 
 
 
 
 
 
 
Table 1.5. A summary view of the bubble 

Boom period 

Crisis 

 Country 

n

i

P
D
G

i

f
o
s
t
n
o
p
%
n

i

e
s
a
e
r
c
n

I

m
o
r
f

s
g
n

i
l
l
e
w
d
n

i

t
n
e
m
t
s
e
v
n

i

.
6
0
0
2
o
t
0
0
0
2

Belgium 
BE 
Czech Republic  CZ 
DK 
Denmark 
DE 
Germany 
EE 
Estonia 
IE 
Ireland 
EL 
Greece 
ES 
Spain 
FR 
France 
IT 
Italy 
CY 
Cyprus 
LV 
Latvia 
LT 
Lithuania 
LU 
Luxembourg 
HU 
Hungary 
MA 
Malta 
NL 
Netherlands 
AT 
Austria 
PL 
Poland 
PT 
Portugal 
RO 
Romania 
SI 
Slovenia 
SK 
Slovakia 
FI 
Finland 
Sweden 
SE 
United Kingdom  UK 
US 
United States 
JP 
Japan 

0,92 
-0,39 
1,89 
-1,39 
4,17 
5,66 
1,86 
3,23 
1,22 
0,76 
3,27 
0,92 
0,77 
-0,37 
0,24 
1,84 
0,43 
-0,79 
-0,25 
-1,93 
0,82 
0,28 
-2,12 
0,77 
1,43 
1,22 
1,17 
-0,45 

6
0
-
0
0
0
2
g
n
d
n
e
l

i

t
e
n
n

i

e
g
n
a
h
C

-0,76 
3,07 
1,55 
7,93 
-10,20 
-4,69 
-0,90 
-5,20 
-3,01 
-1,99 
-1,88 
-16,96 
-3,00 
-0,69 
0,52 
5,79 
2,60 
3,61 
3,25 
-0,23 
-6,73 
0,38 
-5,08 
-2,97 
3,48 
-0,77 
-3,20 
1,44 

%

(

7
0
-
0
0
0
2
g
n
i
v
a
s

e
t
a
v
i
r
p
n

i
e
g
n
a
h
C

)
I

D
N
G

0,93 
-1,51 
-1,32 
4,76 
-5,50 
1,89 
0,23 
-4,80 
-0,57 
-1,40 
-9,16 
-5,82 
0,96 
0,75 
-1,20 
-0,78 
1,18 
1,28 
-2,10 
-3,63 
-2,53 
-0,09 
-0,82 
0,16 
4,92 
3,44 
0,26 
-0,46 

7
0
0
2
o
t
0
0
0
2
m
o
r
f

s
t
r
o
p
x
e
t
e
n
f
o
e
g
n
a
h
C

P
D
G

i

f
o
s
t
n
o
p
%
n

i

0,92 
7,99 
-3,60 
6,72 
-7,71 
-3,25 
2,41 
-3,65 
-2,77 
-1,17 
-7,10 
-13,12 
-7,07 
12,47 
5,25 
8,69 
3,10 
4,11 
3,55 
3,37 
-8,59 
1,76 
1,44 
-3,94 
1,48 
-1,37 
-1,23 
0,22 

%

(

9
0
-
7
0
0
2
g
n
i
v
a
s

e
t
a
v
i
r
p
n

i
e
g
n
a
h
C

)
I

D
N
G

1,15 
1,65 
3,85 
-1,13 
7,67 
3,44 
4,28 
11,13 
1,07 
0,17 
6,31 
17,29 
7,95 
-4,19 
2,82 
-5,66 
-1,81 
0,89 
3,19 
2,65 
9,79 
-0,02 
-2,44 
-1,52 
-1,29 
3,00 
4,57 
-0,15 

-
7
0
0
2
m
o
r
f
n
o
i
t
p
m
u
s
n
o
c
e
t
a
v
i
r
p
n

i

l
l
a
f

%

9
0
0
2
o
t

8
0

-1,64 
-0,20 
-4,84 
0,23 
-22,30 
-7,86 
-1,79 
-5,41 
0,82 
-2,50 
-3,01 
-26,62 
-16,99 
-0,56 
-7,98 
1,16 
-2,51 
0,36 
2,25 
-0,79 
-10,54 
-1,41 
-0,67 
-2,12 
-1,07 
-3,22 
-0,85 
-1,67 

9
0
0
2
o
t
8
0
0
2
m
o
r
f

P
D
G
n

i

l
l
a
f

%

-2,01 
-1,68 
-4,47 
-3,55 
-14,58 
-10,05 
-0,69 
-3,43 
-1,44 
-3,00 
-1,75 
-18,62 
-16,94 
-4,05 
-1,69 
0,26 
-4,31 
-1,77 
5,42 
-1,54 
-4,54 
-6,04 
-5,79 
-7,17 
-3,09 
-3,63 
-1,28 
-6,12 

Source: AMECO database, European Commission. 

1.3.2  Growing distortions and external competitiveness 

Growing  imbalances  during  the  boom  period  could  have  had  an  impact  on  factors  that  will 
condition  productivity  growth,  and  hence  would  affect  the  performance  of  some  Member 
States  beyond  their  recovery  from  the  recession  (see  Box  1.3).  For  instance,  the  real  estate 
31
EN 
EN 

 
 
 
 
 
 
 
 
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
boom could have detracted resources from productive sectors damaging productivity growth; 
or  nominal  wage  inflation  could  erode  the  international  competitiveness  of  domestic  firms, 
notably in countries within the Euro area. 

In particular, much attention has been paid to the large changes in the trade balance of many 
countries illustrated in Figure 1.7. The excess of imports over exports is often associated with 
a  loss  of  external  competitiveness.  As  the  story  goes,  so-called  surplus  countries  like 
Germany  were  able  to  compete  more  effectively  in  international  markets  (e.g.  by  keeping 
wages  low)  and  then  invested  abroad  the  surplus  of  its  trade  balance,  thus  financing  the 
commercial  deficit  of  other  less  well  performing  countries,  the  deficit  countries  like  Spain. 
This view, however, cannot explain some of the key facts discussed in Box 1.2. In particular, 
it does not explain why the 'surplus' countries typically saw their saving rate soar during the 
boom period while deficit countries experienced the opposite, as illustrated in Figure 1.816.  

The  remainder  of  this  section  argues  that  the  deterioration  of  the  trade  balance  is  only 
reflecting capital flows ― in turn reflecting differences in asset prices across countries ― and 
that  external  competitiveness,  as  measured  by  exports  performance,  was  neither  playing  an 
important role in this deterioration nor being substantially affected by these developments. In 
other  words,  as  we  shall  discuss  below,  in  the  EU  trade  deficits  were  related  to  significant 
capital flows within Member States while external competitiveness seemed to be more related 
to developments in productivity. 

16   Box 1.5 below examines in detail the cases of Germany and Spain. Both before and during the crisis, these 
countries constitute two polar cases as far as the experience the last decade is concerned. 

EN 

32

EN 

 
 
 
 
                                                 
Box 1.3. Imbalances do not (necessarily) reflect distortions 

If two trading countries, for whatever institutional reasons, have two different saving rates, 
they  will  always  have  a  commercial  deficit  and  surplus  respectively:  because  the  saving 
country will permanently finance a level of imports higher than exports in the consuming 
country.  This  type  of  equilibrium  is  sometimes  said  to  entail  an  ‘imbalance’  in  the 
literature17.  However,  as  long  as  prices  correctly  reflect  preferences  and  technology,  it 
does not need to reflect any fundamental problem. A typical case would be fast catching-
up developing countries that constitute attractive investment opportunities. 

In contrast, when some prices are sending the wrong signal, similar ‘imbalances’ may be 
reflecting  true  distortions  that,  accumulated,  may  lead  to  an  adjustment  process  that  can 
take the form of a recession like the current one. The flows of capital referred to in section 
1.3.1  reflected  the  overpricing  of  certain  assets  in  certain  countries.  Correcting  this 
deviation  of  prices  from  the  fundamental  value  of  the  assets  was  the  first  stage  in 
readjusting the consumption-saving behaviour of households and was the ultimate cause of 
the downturn. 

In other words, an ‘imbalance’ may or may not signal an underlying problem depending 
on  whether  it  reflects  some  mispricing.  That  is  most  likely  the  reason  why  even  ex  post 
there is no consensus on whether the so-called ‘global imbalances’ are at the origin of the 
crisis; see Suominen (2010) and references therein. 

1.3.3  Rising unit labour costs, cause or consequence? 

The boom years witnessed  a  major increase in unit labour costs  (ULC) in  certain countries, 
generally  the  so-called  deficit  countries.  It  has  been  suggested  that  large  increases  in  ULC 
could explain, if not the crisis, at least its depth and duration.  

However,  the  development  of  ULC  does  not  seem  to  have  had  a  significant  effect  beyond 
being  associated  with  corresponding  increases  in  the  general  level  of  prices.  As  discussed 
below, if there is a relation between ULC and export performance, it is weak and of second 
order  of  magnitude  compared  with  the  deterioration  of  the  trade  balance  (and  hence  the 
former cannot be the cause of the latter). 

17   In European Commission documentation an imbalance only occurs when there is a market or policy failure. 
Hence, housing bubbles like those examined in this chapter would be indeed classified as an imbalance. 

EN 

33

EN 

 
 
 
 
 
                                                 
Figure 1.11. Rising unit labour costs, inflation and the share of labour in income 

160

150

140

130

120

110

100

)
0
0
1
=

0
0
0
2
(
7
0
0
2
n

i

x
e
d
n

I

e
c
i
r

P

r
e
m
u
s
n
o
C
d
e
z
n
o
m
r
a
H

i

BG
HU

SK

SV

EE

LV

EL

IE
ES

PT

LU

US
NL
EU-27
MA
EU-15
BE
FR

ITCY
CZ

DK

UK

SE

PL

AT

DE

LT

FI

JP

90

80

100

120

140

160

180

Nominal Unit Labor Costs in 2007 (2000 = 100)

110

105

100

95

90

85

80

)
0
0
1
=

0
0
0
2
(

s
t
s
o
c
r
o
b
a

l

t
i
n
u

l

a
e
R

75

80

LV

EE

DK
CZ

IT

LT

IE

FI

SE

CY
EL

UK
FR
MA
NL
BE
EU-15
PT
US
EU-27

HU

SI

AT

DE

SK

ES

LU

JP

PL

100

120

140

160

180

Nominal Unit Labor Costs in 2007 (2000 = 100)

(a) 

(b) 

Source: AMECO database, European Commission.  

A bubble economy may affect the development of wages because the inflows of capital will 
not be entirely directed to the demand for foreign goods. As these flows increase demand for 
domestic  goods  beyond  productivity,  domestic  prices  will  rise,  thereby  applying  upward 
pressure on nominal wages and increasing ULC. But this is a nominal effect, not necessarily 
affecting real wages in net terms18. 

Figure  1.11(a)  can  thus  be  seen  as  not  only  reflecting  a  logical  relation  between  nominal 
wages and prices, but also suggesting that real wages did not deviate from productivity that 
much  during  the  boom  period.  This  is  can  be  seen  from  the  absence  of  any  link  between 
nominal  unit  labour  costs  and  the  share  of  'compensation  of  labour'  in  national  income,  i.e. 
real unit labour costs, in Figure 1.11(b). Changes in the general level of prices have brought 
down  real  wages  and  left  labour's  share  of  income  at  its  slightly  declining  level  of  recent 
years. 

To test this conjecture one can compare the increase in nominal wages over the general level 
of prices with the increase in productivity. This is done in Figure 1.12 where it can be seen 
that, with some exceptions, wherever nominal wages increased over the general level of prices 
during  the  boom  years,  it  was  because  productivity  was  increasing  by  a  similar  magnitude. 
That  real  wages  have  not  grown  beyond  productivity  in  most  European  economies  is 
confirmed by the general downward trend of the share of wages in national income 2000-07: 
for the EU-27 as a whole prices (HICP) grew by 18%, ULC by 14% and the share of labour in 
income fell by 5% (see again Figure 1.11(b))19. 

18   Even  inside  a  monetary  union,  this  nominal  effect  is  not  necessarily  translated  into  a  real  effect;  it  will 
depend on the extent to which these wage distortions are concentrated in non-tradables or tradables sectors; see 
box 1.4 below. 
19   Manipulating the definition of ULC, one can prove that the gap between the growth rates of ULC and the 
general level of prices is approximately the percentage change in the share of wages in income. 

EN 

34

EN 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                 
Figure 1.12. Real wages and productivity: changes 2000-07 

In c r e a s e  in n o m in al  w a g e s  o v er  in fla tion

In c r e as e in  p r od u c tiv ity

E
B

K
D

E
D

E

I

L
E

S
E

R
F

T

I

U
L

L
N

T
A

T
P

I

F

E
S

K
U

Inc r e a s e  in n o m in a l w a g e s  o v er  in fla tio n

In c r e a s e in  p r od u c tiv ity

t

h
w
o
r
g
%

h
t
w
o
r
g
%

2 4

1 9

1 4

9

4

- 1

- 6

2 0 0

1 5 0

1 0 0

5 0

0

G
B

Z
C

E
E

Y
C

V
L

T
L

U
H

A
M

L
P

O
R

I

S

K
S

Source: AMECO database, European Commission.  

It is not surprising, then, that the rise in unit labour costs bears no relation to the changes in 
unemployment rates during this period (Figure 1.13). In short, labour market institutions do 
not seem to have played any great role in the boom period beyond their ability or inability to 
track productivity without causing inflation (mostly in non-tradables sectors, see Box 1.4). 

EN 

35

EN 

 
 
 
 
 
 
 
Figure 1.13. Rising unit labour costs and unemployment 

7
0
-
0
0
0
2

e
t
a
r

t
n
e
m
y
o
p
m
e
n
u

l

n

i

e
g
n
a
h
C

5

3

1

-1

-3

-5

-7

-9

-11

-13

PT

LU

DE

AT

BE

SE

NL

IE

UK
MA
DK
CY

FR

HU

RO

SI

FI

ELES
CZ
IT

PL

SK

LV

EE

BG

LT

90 100 110 120 130 140 150 160 170 180 190 200 210 220 230 240 250 260 270 280

Nominal Unit Labor Costs in 2007 (2000 = 100)

Source: AMECO database, European Commission.  

1.3.4  World market shares 

The  emphasis  on  nominal  labour  costs  is  generally  justified  by  the  open  character  of  our 
economies.  However,  exports’  performance,  as  measured  by  world  market  shares,  does  not 
seem to be affected by changing labour costs either — even if there is a good reason for this 
to be the case in theory, at least within the Euro area. 

EN 

36

EN 

 
 
 
 
 
 
Figure 1.14. Rising unit labour costs and changing world market shares 

0
0
1
=
0
0
0
2

x
e
d
n

i

;
7
0
0
2

s
t
r
o
p
x
e

f
o
e
r
a
h
S

250

200

PL

SK

LT

CZ

LV

150

100

50

0
100

CY

SI

HU

EE

D E

AT

LU

NL

BE

ES

PT

IT
DK
EL

FI

SE

FR

UK

IE

MA

110

120

130

140

150

160

170

180

Nominal Unit Labor Costs 2007 (2000 = 100)

Source: AMECO database, European Commission. 

In  principle,  increasing  the  nominal  cost  of  labour  may  affect  the  competitive  position  of 
domestic  firms  in  international  markets.  This  is  particularly  true  in  countries  in  a  monetary 
union  where  there  is  no  national  currency,  and  hence  no  possibility  of  depreciation  or 
devaluation. However, Figure 1.14 compares the changes in nominal unit labour costs in the 
boom period with changes in world market shares as measured by the share of exports in total 
world exports; the only obvious fact that arises from this chart is the large expansion in EU-12 
Member States in this post-enlargement period. Focusing on intra-EU trade and distinguishing 
between euro area and non-euro area countries does not reveal any obvious pattern either. 

EN 

37

EN 

 
 
 
 
 
 
 
 
Figure 1.15. Rising unit labour costs and intra-EU trade for Euro and non-Euro area 

Non-Euro area

Euro area

7
0
-
0
0
0
2

e
r
a
h
s

'

s
t
r
o
p
x
e
U
E

-
a
r
t
n

i

n

i

e
g
n
a
h
c
%

220

200

180

160

140

120

100

80

60

95

105

115

125

135

145

155

165

175

185

195

Nominal Unit Labor Costs 2007 (2000 = 100)

Source: AMECO database, European Commission.  

One possible explanation for the lack of any relation between ULC and export shares is that 
trading  sectors  face  competitive  pressures  that  prevent  nominal  wages  growing  much  faster 
than  productivity  or,  alternatively,  limit  the  ability  of  firms  to  pass  the  increasing  cost  of 
labour through to higher prices. There is some evidence for this (see Box 1.4). 

EN 

38

EN 

 
 
 
 
 
 
 
 
 
Box 1.4. Unit labour costs in tradables and non-tradables 

Most  economic  activity  in  large  countries  is  domestic.  The  aggregate  evolution  of  ULC 
may reflect wage developments in sectors not exposed to trade. A case in point is that of 
Spain,  an  economy  displaying  one  of  the  largest  housing  bubbles  as  well  as  one  of  the 
largest  increases  in  ULC.  In  the  boom  times  the  general  level  of  prices  rose  by  24%,  8 
points above euro area inflation. Nevertheless, the deflator of exports rose by 15%, a point 
below  the  euro  area  level.  This  is  no  exception:  the  long-term  behaviour  of  ULC  differs 
between tradables and non-tradables as illustrated in Figure 1.16 for the EU as a whole. 

This differing behaviour may stem from two different forces. On the one hand, industry, 
typically  producing  tradables,  is  more  exposed  to  international  competition  than  are 
services.  On  the  other,  the  faster  productivity  growth  in  manufacturing  compared  with 
services may also explain a large share of this differing behaviour. 

Figure 1.16. Sectoral unit labour costs in the EU-27; index 1995=100 

160

150

140

130

120

110

100

90

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Industry

Wholesale and retail trade

Financial intermediation and business services

Source: European Union Industrial Structure 2011, forthcoming. 

The share of exports in world exports for most European countries has been roughly constant 
or  decreasing  since  2000.  This  general  decreasing  trend  is  most  likely  due  to  a  compound 
effect resulting from the fast increase of the level of trade during this period, in turn due to the 
rise of emerging economies. 

EN 

39

EN 

 
 
 
 
 
 
 
 
 
Figure 1.17. Share of exports in world exports 2000-07 

2000

2007

2000

2007

s
t
r
o
p
x
e
d
l
r
o
w
%

10

9

8

7

6

5

4

3

2

1

0

s
t
r
o
p
x
e
d
l
r
o
w
%

1.2

1.0

0.8

0.6

0.4

0.2

0.0

T
A

E
B

E
D

K
D

L
E

I

S F
E

R
F

E

I

T

I

U
L

L
N

T
P

E
S

K
U

G
B

Y
C

Z
C

E
E

U
H

T
L

V
L

A
M

L
P

I

O S
R

K
S

Source: AMECO database, European Commission.  

Figure 1.18. Contribution to changes in the share of exports 
in world exports 2000-07 by extra- and intra-EU trade 

Extra-EU

Intra-EU

Extra-EU

Intra-EU

e
r
a
h
s

e
h
t

n

i

e
g
n
a
h
c
%

30

20

10

0

-10

-20

-30

e
r
a
h
s

e
h
t

n

i

e
g
n
a
h
c
%

160

120

80

40

0

-40

-80

AT BE DE DK EL ES FI FR IE IT LU NL PT SE UK

BG CY CZ EE HU LT LV MA PL RO SK SV

Source: AMECO database, European Commission, and own calculations. 

The focus, however, should be on Figure 1.19. It is in regard of this figure that it is clear that 
countries with a housing bubble ― inside the euro area like Spain or outside it like Denmark 
―  retained  their  market  share  reasonably  well.  Germany  increased  its  export  share  by  10% 
but the contribution of intra- and extra-EU trade is roughly the same; France lost ground in 
both intra- and extra-EU markets, and by the same magnitude as the UK, which is not in the 
euro  area.  This  is  evidence  against  the  hypothesis  that  countries  like  Spain  or  France,  with 
relatively  high  unit  labour  costs,  have  lost  market  shares  to  countries  like  Germany,  with 
lower unit labour costs, because of a deterioration of ‘cost-competitiveness’ in the euro area. 

EN 

40

EN 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1.3.5  Summarizing 

In  short,  net  exports  only  reflect  capital  flows  caused  by  mispriced  assets,  not  losses  of 
external competitiveness. In fact, there is no clear relation between the real estate bubble and 
the performance of exports during the boom period. In other words, the growing imbalances 
of the boom period do not seem to have had a very clear impact on external competitiveness; 
if  any,  through  growing  nominal  labour  costs,  and  of  second  order  of  magnitude  compared 
with the accumulated imbalances and the ensuing contraction20. 

What about productivity growth? If large capital inflows during the boom period are not used 
productively  to  eventually  generate  resources  to  pay  back  the  external  debt,  they  are 
hampering  the  ability  of  countries  to  generate  income  in  the  future  while  at  the  same  time 
increasing the interest burden on these economies. 

This is the possibility explored in the next section. 

1.4  The impact of the boom on industry and competitiveness 

From the discussion in the previous section, the boom period does not seem to have had any 
obvious  impact  on  external  competitiveness  as  measured  by  the  ability  to  maintain  exports 
shares.  True,  the  boom  period  has  affected  nominal  wages  and  prices  but  there  is  no 
systematic impact on exports. Countries like France with moderate increases in ULC or even 
reductions in real effective exchange rates (REER)21 have lost substantial international market 
shares  (see  again  Figure  1.19)  while  others,  like  Spain,  with  large  increases  in  ULC  and 
REER, have more or less kept their market shares. 

Nevertheless, this lack of impact on exports (external competitiveness) does not rule out the 
possibility that these developments may have distorted the way resources are allocated within 
countries  and  across  sectors  hampering  productivity  growth  in  the  years  to  come 
(competitiveness as productivity growth). 

1.4.1  Has the housing bubble crowded out productive investment? 

The  most  obvious  distortion  one  would  expect  is  not  apparent:  it  does  not  seem  that 
investment in dwellings crowded out productive investment at the aggregate level (productive 
investment  here  is  gross  fixed  capital  formation  excluding  dwellings  but  including  non-
residential  construction  and  civil  engineering).  In  other  words,  countries  that  increased 
considerably their investment in dwellings, also increased their productive investment. 

20   At  this  point  it  may  be  worth  recalling  that  this  chapter  examines  the  impact  of  growing  imbalances  in 
competitiveness  and  external competitiveness.  To  conclude  that  the  evolution of  the  ability  to  export does  not 
seem to bear a clear relationship with these imbalances is not to say that they are not fundamental to understand 
the crisis and the recovery. First, countries more affected by these distortions tended afterwards to be more hit 
hard  by  the  recession,  as  illustrated  in  figure  1.10.  Second,  the  accumulation  of  imbalances  yielded  in  many 
cases a leveraged household and corporate sector ―this is a promise of a slow recovery in countries affected by 
the bubble (see Kocherlakota (2010) and McKinsey Global Institute (2010)). 
21   The real effective exchange rate (REER) is another common indicator of external competitiveness; see graph 
I.1 in European Commission (2010a). 

EN 

41

EN 

 
 
 
 
 
                                                 
Figure 1.19. Changes in productive investment and investment in dwellings in 2000-06 

)

P
D
G
s
t
n
o
p
%
n
i
(

i

t
n
e
m
t
s
e
v
n

i

e
v
i
t
c
u
d
o
r
p

n

i

e
g
n
a
h
C

8

6

4

2

0

-2

-4

LV

RO

LT

FR
UK

IT
FI
BE

SE

US

SK

HU

CZ

SI

LU

D E

JP

AT

PT

NL

PL

DK

MA

EL

EE

ES

C Y

IE

-4

-2

0

2

4

6

8

Change in investment in dwellings (in % points GDP)

Source: AMECO database, European Commission.  

If there is any distortion, it is that countries engaged in heavy borrowing have also increased 
their productive investment. It is a small effect, though; from Figure 1.20 it is clear that the 
largest changes in productive investment in 2000-06 occurred in new Member States, which 
were also the target of substantial foreign direct investment. 

Figure 1.20. Changes in lending/borrowing position and productive investment in 2000-

06 

LV

RO

EE

LT

SK
ES

FR

UK

CYIT

HU

SI

IE

FI
US

LU
BE

DK
JP

CZ

SE

AT

DE

NL

PL

MA

PT

EL

8

6

4

2

0

-2

-4

)

P
D
G
s
t
n
o
p
%
n
i
(

i

t
n
e
m
t
s
e
v
n

i

e
v
i
t
c
u
d
o
r
p
n

i

e
g
n
a
h
C

-20

-15

-10

-5

0

5

10

Change in net lending (+) / borrowing (-) in 2000-06 (% GDP)

Source: AMECO database, European Commission.  

EN 

42

EN 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Box 1.5. Two polar cases 

The cases of Spain and Germany illustrate two contrasting experiences in the boom period. 
Examining the different paths followed by these two economies may help us to understand 
the imbalances and the different behaviour during the subsequent adjustment. 

One major argument is that unit labour costs are not growing enough in Germany. Figure 
1.21 shows for 2000-07 nominal compensation per employee and productivity defined as 
real value added per person in employment in the respective sector. 

A  glance  at  these  charts  reveals  two  significant  differences.  First,  unit  labour  costs,  the 
ratio of these indexes, are increasing in all sectors in the Spanish economy and decreasing 
in  most  German  sectors.  Second,  productivity  is  up  in  most  German  sectors,  often  on  a 
significant  scale,  while  for  Spanish  sectors  productivity  is  either  falling  or  growing  only 
modestly. In the light of the discussion about the role of aggregate unit labour costs and 
export  performance  in  the  previous  section,  the  second  fact  is  more  likely  to  be  the 
relevant one, and the one explaining the roughly 10% increase in market share of German 
exports in 2000-07. 

This  interpretation  is  further  strengthened  by  Table  1.6.  As  mentioned  above,  the  two 
countries  differ  markedly  in  their  experience  over  recent  years.  In  particular,  unit  labour 
costs increased significantly in Spain during the boom period. However, these differences 
are not reflected in the distribution of exports between the EU and the rest of the world. If 
any,  between  2000  and  2007  Spain  displays  a  slight  bias  towards  low-tech  exports.  For 
Germany there is no obvious trend; this is consistent with  
Figure 1.18 above, where the increase in the world market shares of Germany is shown to 
be due as much to intra-EU trade as to extra-EU trade. 

EN 

43

EN 

 
 
 
 
 
E
N

4
4

E
N

S
o
u
r
c
e
:

E
U
K
L
E
M
S
r
e
s
e
a
r
c
h
d
a
t
a
b
a
s
e

a
n
d
o
w
n

c
a
l
c
u
l
a
t
i
o
n
s
.

4
0

6
0

8
0

1
0
0

1
2
0

1
4
0

1
6
0

D
E

-

G
e
r

m
a
n
y

TOTAL INDUSTRIES

    Mining and quarrying

TOTAL INDUSTRIES

    Mining and quarrying

4
0

6
0

8
0

1
0
0

1
2
0

1
4
0

1
6
0

     Food products, beverages and tobacco

     Food products, beverages and tobacco

     Textiles, textile products, leather and
footwear

     Textiles, textile products, leather and
footwear

     Wood and products of wood and cork

     Wood and products of wood and cork

     Pulp, paper, paper products, printing
and publishing

     Coke, refined petroleum products and
nuclear fuel

     Pulp, paper, paper products, printing
and publishing

     Coke, refined petroleum products and
nuclear fuel

     Chemicals and chemical products

     Chemicals and chemical products

     Rubber and plastics products

     Other non-metallic mineral products

     Basic metals and fabricated metal
products

     Machinery, nec

   Electrical and optical equipment

     Transport equipment

     Manufacturing nec; recycling

    Construction

C
o
m
p
e
n
s
a

t
i

o
n

p
e
r

l

e
m
p
o
y
e
e

P

r
o
d
u
c
t
i

v

i
t
y

     Rubber and plastics products

     Other non-metallic mineral products

     Basic metals and fabricated metal
products

     Machinery, nec

   Electrical and optical equipment

     Transport equipment

     Manufacturing nec; recycling

    Construction

E
S

-

S
p
a
n

i

C
o
m
p
e
n
s
a
t
i
o
n
p
e
r

l

e
m
p
o
y
e
e

P

r
o
d
u
c
t
i
v
i
t
y

F
i
g
u
r
e

1
.
2
1
.

N
o
m
i
n
a
l

w
a
g
e
s

a
n
d
p
r
o
d
u
c
t
i
v
i
t
y
i
n
2
0
0
7
;

i
n
d
e
x
2
0
0
0
=
1
0
0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
          
Table 1.6. Export characteristics — a comparison between Germany and Spain 

Germany 

Spain 

Share of 
exports over 
total exports 

Share of 
exports to the 
EU over total 
exports 

Share of 
exports over 
total exports 

Share of 
exports to the 
EU over total 
exports 

2000 
2007 
100,0  100,0 

2000 
63,2 

2007 
2000 
63,3  100,0 

2007 
100,0 

2000 
72,4 

2007 
70,0 

0,9 

0,7 

65,9 

75,1 

6,0 

5,4 

90,7 

90,0 

0,2 

0,2 

80,5 

79,1 

0,5 

0,5 

51,8 

46,4 

96,0 

91,2 

63,3 

62,1 

91,6 

91,4 

72,2 

70,1 

4,0 

3,9 

80,9 

81,4 

8,1 

8,6 

71,9 

74,9 

3,8 
0,6 

2,7 
0,7 

74,6 
70,7 

72,9 
72,4 

6,4 
0,7 

5,5 
0,7 

67,4 
73,2 

66,4 
72,3 

3,2 

2,8 

72,9 

73,2 

3,1 

2,5 

69,7 

74,8 

17,1 
1,4 

18,3 
1,2 

59,0 
64,2 

62,7 
63,1 

16,2 
3,3 

19,9 
2,9 

62,7 
60,1 

58,3 
64,8 

7,9 

9,0 

68,8 

67,5 

7,8 

9,9 

69,4 

75,2 

33,0 

30,2 

60,0 

53,5 

16,3 

14,4 

68,9 

64,1 

23,2 

21,2 

62,6 

63,3 

27,5 

25,3 

84,0 

80,1 

1,9 

1,8 

66,2 

71,2 

2,3 

1,7 

65,9 

68,5 

19,1 

17,3 

60,8 

61,1 

9,3 

9,5 

70,8 

68,8 

48,0 

46,7 

59,8 

57,3 

42,9 

41,4 

79,1 

74,7 

14,1 

15,9 

67,4 

66,4 

18,8 

21,6 

60,0 

60,3 

13,4 

11,9 

74,7 

75,5 

20,6 

19,0 

69,5 

71,8 

11,3 

8,9 

66,7 

60,7 

6,0 

4,0 

76,0 

78,0 

CTOTAL: GRAND TOTAL 
C01T05: AGRICULTURE 
FORESTRY AND FISHING 
C10T14: MINING AND 
QUARRYING 
C15T37: TOTAL 
MANUFACTURING 
C15T16: + Food beverages and 
tobacco 
C17T19: + Textiles leather and 
footwear 
C20: + Wood and cork 
C21T22: + Pulp paper printing 
and publishing 
C23T25: + Chemical rubber 
plastics and fuel 
C26: + Non-metallic products 
C27T28: + Basic metals and 
fabricated metal products 
C29T33: + Machinery and 
equipment 
C34T35: + Transport 
equipment 
C36T37: + Manufacturing n.e.c 
and recycling 

HITECH: HIGH 
TECHNOLOGY 
MANUFACTURES 
MHTECH: MEDIUM-HIGH 
TECHNOLOGY 
MANUFACTURES 

MLTECH: MEDIUM-LOW 
TECHNOLOGY 
MANUFACTURES 
LOTECH: LOW 
TECHNOLOGY 
MANUFACTURES 
ICTMAN: ICT 
MANUFACTURES 

 Source: OECD STAN Bilateral Trade and own calculations. 

1.4.2  Employment growth in construction and real estate services 

In 2000-2007 employment in the EU-27 increased by more than 6 %, from 211 million to 224 
million. The employment rate improved by more than 3 percentage points in 2000-2007 (see 
Table 1.7.). Some of the countries with low or average employment at the beginning of the 

EN 

45

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decade  managed  to  increase  their  rates  close  to  the  Lisbon  target  (e.g.  Estonia,  Ireland,  and 
Latvia). 

Table 1.7. Employment rates 

2000

2007

Employment rates, %

EU27
Belgium
Bulgaria
Czech Republic
Denmark
Germany 
Estonia
Ireland
Greece
Spain
France
Italy
Cyprus
Latvia
Lithuania
Luxembourg 
Hungary
Malta
Netherlands
Austria
Poland
Portugal
Romania
Slovenia
Slovakia
Finland
Sweden
United Kingdom
United States
Japan

62,2
60,5
50,4
65,0
76,3
65,6
60,4
65,2
56,5
56,3
62,1
53,7
65,7
57,5
59,1
62,7
56,3
54,2
72,9
68,5
55,0
68,4
63,0
62,8
56,8
67,2
73,0
71,2
74,1
68,9

65,4
62,0
61,7
66,1
77,1
69,4
69,4
69,1
61,4
65,6
64,3
58,7
71,0
68,3
64,9
64,2
57,3
54,6
76,0
71,4
57,0
67,8
58,8
67,8
60,7
70,3
74,2
71,5
71,8
70,7

Growth in 
employment rates 
2000-07, 
percentage points
3,2
1,5
11,3
1,1
0,8
3,8
9,0
3,9
4,9
9,3
2,2
5,0
5,3
10,8
5,8
1,5
1,0
0,4
3,1
2,9
2,0
-0,6
-4,2
5,0
3,9
3,1
1,2
0,3
-2,3
1,8

Source: Eurostat, LFS series. 

In  this  context,  countries  affected  by  the  housing  boom  showed  different  patterns  regarding 
manufacturing.  In  Spain,  for  example,  employment  in  manufacturing  increased  (3.5 %), 
especially in manufacturing of food, chemicals, rubber products, mineral and metal products, 
machinery  and  transport  equipments  —  taking  into  account  branches  with  larger  relative 
weights. At the same time in Ireland, the number of people employed in manufacturing fell by 
8 %, with decreases virtually across the board. 

As expected, the role of construction in employment changed considerably during 2000-2007 
(at  the  EU  level  by  17 %,  which  is  more  than  2  million  people  in  absolute  terms).  A 
significant  drop  can  be  observed  only  in  Germany,  Austria  and  Portugal,  while  the  role  of 
construction  gained  in  importance  in  almost  all  the  other  countries,  especially  in  Ireland, 

EN 

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Spain  and  in  the  Baltic  republics  (see  Table  1.8.)22.  Generally,  this  can be  explained  on  the 
one hand by rising demand for housing requiring huge numbers of construction workers, and 
by  huge  infrastructural  development  works  (motorways,  roads,  railways  etc.)  on  the  other. 
The share of construction in total employment exceeded 13% in Ireland and Spain (see Figure 
1.23.). This could have caused tensions in the labor market but the role of immigrant workers 
became important: they helped to alleviate capacity constraints in the sector and at the same 
time contributed to the increasing demand for housing23. 

Figure 1.22. Employment in construction over total employment 

t
n
e
m
y
o
p
m
e

l

l

a
o

t

t

f

o
%

14

13

12

11

10

9

8

7

6

5

4

EU27
Ireland
Spain
Latvia
Lithuania
Estonia

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: Eurostat, National Accounts. 

Another activity related to the housing boom is the banking sector. The role of the financial 
sector in employment increased, especially in the countries affected by the housing boom and 
where the role of external financial sources became more important in those years. Significant 
increases occurred in most new member states (Baltic republics, Bulgaria, Romania, Poland) 
and in Ireland24. Finally, the growing importance of housing investment was reflected in the 
growing number of employees in the real estate sector (almost half a million people — a 24 % 
increase  at  the  EU  level).  Real  estate,  renting  and  business  activities  together  registered  an 
increase of 5.8 million employees (26 %), with 'other business activities' (NACE 74) playing 
the most significant role.  

22   Bover  and  Jimeno  (2007)  examined  the  relationship  between  house  prices  and  labour  demand  in  the 
construction  sector.  They  found  substantial  cross-country  differences  in  the  time  series  correlation  of  house 
prices  and  sectoral  composition  of  employment.  Countries  with  more  building  possibilities,  like  Spain, 
experienced a high sectoral allocation of employment and displayed larger elasticities of labour demand in the 
construction with respect to house prices than countries that were not affected by the housing boom.  
23    See Aherne et al (2008). 
24   More widely available and lower-cost housing financing contributed to the rapid growth of mortgage debt in 
several countries (IMF, 2008). For instance in Ireland, residential mortgage lending grew annually by 25% on 
average  in  the  period  2000-2006  (Malzubris,  2008).  In  Estonia  credit  inflows  progressively  accelerated:  gross 
debt liabilities increased on average by 32% annually in 2005-2007 and by 20% in 2000-2004 (Lamine, 2008).  
47

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Table 1.8. Employment changes between 2000 and 2007 

NACE 

Manufacturing 

Construction 

Wholesale and 
retail trade 

Hotels and 
restaurants 

Financial 
intermediation 

Real estate, 
renting and 
business 
activities 

EU27 
EU15 
Belgium 
Bulgaria 
Czech 
Republic 
Denmark 
Germany  
Estonia 
Ireland 
Greece 
Spain 
France 
Italy 
Cyprus 
Latvia 
Lithuania 
Luxembourg  
Hungary 
Malta 
Netherlands 
Austria 
Poland 
Portugal 
Romania 
Slovenia 
Slovakia 
Finland 
Sweden 
United 
Kingdom 

in 1000 
-1873,0 
-2229,7 
-69,2 
69,1 

60,6 
-51 
-566 
3,9 
-27,3 
17,2 
104,4 
-413,7 
64,6 
0,6 
7,8 
12,8 
2,1 
-56,2 
-5 
-109,3 
4,3 
349,1 
-129,8 
36,2 
-18,3 
10,6 
-19,6 
-64,7 

in % 
-4,8 
-7,5 
-10,5 
10,5 

4,4 
-11,4 
-7,0 
3,0 
-9,1 
3,5 
3,5 
-11,3 
1,3 
1,6 
4,9 
5,1 
6,3 
-5,7 
-14,1 
-10,5 
0,7 
12,5 
-13,0 
1,9 
-7,1 
2,1 
-4,3 
-8,2 

in 1000 
2428,6 
1608,8 
13,0 
99,7 

28,6 
26,0 
-560,0 
35,2 
112,3 
85,2 
876,9 
288,2 
397,1 
12,1 
70,5 
86,1 
11,1 
64,4 
3,2 
-4,0 
-14,3 
170,0 
-52,9 
275,2 
13,7 
34,7 
28,8 
56,1 

in % 
16,7 
13,4 
5,3 
75,6 

6,6 
15,6 
-20,2 
89,8 
65,5 
28,4 
48,1 
19,7 
25,6 
46,2 
127,0 
103,6 
42,9 
24,5 
36,0 
-0,8 
-5,0 
19,7 
-9,0 
71,2 
20,5 
25,9 
18,5 
25,6 

in 1000 
2403,3 
1518,9 
29,1 
146,4 

in % 
7,7 
6,0 
5,0 
38,1 

in 1000 
1582,3 
1387,2 
1,9 
42,9 

in % 
18,3 
18,0 
1,3 
41,9 

in 1000 
188,7 
110,1 
-6,3 
13,5 

in % 
3,2 
2,2 
-4,3 
36,9 

in 1000 
5807,2 
5141,8 
156,0 
83,9 

in % 
26,4 
26,0 
26,1 
71,2 

34,8 
30,0 
-149,0 
9,1 
63,0 
186,0 
610,6 
202,2 
230,0 
14,2 
50,2 
60,8 
5,6 
46,4 
n.a. 
57,9 
n.a. 
162,6 
113,7 
252,2 
7,0 
126,6 
31,7 
26,7 

4,8 
6,9 
-2,5 
11,0 
26,1 
23,1 
24,1 
6,4 
6,7 
25,1 
32,4 
30,4 
14,7 
8,5 
n.a. 
4,2 
n.a. 
7,7 
14,6 
28,4 
6,3 
45,4 
10,9 
5,1 

15,2 
15 
210 
3,1 
18,8 
38,3 
430,4 
111 
274,2 
4,6 
13 
5,4 
2,7 
18,2 
n.a. 
22,7 
n.a. 
75,6 
n.a. 
7,4 
2,9 
10,4 
4,8 
14,2 

8,7 
18,1 
13,0 
15,0 
17,2 
14,4 
41,9 
12,8 
28,4 
13,0 
60,5 
20,5 
21,3 
13,7 
n.a. 
7,6 
n.a. 
35,2 
n.a. 
6,1 
9,6 
21,2 
6,5 
12,0 

2,7 
8 
-78 
2 
23,4 
8,8 
42,9 
63,2 
46,1 
1,2 
3,8 
7,8 
8,8 
-0,3 
n.a. 
0,4 
n.a. 
73,1 
n.a. 
10,6 
3 
-3,6 
-0,4 
-1,9 

3,1 
10,1 
-6,1 
24,7 
33,9 
8,2 
11,8 
8,7 
7,8 
7,2 
23,2 
53,8 
29,8 
-0,4 
n.a. 
0,1 
n.a. 
25,4 
n.a. 
12,1 
15,1 
-9,4 
-1,0 
-2,0 

140,1 
96,0 
1097,0 
10,5 
54,7 
92,2 
755,0 
566,2 
702,0 
8,9 
29,5 
32,2 
13,9 
78,0 
n.a. 
229,5 
n.a. 
139,3 
n.a. 
88,9 
41,3 
69,9 
74,2 
113,8 

32,9 
34,4 
24,2 
26,0 
38,0 
45,8 
59,1 
16,3 
29,8 
56,0 
49,0 
74,5 
33,9 
38,2 
n.a. 
16,8 
n.a. 
17,1 
n.a. 
45,8 
60,7 
51,0 
35,0 
23,0 

-1019 

-24,3 

364 

19,5 

n.a. 

n.a. 

n.a. 

n.a. 

n.a. 

n.a. 

n.a. 

n.a. 

Notes: manufacturing and construction from NACE 6 others from NACE 31 data when data for 2007 not available 2006 used instead. 

Source: Eurostat, National Accounts, and own calculations. 

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48

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Figure 1.23. Changes in value added and productivity in the EU-25* in the boom period 

2000-07 

Productivity

Value added

 AGRICULTURE, HUNTING, FORESTRY AND FISHING

TOTAL INDUSTRIES

 MINING AND QUARRYING

 TOTAL MANUFACTURING

  FOOD , BEVERAGES AND TOBACCO

  TEXTILES, TEXTILE , LEATHER AND FOOTWEAR

  WOOD AND OF WOOD AND CORK

  PULP, PAPER, PAPER , PRINTING AND PUBLISHING

  CHEMICAL, RUBBER, PLASTICS AND FUEL

   Coke, refined petroleum and nuclear fuel

   Chemicals and chemical products

   Rubber and plastics

  OTHER NON-METALLIC MINERAL

  BASIC METALS AND FABRICATED METAL

  MACHINERY, NEC

  ELECTRICAL AND OPTICAL EQUIPMENT

  TRANSPORT EQUIPMENT

  MANUFACTURING NEC; RECYCLING

 ELECTRICITY, GAS AND WATER SUPPLY

 CONSTRUCTION

 WHOLESALE AND RETAIL TRADE

 HOTELS AND RESTAURANTS

 TRANSPORT AND STORAGE AND COMMUNICATION

  TRANSPORT AND STORAGE

  POST AND TELECOMMUNICATIONS

FINANCE, REAL ESTATE AND BUSINESS SERVICES

  REAL ESTATE, RENTING AND BUSINESS ACTIVITIES

  FINANCIAL INTERMEDIATION

   Real estate activities

   Renting of m&eq and other business activities

 COMMUNITY SOCIAL AND PERSONAL SERVICES

  PUBLIC ADMIN AND DEFENCE

  EDUCATION

  HEALTH AND SOCIAL WORK
  OTHER COMMUNITY, SOCIAL AND PERSONAL
SERVICES

  PRIVATE HOUSEHOLDS WITH EMPLOYED PERSONS

-30

-20

-10

0

10

20

30

40

50

60

*EU-25 refers to Member States as of 1st of  May 2004 

Source: EU KLEMS research database and own calculations.  

Inspection  of  productivity  changes at  the  sectoral  level  does  not  reveal  a  very  clear  pattern. 
Again, it is difficult to disentangle an eventual impact of the boom years from secular trends. 
Breaking  down  productivity  changes  by  broad  sectors  shows,  not  surprisingly,  that  it  is  in 
49
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industry  where  the  largest  increases  in  productivity,  10%,  are  recorded  (which  eventually 
could  explain  the  behaviour  of  export  shares,  Figure  1.17).  The  only  clear  impact  of  the 
hosing  boom  is  in  the  construction  and  real  estate  sectors:  productivity  was  down  in 
construction  by  more  than  5%,  mainly  because  of  the  flow  of  workers  (particularly  migrant 
workers) reflected in Figure 1.22.  

1.4.3  The allocation of productive investment 

In  section  1.4.1  we  argued  that  aggregate  productive  investment  was  not  crowded-out  by 
investment  in  dwellings.  Another  kind  of  distortion,  however,  would  be  that  part  of  this 
productive  investment  was  disproportionately  directed  to  housing-related  sectors  to  the 
detriment of other productive sectors. There is some evidence in this direction. 

In countries affected by the housing boom (e.g. Estonia, Spain, Ireland, United Kingdom) the 
relative weight of manufacturing investment shrank considerably during this period. In these 
economies real investments were typically reallocated to the non-tradable sectors25, especially 
to construction and real estate26. These figure come, however, with a caveat: it is difficult to 
disentangle this drop and the increasing role of market services against manufacturing in the 
European  economy  (a  long-term  structural  trend)27.  Figure  1.25  depicts  the  evolution  of 
investment by type of assets in the EU-27. Taking into account the asset type distribution of 
GFCF, the role of housing and other construction investment increased significantly in the EU 
during  the  review  period.  At  the  same  time  the  share  of  metal  products  and  machinery 
dropped considerably. This points partly to less investment in tradable sectors, but it is also in 
line  with  a  GVA  share  and  employment  loss  in  manufacturing  and  the  increasing  role  of 
services in general.  

25   Brixiova et al. (2009). 
26   In  Estonia,  for  instance,  the  shares  of  the  construction  and  the  real  estate  sectors  in  total  fixed  investment 
exceeded  the  weight  of  the  sectors  in  total  value  added,  while  in  manufacturing  the  investment  share  fell 
increasingly below the share in total value added in 2005-2007 (Lamine, 2008). 
27   European Commission (2004). 

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Figure 1.24. GFCF in the EU-27 by asset types; % of GDP 

Other products

Transport

Other construction

Construction housing

Metal products and machinery 

Agricultural products

6,4%

6,1%

5,6%

5,2%

5,2%

2,0%

1,9%

1,9%

1,9%

1,9%

5,0%

4,9%

4,9%

5,1%

5,2%

5,7%

5,7%

5,6%

5,7%

5,7%

1,5%

2000

1,6%

2001

1,6%

2002

1,6%

2003

1,6%

2004

5,3%

1,9%

5,4%

5,8%

1,6%

2005

5,3%

2,0%

5,6%

2,1%

5,7%

5,7%

6,0%

6,2%

1,7%

2006

1,7%

2007

25%

20%

15%

10%

5%

0%

Source: Eurostat, National Accounts, and own calculations. 

1.4.4  Summarizing 

In short, if the boom years have affected future productivity growth, the effect does not seem 
to be obvious. Appart from the growth in employment in housing-related sectors, there is no 
obvious  deviation  from  secular  trends:  decreasing  weight  of  manufacturing  in  employment 
and value added caused by faster productivity growth relative to services. If any, there is some 
evidence that productive investment has been disproportionately directed to construction and 
real  estate  activities.  It  is  not  clear,  however,  whether  the  magnitude  of  this  distortion  is 
enough to provoque a productivity slowdown in the coming years. 

1.5.  The impact of the crisis on industry 

Both by international standards and in comparison with other parts of the EU economy, the 
EU manufacturing and construction industries were very severely hit by the global recession. 
Output dropped in all sectors but one, and jobs were lost on a massive scale. 

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Table 1.9. The crisis and European industry 

NACE Rev.2 

% change in 2009Q04 relative to 2008Q01 * 

Output  Employment 

Hours 

Productivity 
** 

Highest drop 
in output 
relative to 
2008q01 

Manufacturing 
Food products 

c 
c10 
c11  Beverages 
c12  Tobacco products 
c13  Textiles 
c14  Wearing apparel 
c15  Leather and related products 
c16  Wood and of products of wood and cork 
c17 

Paper and paper products 
Printing and reproduction of recorded 
media 

c18 

Fabricated metal products 

c19  Coke and refined petroleum products 
c20  Chemicals and chemical products 
c21  Basic pharmaceutical products 
c22  Rubber and plastic products 
c23  Other non-metallic mineral products 
c24  Basic metals 
c25 
c26  Computer, electronic and optical products 
c27  Electrical equipment 
c28  Machinery and equipment n.e.c. 
c29  Motor vehicles, trailers and semi-trailers 
c30  Other transport equipment 
c31 
c32  Other manufacturing 
c33  Repair and installation of machinery 

Furniture 

-19,03 
-2,87 
-7,40 
-12,28 
-24,23 
-16,12 
-19,25 
-21,47 
-14,93 

-12,03 
-10,05 
-19,54 
-0,29 
-21,54 
-28,03 
-35,57 
-27,11 
-22,23 
-24,88 
-30,26 
-39,24 
-13,64 
-22,46 
-7,35 
-6,82 

-18,10 
-2,87 
-6,62 
-12,28 
-23,40 
-16,12 
-18,41 
-21,47 
-11,93 

-12,03 
-10,05 
-12,17 
4,65 
-16,44 
-28,03 
-28,32 
-26,85 
-21,98 
-22,50 
-30,18 
-28,22 
-13,64 
-22,29 
-6,54 
-6,82 

-10,63 
-3,55 
-10,17 
-9,30 
-18,56 
-20,80 
-15,88 
-17,82 
-7,50 

-8,85 
-5,01 
-7,13 
-4,48 
-8,56 
-18,15 
-12,54 
-11,00 
-12,20 
-10,67 
-7,94 
-11,91 
-7,87 
-15,18 
-4,76 
-2,89 

-10,01 
-2,04 
-8,18 
-3,21 
-17,39 
-17,63 
-13,05 
-16,09 
-9,03 

-6,07 
-9,70 
-5,21 
-3,25 
-9,02 
-14,53 
-16,32 
-10,89 
-11,89 
-11,95 
-11,31 
-15,57 
-7,75 
-15,09 
-4,31 
2,90 

-8,77 
0,06 
2,74 
-5,74 
-7,78 
1,52 
-6,42 
-5,27 
-4,60 

-4,73 
1,50 
-10,88 
8,27 
-10,41 
-13,19 
-17,70 
-18,14 
-11,73 
-14,02 
-21,41 
-19,94 
-5,07 
-8,68 
-2,90 
-9,31 

* When 2009Q04 not available 2009Q03 used instead, notably for hours and productivity. 
** Productivity is measured as output per hour; rates of change approximate rates of change of value added per hour. 

Source: Eurostat, Short-term Business Statistics. 

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The effects of the crisis were not identical across sectors, though: some manufacturing sectors 
fared better than manufacturing as a whole, others considerably worse. Examples of sectors 
outperforming other manufacturing sectors during the crisis include food products and basic 
pharmaceutical  products  and  pharmaceutical  preparations.  At  the  other  end  of  the  scale, 
sectors  such  as  motor  vehicles,  trailers  and  semitrailers,  machinery  and  equipment,  textiles, 
wearing  apparel,  leather  and  leather-related  products  suffered  the  greatest  job  losses  and 
output  reductions.  The  construction  industry,  being  highly  cyclical,  also  falls  in  the  latter 
category. 

Whereas manufacturing industry as a whole started to recover by mid-2010, some of the worst 
affected manufacturing sectors were still shrinking and may not yet have reached their lowest 
level and the start of recovery. A similar scenario might await the construction industry. 

1.5.1  Output 

Across  the  manufacturing  industry  as  a  whole,  output  fell  by  almost  15 %  from  its  cyclical 
peak in the first quarter of 2008 to the first quarter of 2010. By mid-2009 output had dropped 
by even more, but it then started to recover and this general recovery has continued in 2010. 
The volume of output is now some 7 % higher than at the lowest point in 2009, and around a 
quarter of the total drop from the 2008 peak to the 2009 nadir has been recovered. 

However,  as  Figure  1.25  shows,  the  overall  recovery  is  not  reflected  in  all  manufacturing 
sectors.  In  some  sectors  (notably  furniture,  coke  and  refined  petroleum  products,  tobacco 
products, and beverages) output is still diminishing and may not yet have reached its lowest 
level.  In  other  sectors  the  drop  in  output  was  far  greater  than  the  average  manufacturing 
output  loss  (motor  vehicles,  trailers  and  semitrailers  –39.5 %;  basic  metals  –35.8 %; 
machinery  and  equipment  –30.5 %),  and  although  output  has  since  started  to  recover  it  still 
has some way to go to make up the average of nearly –15 % across all manufacturing sectors, 
as reflected in Figure 1.25. 

The  figure  also  shows  the  remarkable  resilience  of  the  pharmaceutical  sector  (basic 
pharmaceutical  products  and  pharmaceutical  preparations),  where  output  now  stands  at  a 
higher  level  than  in  2008.  The  recession  initially  caused  output  to  drop  slightly  in  the 
pharmaceutical sector too, but it quickly returned to positive growth and has since bucked the 
trend  of  negative  growth  in  other  sectors.  The  food  sector  has  also  been  able  to  keep  up 
production remarkably well in spite of initial output reductions and despite having had to shed 
more than 3 % of its workforce (see the next section). 

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Figure 1.25. Construction and manufacturing sector output in 2010Q1; index 

2008Q1=100 

Pharmaceutical products and preparations

Food products

Other manufacturing

Other transport equipment

Beverages

Tobacco products

Paper products

Chemicals and chemical products

Recorded media

Coke and petroleum products

Wearing apparel

Rubber and plastic products

Manufacturing: all sectors

Computers, electronic and optical products

Construction

Leather and related products

Electrical equipment

Textiles

Wood products

Basic metals

Furniture

Motor vehicles

Metal products

Non-metallic mineral products

Machinery and equipment 

65

70

75

80

85

90

95

100

105

110

Source:  Monthly  note  on  economic  recovery  in  manufacturing,  construction,  and  selected  service  industries, 
June 2010, DG Enterprise and Industry, European Commission. 

Output  in  the  construction  industry  fell  by  16.2 %  from  the  first  quarter  of  2008  to  the  first 
quarter  of  2010,  and  may  have  fallen  further  since.  As  in  some  manufacturing  sectors,  the 
construction industry may yet have to reach it lowest  output level  of this  cyclical  downturn 
before returning to positive growth. 

Taking  into  account  change  of  production  and  employment  in  terms  of  end-use  categories 
(intermediate  goods,  capital  goods,  consumer  durables,  consumer  non-durables  and  energy) 
the following can be observed.  

Intermediate goods (accounting for the largest weight of total) suffered most during the crisis, 
indicating significantly less demand for goods used in manufacturing production. Production 
of  capital  goods  showed  the  largest  drop  as  compared  to  the  period  before  the  recession, 
representing very weak investment activity in the business sector. These two categories, given 
their  large  shares  in  total,  had  the  most  significant  effect  on  the  production  index  of  total 
industry. Households responded to the changed circumstances quite rapidly, as reflected in the 
sharp contraction for durable goods. Non-durable consumer goods recorded only a maximum 
drop of 5 % compared with the pre-crisis peak. 

EN 

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Figure 1.26. Production index change of end-use categories in the EU-27 

Capital goods
Durable consumer goods
Intermediate goods
Non-durable consumer goods
Energy 

%

,
0
0
1
=
5
0
0
2

125

120

115

110

105

100

95

90

85

80

1
Q
7
0
0
2

2
Q
7
0
0
2

3
Q
7
0
0
2

4
Q
7
0
0
2

1
Q
8
0
0
2

2
Q
8
0
0
2

3
Q
8
0
0
2

4
Q
8
0
0
2

1
Q
9
0
0
2

2
Q
9
0
0
2

3
Q
9
0
0
2

4
Q
9
0
0
2

1
Q
0
1
0
2

Source: Eurostat, Short-term Business Statistics. 

Looking  at  individual  EU  countries'  performance  in  industries,  the  largest  GDP  contraction 
and  decline  in  industrial  output  occurred  in  small  open  economies  like  Estonia  or  Slovakia, 
but  their  impact  on  EU  industrial  output  as  a  whole  was  not  significant,  because  of  their 
relatively small weights. In contrast, Germany, representing the highest share in EU industrial 
output, contributed considerably to the fall in EU industrial performance. Italy, representing 
the fourth largest weight in industrial value added, showed the second largest impact on the 
overall EU industrial production index28. 

1.5.2  Employment 

Employment  in  the  manufacturing  industry,  which  accounts  for  around  16 %  of  total  EU 
employment,  fell  by  11.8 %  from  its  peak  in  the  first  quarter  of  2008  to  the  first  quarter  of 
2010.  Though  it  fell  short  of  the  15 %  reduction  in  output  over  the  same  period,  the  fall 
nonetheless meant that more than four million jobs were lost in manufacturing, representing 
nearly two-thirds of all job losses in the EU from the first quarter 2008 to the first quarter of 
2010. No other part of the EU economy has suffered job losses on a similar scale. 

Employment diminished in all manufacturing  sectors from the first  quarter 2008 to  the first 
quarter  of  2010;  in  two  sectors,  textiles  and  wearing  apparel,  job  losses  were  in  excess  of 
20 %. The manufacture of leather and related products also suffered similar cuts in numbers. 
This is the reason for the diminished shares of overall employment for these three sectors in 
Figure 1.27. It is worth noting that while the job losses in the textiles and leather sectors were 
proportionate to the output reductions in those sectors from 2008 to 2010, the wearing apparel 
sector  employed  22.5 %  fewer  people  in  the  first  quarter  of  2010  than  the  same  quarter  of 
2008  but  the  remaining  workforce  produced  more  than  85 %  of  the  2008  sector  output, 
reflecting higher labour productivity. 

28    European Commission (2010c) 

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Several  manufacturing  sectors  reported  job  losses  of  less  than  5 %  during  the  period:  food 
products (–3.1 %), basic pharmaceutical products and pharmaceutical preparations (–4.0 %) as 
well as coke and refined petroleum products (–4.9 %). This explains why the relative shares of 
these  three  sectors  in  overall  employment increased  between  2008  and  2010,  as  depicted  in 
Figure 1.27. 

Employment  in  the  construction  industry,  which  represents  around  6 %  of  total  EU 
employment, fell by 13.9 % from the first quarter of 2008 to the first quarter of 2010, or by 
more  than  two  million  jobs.  As  a  consequence  the  share  in  overall  employment  of 
manufacturing and construction diminished from 30.5% to 30.1 %. 

Figure 1.27. Industry sectors and construction, relative shares of employment 

0,1%

0,3%

0,3%

0,4%

1,0%

1,3%

1,2%

1,5%

1,9%

2,6%

2,4%

2,9%

2,6%

3,3%

30,5%

8,1%

8,7%

7,6%

4,7%

3,6%

3,6%

3,6%

4,1%

3,8%

30,1%

0,1%

0,3%

0,4%

0,4%

1,0%

1,2%

1,3%

1,5%

2,0%

2,3%

2,4%

2,7%

2,8%

3,0%

3,4%

3,7%

3,7%

3,8%

3,9%

4,8%

8,9%

8,6%

7,8%

Construction
Food products
Metal products
Machinery, equipment
Motor vehicles
Recorded media
Furniture
Rubber/plastic products
Electrical equipment
Non-metallic mineral products
Wearing apparel
Chemical products
Wood products
Basic metals
Textiles
Transport equipment
Paper products
Pharmaceutical products
Leather products
Beverages
Other manufacturing
Coke, petroleum
Computers, electronics
Tobacco products

Employment in first quarter 2008 (55 million) and first quarter 2010 (48.5 million). 

Source:  Monthly  note  on  economic  recovery  in  manufacturing,  construction,  and  selected  service 
industries, June 2010, DG Enterprise and Industry, European Commission. 

As  regards  end-use  categories,  however,  the  largest  drops  were  registered  in  capital  and 
intermediate  goods  in  terms  of  production,  while  job  losses  were  more  significant  in  other 
categories (durables and non-durables). Comparing the two figures (Figure 1.26 and 1.28), it 
can  be  seen  that  while  enterprises  responded  to  the  changed  circumstances  very  fast  by 
reducing production, job losses were more gradual and more protracted.  

EN 

56

EN 

 
 
 
 
 
Figure 1.28. Labour input index change of end-use categories in the EU27 

 Capital goods
Durable consumer goods
Intermediate goods
Non-durable consumer goods
Energy

%

,
0
0
1
=
5
0
0
2

110

105

100

95

90

85

80

1
Q
7
0
0
2

2
Q
7
0
0
2

3
Q
7
0
0
2

4
Q
7
0
0
2

1
Q
8
0
0
2

2
Q
8
0
0
2

3
Q
8
0
0
2

4
Q
8
0
0
2

1
Q
9
0
0
2

2
Q
9
0
0
2

3
Q
9
0
0
2

4
Q
9
0
0
2

1
Q
0
1
0
2

Source: Eurostat, Short-term Business Statistics. 

1.6  Conclusions 

The European Union is in the midst of a considerable downturn. The recession originated in a 
major readjustment of consumption and saving behaviour of households after a boom period 
in which considerable distortions were accumulated — in other words, a classic demand-side 
recession. 

A close inspection of the boom years 2000-07 shows that if these growing distortions had any 
impact  on  competitiveness,  it  was  probably  only  modest  and  mostly  associated  with 
distortions in the allocation of labour across sectors within countries affected by a speculative 
bubble. External competitiveness does not seem to have been affected by these developments; 
large  increases  in  unit  labour  costs  in  some  Member  States  have  not  been  reflected  in  the 
share  of  exports  in  world  trade,  not  even  within  the  euro  area.  One  explanation  for  this 
apparent  paradox  may  be  the  different  setting  of  nominal  wages  in  the  tradable  and  non-
tradable  sectors.  In  turn,  these  differences  may  also  explain  the  growth  in  employment  of 
some domestic sectors in bubble economies, notably the construction sector. Those countries 
that  are  more  severely  affected  by  the  crisis  and  likely  to  undergo  a  longer  readjustment 
process,  especially  as  far  as  employment  is  concerned,  because  of  the  construction  sector 
workers  who  will  have  to  be  redeployed  to  other  sectors.  Other  countries  which  suffered 
collateral  damage  through  trade  and  integration  in  the  global  supply  chain  will  probably 
recover faster. 

EN 

57

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