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# 52011SC1188

**COMMISSION STAFF WORKING PAPER European Competitiveness Report 2011 /\* SEC/2011/1188 final \*/**

  

TABLE OF CONTENTS

4........... Access to
non-energy raw materials and the competitiveness of EU industry. 11

4.1........ Introduction. 11

4.1.1..... Context
of the analysis. 11

4.1.2..... The
goal of the analysis. 12

4.1.3..... Defining
non-energy, non-agricultural raw materials. 13

4.1.4..... Analytical
approach: a framework for interpretation. 14

4.2........ Contextual
data. 15

4.2.1..... Global
demand and the EU.. 16

4.2.2..... Long-term
price evolutions. 17

4.2.3..... The
EU’s supply from a global perspective. 18

4.2.4..... Trade
flows. 20

4.2.4.1.. Trade data. 20

4.2.4.2.. Trade of iron ore, critical raw materials and rare earths. 23

4.2.5..... Import
dependency: evidence from material flow data from Germany and the UK.. 26

4.2.6..... Secondary
raw materials and recycling. 27

4.3........ Qualitative
analysis results. 29

4.3.1..... Interrelation
of the selected industries in the value chain. 29

4.3.2..... Raw
materials insufficiency and related competitiveness issues. 31

4.3.2.1.. Cost competitiveness effects. 31

4.3.2.2.. Responses to shortages of raw material at industry level 36

4.3.2.3.. Policy implications at industry level 44

4.3.3..... The
role of the non-energy extractive industry. 45

4.3.3.1.. Challenges in the non-energy extractive industry. 45

4.3.3.2.. The role of innovation in the future of the non-energy extractive
industry. 46

4.3.3.3.. Policy implications. 46

4.4........ Conclusions
and policy discussion. 47

4.4.1..... Competitiveness
effects. 48

4.4.2..... The
potential of recycling and innovation. 49

4.4.3..... Policy
discussion. 50

5........... EU
Industry in a Sustainable Growth Context 63

5.1........ Introduction. 63

5.2........ Policy
and economic context 63

5.2.1..... EU
policy context 63

5.2.2..... Economic
context: industry gross value added (GVA) and employment 65

5.3........ Eco-performance
of the EU Industry. 71

5.3.1..... Energy
consumption and intensity. 71

5.3.2..... Greenhouse
gas (GHG) emissions and intensity. 76

5.3.3..... Material
flows and resource efficiency. 84

5.3.4..... Waste
generation and treatment 87

5.3.5..... Water 93

5.3.6..... Summary
and tentative discussion on the impact of the recent crisis. 96

5.4........ Eco-expenditure
and eco-innovation. 98

5.4.1..... Eco-innovation. 98

5.4.2..... Eco-innovation
and R&D on energy. 105

5.4.3..... Environmental
protection expenditures. 108

5.5........ Conclusions
and policy implications. 111

5.5.1..... Policy
instruments for sustainable growth. 111

5.5.2..... Policy
design and implementation. 114

Annex : Definitions and concepts. 117

6........... EU
industrial policy and global competition: recent lessons and way forward. 129

6.1........ Introduction. 129

6.2........ Key
challenges for the competitiveness of the EU economy. 130

6.2.1..... Exploiting
the full potential of the enlarged internal market 130

6.2.2..... Creating
a global level playing field with non-EU competitors. 131

6.2.3..... Boosting
the real economy in times of financial trouble and fiscal constraints. 135

6.3........ Fostering
strategic European interests. 139

6.3.1..... The
Lisbon Treaty and competitiveness. 139

6.3.2..... A
new industrial policy for the globalisation era. 140

6.3.3..... A
European policy approach to serve strategic European interests. 143

6.3.3.1.. European interest 144

6.3.3.2.. Strategic nature of such interests. 145

6.3.3.3.. European companies. 146

6.4........ Industrial
competitiveness throughout the production value chain. 148

6.4.1..... Access
to resources. 148

6.4.2..... Innovation. 149

6.4.3..... Access
to markets. 150

6.4.4..... Restructuring. 152

6.5........ Implications
for the interface between industrial policy and other competitiveness-related
policies  153

6.5.1..... Securing
the strength of the European industrial value chain. 153

6.5.1.1.. Applying merger control and antitrust enforcement to support
industrial competitiveness. 153

6.5.1.2.. Making full use of policy toolkits in the global context 156

6.5.2..... Enhancing
the scope, impact and timing of targeted state support 158

6.5.2.1.. Timely and efficient state aid assessment in a global context 158

6.5.2.2.. Maintaining a strong and diversified industrial base in Europe. 159

6.5.2.3.. Support for early adjustment processes and restructuring of
European enterprises. 159

6.6........ Conclusions. 160

7........... Sectoral
Competitiveness indicators. 165

ANNEX.. 177

List of background studies. 177

to the European Competitiveness Report 2011. 177

LIST
OF FIGURES

Figure 4.1: Raw
material use in the production process and the value chain: analytical
framework. 13

Figure 4.2: GDP and GDP evolution of major world countries. 14

Figure 4.3: Top-10 countries by GDP in 2050. 15

Figure 4.4: Price indexes of selected raw materials
(2000=100) 16

Figure 4.5: Share of EU-27 in world mining production. 17

Figure 4.6: Exports and imports of raw materials in the
EU-27, 2009 – part 1. 18

Figure 4.7: Exports and imports of raw materials in the
EU-27, 2009 – part 2. 19

Figure 4.8: Exports and imports of raw materials in the
EU-27, 2009 – part 3. 19

Figure 4.9: Relative evolution of imports-exports in the
EU-27 between 2005 and 2009. 20

Figure 4.10: Absolute evolution of imports-exports in the
EU-27 between 2005 and 2009. 21

Figure 4.11: Major trade flows of iron ore, 2009. 22

Figure 4.12: Production concentration of critical raw
mineral materials, 2006. 22

Figure 4.13: Supply and demand for rare earths, assuming
current trends continue. 23

Figure 4.14: Domestic extraction used, exports and
imports as a percentage of domestic material input, Germany 2007  24

Figure 4.15: Domestic extraction used, exports and
imports as a percentage of domestic material input, United Kingdom 2007. 25

Figure 4.16: Estimated waste stream recovery potential in
the EU in 2006 and 2020. 26

Figure 4.17: Average recycling rates for the EU-27 by
waste stream in 2006. 27

Figure 4.18: Location of the selected industries in the
value chain – Germany 2007. 28

Figure 4.19: Share of selected industries in the EU-27
GDP, 2006. 29

Figure 4.20: Waste: excluding scrap metal 38

Figure 4.21: European paper recycling. 41

Figure 5.1: Industrial GVA in the EU-25 USA and Japan,
1995-2007 (indexed at 1995 prices) 64

Figure 5.2: Total % changes in industrial GVA EU-25,
1995-2009. 65

Figure 5.3: Change in industrial employment and
industrial GVA, 1995-2007. 66

Figure 5.4: Change in industrial employment and GVA per sector
in the EU-25, 1995-2007. 67

Figure 5.5 Change in final energy consumption in million
toe from 1990 to 2008. 70

Figure 5.6: Energy intensity of EU industry
(manufacturing and construction, % change in final energy consumption versus %
change in GVA), 1995 and 2007. 71

Figure 5.7: Energy intensity sector by sector (final
energy consumption (in toe)/GVA in million euros (1995 constant prices)),
1995-2008. 72

Figure 5.8: Total GHG emissions in million Gg of CO2
equivalent, 1990-2008. 75

Figure 5.9: Change in EU GHG emissions and GVA – Whole
economy, i.e. all NACE rev. 1.1 sectors (GHG emissions (Gg CO2 equivalent)/GVA
(in million EUR at 1995 constant prices), 1995-2007. 76

Figure 5.10: Change in GHG emissions from manufacturing
and construction (UNFCCC) and GVA in the EU-23 (NACE rev. 1.1 D + F), 1995-2007. 77

Figure 5.11 Change in EU-25 Member States' industrial GHG
emissions, 2007-2010. 78

Figure 5.12: Change in industrial GHG emissions in the
EU-25, 2007-2010. 80

Figure 5.13: Change in industrial GHG emissions
(manufacturing and construction) and final energy consumption by industry in
the EU-25, 1995-2007. 81

Figure 5.14: Domestic material consumption (DMC) in the
EU-27 by components (in million tonnes) 82

Figure 5.15: Change in DMC and industrial GVA by Member
State, 2000-2007. 83

Figure 5.16: Domestic material consumption in the EU-27
by main material categories, 2000-2007. 84

Figure 5.17: Material productivity in the EU-25 in 2007 
– Industrial GVA in EUR (1995 constant prices) per tonne of DMC in 2007 and
change in material productivity, 2000-2007. 85

Figure 5.18: Total waste generation by industry in the
EU-27 (NACE rev.2 A-F), 2004-2008. 86

Figure 5.19: Change in total waste generation by industry
(NACE rev. 2 A-F) and GVA in the EU-27, 2004-2006  87

Figure 5.20: Total waste treatment in the EU-27,
2004-2008. 90

Figure 5.21: Water abstraction by EU manufacturing
industry by Member State, 1995-2007. 92

Figure 5.22: Change in EPE on wastewater and in water
abstraction by manufacturing industry in selected Member States,  2003-2007. 93

Figure 5.23: Change in EPE on wastewater and GVA in
industry in selected Member States, 2003-2007  94

Figure 5.24: Motives for environmental innovation
(percentage of enterprises with innovation activity), 2008 - Industry (without
construction) 99

Figure 5.25: Relative share of public support to
sub-fields of energy R&D in the EU-16. 104

Figure 5.26: Public support for R&D into renewable
energy resources, international comparison (2009 prices and exchange rates) 105

Figure 5.27: Public support of energy efficiency (not
only industrial) R&D (2009 prices and exchange rates) 106

Figure 5.28: Total environmental protection expenditure
by industry (NACE A-E, excluding construction) in selected Member States,
2001-2006. 107

Figure 5.29: Public-sector EPE investment and current
expenditure by Member State (% of GDP, 2008 unless otherwise indicated) 107

Figure 5.30: Change in industrial EPE and industrial GVA
(NACE A-E, excluding construction) in selected Member States, 2003-2007. 109

Figure 6.1: Sectoral manufacturing output and employment
developments. 134

Figure 6.2: Change in new loans below and above
EUR 1 m — year-on-year change. 135

Figure 6.3: Changes in credit standards applied to the approval
of loans or credit lines to enterprises (net percentage of banks reporting
tightening credit standards) 136

LIST
OF TABLES

Table 4.1: Crosscutting sectoral competitiveness issues
related to non-energy raw materials. 61

Table 5.1: Percentage of enterprises with innovation activity
reporting an environmental benefit, 2008 – Industry (without construction) 102

Table 5.2: NACE rev. 1.1 classifications used in this
report 119

Table 5.3: Entergy intensity of manufacturing plus
construction (NACE rev. 1.1 D+F) by Member State in selected years  121

Table 5.4: Energy intensity of industries, for EU-25, in
selected sectors and selected years Energy use in thousand toe per million EUR
GVA at 1995 constant prices. 122

Table 5.5: GHG emission intensity of manufacturing plus
construction (NACE rev. 1.1 D+F) by Member State plus USA and Japan in Gg CO2
eq. per million EUR GVA at 1995 constant prices. 123

Table 5.6: Materials productivity by Member State per
million EUR of industrial GVA (NACE rev. 1.1 A-F) at 1995 constant prices, per
tonne. 124

of DMC for the whole economy in selected years. 124

Table 5.7 – Green components in economic stimulus
packages, 2009. 125

List
of country abbreviations

AT || Austria

BE || Belgium

BG || Bulgaria

CY || Cyprus

CZ || Czech Republic

DE || Germany

DK || Denmark

EE || Estonia

EL || Greece

ES || Spain

FI || Finland

FR || France

HU || Hungary

IE || Ireland

IS || Iceland

IT || Italy

LI || Liechtenstein

LT || Lithuania

LU || Luxembourg

LV || Latvia

MT || Malta

NL || Netherlands

NO || Norway

PL || Poland

PT || Portugal

RO || Romania

SE || Sweden

SI || Slovenia

SK || Slovakia

UK || United Kingdom

Acknowledgements

This report was prepared in the
Directorate-General for Enterprise and Industry under the overall supervision
of Heinz Zourek, Director-General, and Viola Groebner, Director of the
Directorate for Industrial Policy and Economic Analysis.

The publication was developed in the unit ‘Economic
Analysis and Impact Assessment’, under the management of Konstantin Pashev,
Head of Unit, and João Libório, Project Manager.

Specific contributions and coordination of
work on individual chapters were provided by Tomas Brännström, Jorge
Durán-Laguna, Maya Jollès, João Libório, Ágnes Magai and Mats Marcusson. See
page 301 for a list the background studies on which individual chapters are
built.

Comments and suggestions by many colleagues
from the Directorate-General for Enterprise and Industry as well as from other
services of the Commission are gratefully acknowledged.

Statistical support was provided by Luigi
Cipriani and Claudio Schioppa. Dominique Delbar-Lambourg and Patricia
Carbajosa-Dubourdieu provided administrative and organisational support.

Comments on the report would be gratefully
received and should be sent to:

Directorate-General for Enterprise and
Industry

Unit B4 - Economic Analysis and Impact
Assessment

European Commission

B-1049 Brussels (Belgium)

or by e-mail to konstantin.pashev@ec.europa.eu
or joao.liborio@ec.europa.eu

4.
Access to non-energy raw materials and the
competitiveness of EU industry
4.1.
Introduction
4.1.1.
Context of the analysis

The accessibility and affordability of
non-energy, non-agricultural raw materials[1]
is crucial for ensuring the competitiveness of EU industry.[2] The competitiveness of several
European sectors such as electronics, cars, chemicals or construction can be
hampered by a limited or more costly supply of certain raw materials. Like the
US and Japan, the EU is highly dependent on imports for many of its raw
materials for industrial and manufacturing purposes. While the EU has many raw
material deposits, their exploration and extraction is hindered by increased
competition for land use and the higher costs of safeguarding the environment
and human health.

The fast-changing geopolitical and economic
context affects the supply and demand of these materials. On the one hand, the industrialisation
and urbanisation of emerging economies (e.g. the BRICs) has increased global
demand for particular industrial raw materials,[3]
as these countries have become more important purchasers of such materials on
global markets.[4]
Also the fast diffusion of emerging technologies is expected to raise global
demand.[5]
On the other hand, the mining and production of certain raw materials is
concentrated in a few countries, and the free and transparent operation of
global markets in these raw materials is not ensured. In many cases, distorting
measures such as export taxes, quotas, import subsidies, and restrictive
investment rules hamper access for EU industry.

Recent sectoral studies have highlighted a
number of problems: i) high volatility of world market prices; ii) increased use
of short-term supply contracts (e.g. supply of iron ore); iii) monopolisation
of supply for certain ‘high-tech’ materials in certain countries; iv) growing
competition and demand from emerging economies and increased concentration of suppliers
of raw materials, leading to a more difficult price negotiation position,
especially for SMEs.

The European Commission has launched a
number of policy initiatives to address the challenges regarding access
(conditions) to raw materials. In particular, the Raw Materials Initiative has
highlighted the importance of access to non-energy, non-agricultural raw
materials for the competitiveness of crucial industries in the EU-27 economy.[6] The document set out a three-pillar
approach towards an integrated strategy. These pillars are:

1.
Fair and sustainable supply of raw materials
from global markets;

2.
Fostering a sustainable supply of raw materials
within the EU;

3.
Boosting resource efficiency and promoting
recycling.

This was later followed up by the
identification of 14 critical raw materials.[7]
Their critical nature is based on the fact that they are entirely produced in a
limited number of countries outside the EU, and have low substitutability and
recycling rates. The Communication of February 2011 on ‘Tackling the challenges
in commodity markets and on raw materials’ examined the problems in the wider
context of commodity trade and emphasised the role of commodity derivatives and
the link between physical and financial markets.[8]
The overarching flagship initiative under the Europe 2020 Strategy for a resource-efficient
Europe,[9]
considers the problem of non-energy industrial raw materials in the wider
context of a resource-efficient Europe in a global setting and in relation to
related issues such as climate change, biodiversity, land use, deforestation, sustainable
consumption and competitiveness. In March 2011 the Council of the European
Union endorsed the three-pillar approach and the accompanying actions.[10] The Communication on Trade,
Growth and World Affairs (2010) also addressed the strategic importance of access
to an undistorted supply of raw materials to ensure the competitiveness of the
EU economy[11].
The upcoming Communication on the European Innovation Partnership on Raw
Materials will address the role of R&D and innovation in tackling the
scarcity of raw materials.

4.1.2.
The goal of the analysis

The main objective of this chapter is to
analyse the nature and degree of vulnerability of the EU industry in terms of
access to raw materials in a systematic and qualitative way. The focus is on
the competitiveness effects for certain industries, taking into account the
supply constraints on non-energy, non-agricultural raw materials from a
sectoral point of view. ‘Access’ to raw materials is understood in a wider
sense, meaning also the access conditions.

As part of this overall objective, this
chapter looks into:

·
Recent trends in global demand, the EU's supply
and trade in raw materials, as well as the role of secondary raw materials and
recycling in Europe.

·
The competitiveness effects of a set of selected
sectors for which raw materials are a critical factor in their relative global
competitiveness. It examines supply-related issues regarding raw materials,
e.g. price volatility, location of crucial materials, changes in contracting
terms, etc., and the responses at company level to these challenges, including
improving material efficiency, recycling, use of substitute materials, and
organisational strategies.

·
The role of the EU extracting and recycling
industries in reducing the vulnerability of EU industries with respect to
access raw materials.

·
Potential public policies concerning access to
raw materials, e.g. measures to promote resource efficiency, undistorted access
to raw materials in third countries, measures to promote sustainable supply
from domestic sources (mining plus recycling), and other aspects such as
globalisation and trade in waste streams.

In terms of geographical coverage the focus
is on a comparison of the EU as a whole with the rest of the world (e.g. the
main emerging international players, such as China).

The analysis is qualitative in nature,
comprising an independent and systematic analytical exercise based mainly on
interviews with industry stakeholders, and on relevant literature and data.

4.1.3.
Defining non-energy, non-agricultural raw materials

Non-energy, non-agricultural raw materials
can be defined as raw materials that are mainly used in industrial and
manufacturing processes, semi-products, products and applications and are not
primarily used to generate energy. As such, industrial minerals and purified
elements (e.g. feldspar, silica), ores and their metals and metallic
by-products (e.g. copper, iron but also germanium, rhenium, rare earth
elements) and construction materials (e.g. sand gravel, aggregates) are within
the scope, but it also includes materials such as wood and natural rubber.
Furthermore, crude oil and gas can be also considered as raw materials for
industrial production [12].

This chapter focuses mainly on unprocessed non-energy,
non-agricultural raw materials. However, such raw materials are processed into
various products and components used by sectors further up the product value
chain. These sectors are thus affected indirectly by the same raw materials
issues.

4.1.4.
Analytical approach: a framework for
interpretation

Figure 4.1 depicts the relationship between
raw materials and competitiveness, in the context of the supply chain. It will
serve as the backbone for the various parts of the analysis.

The top part of the figure indicates four
layers of competitiveness that can be distinguished at sectoral level: inputs,
structure, processes and outcomes. These are related to the product market, in
which both producers and consumers (or businesses in the case of intermediate
consumption) operate.

The middle part of the figure shows the raw
material flows throughout the production process, going from raw material to
waste. An important aspect is the recycling of raw materials, leading to
secondary material flows that reduce the import dependency and on top of that
are often associated with lower energy processing costs.

The bottom part indicates the related
risks. While problems such as increasing material prices and price volatility
as well as monopolisation of supply for certain materials and trade restriction
measures can be classified as supply risks, the problem of growing competition
and consumption in emerging markets concerns the demand side of the product
market. Also, risks and (technological) challenges can be identified at the
recycling stage can be identified. These risk factors can be further refined,
such as increased demand due to the development of emerging technologies,
changes in consumer preferences, etc.

Figure 4.1: Raw material use in the production process
and the value chain: analytical framework

Source: IDEA Consult.

4.2.
Contextual data

This section presents
data portraying the EU in its wider global economic context with respect to
non-energy, non-agricultural raw materials. The data revolve around five
themes:

–
Demand: GDP growth of major economic blocks in
the world, indicating where increasing demand for raw materials is expected to
come.

–
Price: changes in the prices of particular raw
materials e.g. copper, zinc, aluminium.

–
Supply: location of major deposits in the world
and the EU’s position.

–
Trade: major raw material trade flows in terms
of value and quantities, indicating that the EU is a major importer.

–
Secondary raw materials and recycling: estimated
waste stream recovery potential.

4.2.1.
Global demand and the EU

The key factors driving the demand for raw
materials are global economic and population growth and new technological
applications. In particular, the growing appetite of the emerging economies for
raw materials is seen as major force driving global demand.[13] The influence of China and,
increasingly, India is commonly seen as dominant in this context. This is both
a reflection of the scale of their economies and their current economic
dynamism. Since the 1990s, developing countries have significantly increased
their consumption of raw materials to help fuel their economies, and are now
among the leading consumers and high long-term demand is expected.[14]

Figure 4.2 shows the GDP of major countries
in the world in 2010 and estimates for 2015. The EU-27 and the US are the main
economic blocks, both in 2010 and in the near future. Yet for other countries,
in particular the BRIC countries, relatively significant changes are
anticipated. According to IMF forecasts, India, Russia and Brazil will have
economies of similar sizes as those of France, Italy and the UK.

Figure 4.2: GDP and GDP evolution of major world
countries

Note: The vertical scale is expressed in billion USD.

Source: IMF.

In
2010, China passed Japan as the world’s second largest producer of goods and
services. Japan is followed by the major European countries Germany, France,
the UK and Italy. For the time being, the United States’ GDP amounts to two and
a half times the GDP of China. The combined GDP of the EU-27 is about 10%
higher than the GDP of the US. According to the IMF's forecasts for the near future,
this world order will not change substantially by 2015. However, it is expected
that China's GDP will be more than half of US GDP by 2015.

According
to other forecasts[15]
the economic world order is expected to change substantially by 2030 (see
Figure 4.3). China will likely have surpassed the United States to top the GDP
rankings, with India third. By 2050, the traditional large economies such as
Japan, UK, Germany and France are expected to fall further back in the global
GDP rankings. Of course, one has to bear in mind that long-term forecasts are
by their nature very speculative. Yet they point to a certain economic growth
pattern that will also have an impact on global demand for non-energy, non-agricultural
raw materials.

Figure 4.3: Top-10 countries by GDP in 2050

Note: The vertical scale is expressed in billion USD.

Source: Goldman Sachs, Global Economics Paper, n 170, ‘The expanding Middle:
The Exploding World Middle Class and Falling Global Inequality’, July 2008.

4.2.2.
Long-term price evolutions

Demand from emerging economies has pushed
up prices for important metals and minerals.[16]
China's economic dynamism is described as a major factor in commodity market
developments. China currently consumes about 30% of the world's base metals,
against about 5% in the early 1980s. Increasing demand from emerging economies
‘appears to represent a longer-term structural shift in consumption’ and not
just a ‘cyclical movement’[17].
The literature also suggests that global markets for metals and minerals tend
to be volatile, partly due to time lags in the response of supply to changes in
demand, but technological change in products also often changes the demand for
strategic metals and minerals, contributing to high price volatility.[18] Furthermore, the export
restriction measures often applied, such as quotas and minimum export prices
have also contributed to soaring raw materials prices.

From
1990 onwards, prices had been relatively stable up to the year 2002. From 2003,
the prices of the materials considered here generally started to increase,
sometimes gradually (aluminium, cement, iron ore) and sometimes sharply
(copper, zinc, iron and steel scrap). Much of the increase in prices from 2003
to 2008 can be explained by the strength of the demand and the lagged response
of the supplying industry (Humphreys, 2009). In the case of copper, prices
stabilised again from 2006 onwards, while in the case of zinc, prices fell
sharply again. The prices of iron ore and steel scrap continued to increase
vigorously up to 2008.

When
prices are measured against their year 2000 levels, one can observe that prices
for zinc, bauxite, aluminium and cement rose at a gentle pace, with increases of
between 20% and 60% during 2000-2008 (See Figure 4.4). On the other hand,
prices for iron ore almost tripled during the same period. Prices for iron and
steel scrap and copper more than tripled, with an average yearly increase of
17% during this period. While the economic crisis of 2008/9 had a significant
impact on the prices of metals, some metal prices, such as copper and iron ore
– have recovered to near pre-crisis levels.

Figure 4.4: Price indexes of selected raw materials (2000=100)

Source: United States Geological Survey (USGS).

4.2.3.
The EU’s supply from a global perspective

The
supply of non-energy, non-agricultural raw materials is described as relatively
inelastic in the literature. This is mainly the result of long lead-times in
the mining and recycling industry. Investments in the extractive industries are
associated with high capital intensity and a long-term payback characteristic,
often involving substantial risk.[19]
Furthermore, investments are very often influenced by environmental
considerations and political decisions. This is one of the reasons why supply
does not immediately respond to changes in demand, since weak price signals can
leave a ‘legacy of underinvestment’ reaching years into the future.[20] The resulting lag in the
response to growing demand can translate into temporary supply gaps.

The second pillar of the EU’s Raw Material
Initiative focuses on fostering sustainable supply within the EU. Figure 4.5
indicates the share of the EU-27 in world mining production for a set of
minerals and metals.

Figure 4.5: Share of EU-27 in world mining production

Source: IDEA
Consult based on USGS.

For
most mining materials, the EU-27 only accounts for a small share of world
mining production. Only for salt and potash is mining production in EU-27 on a
global scale, with shares of 20% and 13% of world production, respectively. For
some critical raw materials, EU-27 share is below 5% (tungsten) or even non-existent
(antimony, manganese, platinum). Due to price increases, the return on
investment of recovery and recycling of certain materials has changed over
recent years, especially in Europe and North America.[21]

Within
the EU, several countries are quite significant producers, yet in terms of
global supply the amounts produced are relatively small. Austria was estimated
to have been the fourth biggest tungsten producer in the world in 2009.
Portugal is also a significant producer of tungsten. Poland is the EU’s biggest
producer of silver, and also quite active in producing of copper, zinc and
lead. Ireland is the EU’s largest producer of zinc. Sweden has a variety of raw
materials. It is the leading producer of iron ore in the EU, and also processes
lead, gold and zinc, too. Bulgaria and Spain are also quite significant
producers of gold. Within the EU, Germany produces most of the potash and the
largest amount of ammonia and salt.

4.2.4.
Trade flows

The
literature on trade and global supply chains highlights the highly uneven
distribution of metal and mineral reserves across countries as a key contextual
factor (see for example OECD 2010a). Large shares of important raw materials
are concentrated in a relatively small number of countries and other economies
have limited domestic supplies and therefore depend on imports. Some of the
major producers and exporters of raw materials are located in developing
economies. The global supply chains for essential raw materials have become
increasingly complex and interdependent, which leaves supply relatively
vulnerable. The vulnerability of industry can be assumed to be greatest in
sectors unable to replace scarce and expensive raw materials with more abundant
and cheaper materials with similar properties (Angerer et al., 2009). The
unequal distribution of raw material reserves is also considered to be an
important source of trade friction.

4.2.4.1. Trade data

The
trade balance for raw materials in the EU-27 leans strongly to the import side
(see Figure 4.6 and 4.7.). For the main raw materials, unagglomerate regards
the most important materials, such as unagglomerated iron ore and copper ore,
imports surpassed USD 5 billion and USD 4 billion in 2009, respectively. Imports
of agglomerated iron ore and precious metals each amounted to more than USD 1
billion in 2009. Other important imports, surpassing USD 300 million in 2009,
are ores from aluminium, molybdenum and titanium ores.

Figure 4.6: Exports and imports of raw materials in
the EU-27, 2009 – part 1

Note: values are in million USD.

Source: UN Trade data.

Figure 4.7: Exports and imports of raw materials in
the EU-27, 2009 – part 2

Note: values are in million USD.

Source: UN Trade data.

Within
the EU-27 some materials have a positive export balance. However, these balances
are much smaller than the positive import balances. Silver has a positive
export balance amounting to USD 80 million. Other materials with a positive
balance sheet are tungsten and some slag and ash materials (Figure 4.8).

Figure 4.8: Exports and imports of raw materials in
the EU-27, 2009 – part 3

Note: values are in million USD.

Source: UN Trade data.

Over
time, it is worth noting that between 2005 and 2009, net imports of some
materials into the EU-27 increased strongly (Figure 4.9). This was the case for
‘niobium, tantalum and vanadium ores’, and for some ash and slag materials. Net
imports of lead ores, copper ores and nickel ores also increased. On the other
hand, net imports decreased for certain materials - roasted molybdenum
concentrates and waste of iron, - and certain ores - zirconium, chromium, zinc
and manganese.

Figure 4.9: Relative evolution of imports-exports in
the EU-27 between 2005 and 2009

Source: UN Trade data.

Figure
4.10 presents the largest changes in absolute net imports were seen evolution
the case of copper with an increase of more than USD 1 billion, and in the case
of iron with a decrease of more than USD 1 billion (both agglomerated and
unagglomerated) decreased in the same value.[22]
Net imports of most materials decreased between 2005 and 2009, by USD 600
million for zinc ores and by USD 500 million for molybdenum ores.

Figure 4.10: Absolute evolution of imports-exports in
the EU-27 between 2005 and 2009

Note: Values are in million
USD.

Source: UN Trade data.

4.2.4.2. Trade of iron ore, critical raw materials and rare earths

Iron
ore, critical raw materials and rare earths are especially important for the
sound functioning of European industry. It is worth taking a closer look at
global trade in these materials.

Iron
/steel is a very important metal being used widely many sectors. The major
flows of iron ore are from the two major production regions (South America,
notably Brazil, and Australia) to the major consuming region (Asia, notably
China, Japan and Korea) (see Figure 4.11). The two producing regions export a
large share of their production. Another important producer, India, only exports
half of its iron ore production, being an important consumer too. Europe, with
a very low production rate (see Figure 4.4), imports mainly from South America
and the Russian Federation. China, as an important producer, has no substantial
exports of its iron ores. In fact, China needs to import iron ores from Russia,
Australia, India and South America.

Figure 4.11: Major trade flows of iron ore, 2009

Source: adapted from www.bhpbilliton.com

The
above overview of certain selected critical raw materials (see Figure 4.12) shows
the high dependency of European industrial countries on other countries, very
often third world countries or emerging economies. By far, the most
resource-rich country in this respect is China. This country is the world’s top
exporter of rare earths, graphite, magnesium, antimony and fluorspar. Moreover,
it has the largest reserves of rare earths, tungsten, graphite and antimony.
Other important countries for these resources are Russia, DR Congo, South
Africa, Brazil and Mexico. European dependency can be observed in the import
column: very often, the most industrialised countries (Germany, France, Spain,
Italy, UK, the Netherlands, Austria and Belgium) are among the top 15 importers.

Figure 4.12: Production concentration of critical raw
mineral materials, 2006

Source: Press release by European Commission MEMO/10/263 on 17/06/2010.

Recent
trends often show a similar picture. Following the economic downturn, demand
for these critical raw materials fell on a global scale. In 2010, global demand
started to increase again, driven by emerging countries, resulting in price
increases in general. Combined with the fact that technological evolution is
further pushing demand for some of these critical raw materials (graphite, rare
earths), prices for 2011 are expected to soar to levels far above those before
the economic downturn. Mining projects are (re)starting production and new
mining opportunities are being explored worldwide (magnesium, fluorspar,
cobalt, antimony). Only in the case of cobalt is production likely to outpace
demand, possibly resulting in lower prices.

Rare
earth elements[23]
are widely used in a variety of applications that are growing on a global
scale, such as cell phones, computers, electric and hybrid vehicle motors, wind
turbines etc. Rare earth elements are relatively plentiful in the earth's
crust;. However, it is difficult to find them in sufficient concentration in
places where they can be profitably mined and processed. China, with the most
abundant resources in the world, dominates the world market and exports the
largest amounts of rare earth compounds and metals, followed by Austria, Japan,
Russia and the USA. In recent years, the biggest importers of rare earth have
been Japan, USA, Germany, France and Austria. Figure 4.13 shows that global
demand for rare earth is expected to outpace Chinese supply if current trends
continue. To meet this demand, production and supply by the rest of the world
should further increase during the following years.

Figure 4.13: Supply and demand for rare earths,
assuming current trends continue

Source: Industrial Minerals Cooperation, http://www.industrialmineralscorp.com.au/
accessed on 2nd February 2011.

4.2.5.
Import dependency: evidence from material flow
data from Germany and the UK

A
natural question to ask after having discussed the limited supply of non-energy,
non-agricultural raw materials in Europe, its relatively large net import
rates, and the EU’s recovery prospects is to what degree can the EU´s material
requirements be covered by own supply. It is clear from the analysis in
previous sections that the answer in general is relatively little. However, a
more precise answer can be given on the basis of material flow data. These data
are shown for two major economies in the EU: Germany and the UK.

Material
flow data from Germany and the UK show a 100% import dependency for a range of
raw materials, such as bauxite, alumina, nickel, copper, lead, zinc, tin and
iron ores, as there is virtually no domestic extraction that can be used in
domestic industries. Germany imports substantially higher shares from inside the
EU-27 in comparison with the United Kingdom.[24]

For
certain materials, domestic extraction has to be supplemented by imports. In
Germany, this is the case for marble and granite, chalk and slate. In Germany,
domestic extraction fills up the domestic needs for limestone, salt, sand and
gravel and certain non-metallic minerals, while there is an extraction
overabundance that can be exported for wood and certain clays.

Figure 4.14: Domestic extraction used, exports and
imports as a percentage of domestic material input, Germany 2007

Note: DEU: domestic extraction used which is the total amount of the
domestic mining/quarrying extraction used in domestic industries or for export.
DMC: domestic material consumption:, which is the total of the domestic extraction
used and the difference between imports and exports, which is the total amount
used of a certain material in domestic industries.

Source: Eurostat, Material Flow Accounts.

In
the UK, however, significant amounts of fertiliser materials, wood and biomass are
available from domestic sources, though additional imports are needed. Domestic
extraction meets domestic demand for chalk and limestone. Small surpluses can
be exported in the cases of salt, sand and gravel, certain clays and slate.

Figure 4.15: Domestic extraction used, exports and
imports as a percentage of domestic material input, United Kingdom 2007

Source: Eurostat,
Material Flow Accounts.

4.2.6.
Secondary raw materials and recycling

A substantial
increase in world output has boosted the demand for raw materials used for
industrial and manufacturing purposes. At the same time, the quantity of waste
produced has risen, so the potential to use more secondary raw materials as
inputs has also increased. As the previous section reports, although the EU’s
global position is relatively modest as a supplier of primary raw materials, in
terms of secondary raw materials, there is still substantial potential.

Recycling has often
been identified as an important component of improved and sustainable resource
management. Together with the development of substitute materials, recycling
and improved resource management may reduce the current global population’s
current resource footprint, implying a decoupling of economic growth and
environmental impact.

As regards the
recovery and reuse of raw materials good waste management is a crucial point.
The EU has seen a significant change in waste management in general, driven by
EU and national legislation[25]
and supported by rising prices for both energy and non-energy raw materials.

Birnstengel and
Hoffmeister (2010) estimated that in 2006, 23 % of the EU’s total waste stream
could be recovered as secondary raw materials, amounting to 675 million tonnes.
Somewhat more than half was actually being recovered for energy and material,
leaving 45 % of the potential still largely unused, mainly dumped as landfill
or incinerated without energy recovery. Figure 4.16 indicates the EU’s
recycling potential for each of the 17 identified waste streams for 2006 and
projections for 2020. It is evident that the potential differs across waste
streams. The biggest potential is found for paper, plastics, bio-waste and
wood, but also for iron and for ashes and slag.

Figure 4.16: Estimated waste stream recovery
potential in the EU in 2006 and 2020

 Source: Birnstengel and Hoffmeister (2010).

To
a certain degree, the potential depends inversely on the actual EU recovery
rate. However, the variance across Member States also plays a role. Ceteris
paribus, the higher the variance, the higher the potential. Figure 4.17 shows
the EU recovery rate per material and the range of recovery rates across Member
States. One can observe that for the major raw materials (rubber and tyres,
iron and steel, copper, lead, paper and cardboard, aluminium, solvents, zinc,
glass and ashes) the recovery rates are more than 60 % for the EU as a whole.
For other metals, plastics and textiles, recovery is still on the low side.

Figure 4.17: Average recycling rates for the EU-27 by
waste stream in 2006

Note: the yellow whisker plots indicate the ranges
over the Member States. The green bars indicate recovery rates for the EU-27 as
a whole.

Source: Birnstengel and Hoffmeister (2010), p.4.

One
may conclude that for certain metals and minerals there is still substantial
untapped potential within the EU as a whole for the recovery of non-energy raw
materials.[26]
Conversely, for other materials such as copper, aluminium, lead, zinc as well
as ‘other metals’, recovery is gradually reaching its full potential.

4.3.
Qualitative analysis results

The following section complements the
statistical evidence with qualitative information from expert interviews for a
selection of industries. They were selected through an iterative process,
starting with a literature review, followed by inquiries among experts for an
independent view and subsequently discussions with industry representatives.[27] In this section, the positions
of the selected sectors in the value chain are first identified, then the main
competitiveness issues with respect to raw materials shortages are discussed.
Following this, policies related to each sector and the role and challenges of
the European non-energy extractive industry are illustrated, since the industry
plays an increasing role in reducing dependency on imports of raw materials.

4.3.1.
Interrelation of the selected industries in the
value chain

An important aspect is the interrelation of
the raw material intensive industries and the way in which raw materials risks
and consequences pass through the value chain. To give an example, the Figure
4.18 for Germany presents the share of the selected industries to GDP and their
position in the value chain. The latter is calculated as the percentage of
output produced for final use.[28]

Figure 4.18: Location of the selected industries in
the value chain – Germany 2007

Note: the numbers refer to the NACE
classification.

Source: IDEA Consult based on Eurostat: symmetric
input-output table for Germany, 2007.

An important observation is that industries
higher up in the value chain contribute to a larger degree to the economy’s
GDP. While in certain EU Member States such as Sweden, metal ores and other
mining and quarrying might have bigger weights in the economy, it is
characteristic for EU economies that these activities account for relatively
small shares in overall GDP.

In order to present a picture closer to the
situation of the EU-27 and to the selected sectors discussed later, Figure 4.19
shows the % share in GDP for the EU-27 as a whole. In general, one can observe
a similar pattern for the EU-27 as for its largest economy, in terms of
relative position. Yet there are a few important differences. The German economy
has relatively higher shares for most of the selected sectors. The share of
machinery and equipment is much lower for the EU as a whole than for its main
economy. Based on the economic importance of the manufacturing sectors and
their high raw material intensity, the impacts of shortages of raw materials on
the steel, non-ferrous metal, automotive, chemical as well as paper and pulp
industries will be investigated in the next section.

Figure 4.19: Share of selected industries in the
EU-27 GDP, 2006

Note: ‘Basic iron and steel’, ‘Basic precious and
other non-ferrous metals’ and ‘Recovery of sorted materials’, based on data 2008.

Source: Eurostat.

4.3.2.
Raw materials insufficiency and related
competitiveness issues

The competitiveness effects of non-energy
raw materials on the selected European industries are illustrated in this
section. Two main competitiveness issues can be identified in terms of raw
materials shortages. The first concerns cost competitiveness effects on
essential raw material inputs for production, stemming from different sources,
such as increasing global demand, trade restrictions, transportation costs etc.
The second issue concerns the solutions and strategies that industries tend to adopt
to tackle the relative shortage of raw materials, including increasing material
efficiency, using recycled and substitute materials, as well as choosing
various organisational strategies. Finally, the policy implications relevant to
each industry are presented.

4.3.2.1. Cost competitiveness effects

The input effects resulting from shortages of
raw materials differ across industries, not only in terms of subject, but also
in terms of weight. The price increase in globally-traded raw materials has hit
most industries, ranging from steel and non-ferrous metals, to sectors such as
car manufacturing. There are several reasons for rising input costs for raw
materials. Those most important for the sectors selected will be illustrated
here.

First, prices for most raw materials have
been escalating over the last decade (see section 4.2.2). Prices of raw
materials depend mainly on the time lag with which supply follows demand. Increasing
demand from emerging countries has been a major factor accounting for the rise
in prices. Clearly, these lagged adjustments have an important effect on price
levels and there volatility.

Second, besides supply scarcity and
adjustments, supply concentration is also a factor in determining prices. A large
share of many raw materials is concentrated in a small number of countries,
which often apply export restriction measures.[29]
Export restrictions lead to a decrease in export volumes, thus affecting global
competition and supply chains. Export restrictions contribute to pushing up
international raw material prices due to curbs on supply to the global market,
while domestic consumers of raw materials enjoy lower input costs for
production. Certain countries often support their domestic industries by offering
them lower prices for raw materials (and energy). So the gap between domestic
and international prices provides an artificial cost advantage for domestic
consumers[30].

Third, Europe faces a competitive
disadvantage in terms of transport and trade costs for raw materials whose
sources are concentrated in other continents, e.g. in Asia, Africa or South
America.

Finally, the oligopolistic nature of
production for many raw materials, as well as changing contract terms, also
affects prices. Due to the relatively strong bargaining position of suppliers,
the duration of contracts has been switched from long-term to short term, and
negotiations take place more frequently. This leads to price volatility, and in
many cases, price increases.

All of these dimensions may raise production
costs directly or indirectly. When this increase is not equalled in other
regions of the world, Europe's competitive position deteriorates. The more raw
material-intensive an industry is, the stronger the effects on competitiveness are
likely to be. The impacts of issues concerning raw materials can differ depending
on their place in the value chain. Process industries such as non-ferrous metal
industry are directly affected, while industries active further down the value
chain, such as the car industry, undergo knock-on effects from the same raw
material issues. The market structure and power relations between industries
along the value chain determine the extent to which a shortage of raw materials
is transmitted to downstream industries and, ultimately, to the final consumer.
Below, selected sectors are given as examples to illustrate the related cost
competitiveness effects.

·
Steel industry

As one of the key sectors in the EU, the
steel industry is a good example to illustrate the channels through which prices
for the main input material for production have been escalating for the main
input material. This puts additional competitive pressure on producers if costs
to downstream industries and consumers can not be passed on. Rising costs for raw
material in this sector stem from different sources such as the oligopolistic
structure of the iron ore market, trade costs and unfair trade conditions.

The steel sector is very dependent on the
supply of raw materials. In 2010, costs of raw materials accounted for roughly
70% of total costs, and iron ore[31]
for more than 40%. Even though the EU produces iron ore, a significant portion
of iron ore needs (84%) is imported from overseas. Accordingly, costs of raw
material have a considerable impact on profitability and strategic investment
decisions.

Following a strong increase in market
concentration over the last decade, three big suppliers[32] control the market for the
supply of iron ore. Over a third of the world supply of iron ore and 67% of
world seaborne iron ore are concentrated in the hands of these three major
exporters. One of the consequences of this oligopolistic structure is that iron
ore prices have outpaced mining costs significantly. Prices for iron ore are
now about four times the cost of production (about USD 30.00/tonne) at main
mines[33].
Producers’ market power has increased significantly, resulting for example in
the introduction of short-term contracts which transfer the price hikes, and
associated risks, more easily further downstream in the supply chain. Since
2010, after a tradition that lasted 40 years, contract prices are set on a
quarterly basis, reflecting a switch of power from the steel industry to the
mining industry. As well as higher prices, the steel industry also faces price
uncertainty. This affects the its ability companies to hedge against the risk
of higher prices in future make forward-looking business plans, more generally.

As prices of iron ore are set globally,
increased input prices would not necessarily create an advantage for countries
with better access to iron ore. However, producers in regions with abundant
reserves usually enjoy a strategic cost advantage over steel producers that
need to import iron ore from abroad. The cost of raw materials in production
has been highest for Western Europe, while Russia, India, South Africa and Brazil
are among the most competitive steel producers in the world, partly due to
local access to iron ore resulting in lower raw material costs.[34]

The competitiveness of the European steel
industry is also affected by high transport costs for imported iron ore and
other raw materials. According to Eurofer[35],
transport costs represent up to 15% of the production costs. It is clear that
countries with better access to raw materials have a competitive advantage because
of lower transport costs.

Export restrictions are partly responsible
for the limited supply of iron ore available or for higher prices on the global
market. The forms of export restriction most often applied are export taxes and
quotas, which have contributed to raising international prices for iron ore and
scrap. Export taxes imposed mainly by emerging countries can range from between
5-20% for iron ore and 10-35% for scrap, pushing up international prices
significantly. Additionally, emerging countries producing steel are also
imposing export restrictions on the export of scrap, giving an unfair cost advantage
to the local industry.

The combination of the above factors,
basically pushed by the increasing demand from industrialising economies, has
resulted in serious price increases for both iron ore and scrap. The cost
structure of steel production has gone through a significant change. In 2005,
the cost of iron ore in the production process for Western Europe accounted for
slightly above 20% against an estimated 40% in 2010.[36] The extra costs and risks
(because of difficult planning and hedging) are also problematic for the steel
industry's customers, as costs are passed on down the supply chain as far as
possible.

·
Non-ferrous metals industry

The non-ferrous metals[37] industry can be characterised
by competitiveness issues similar to those the steel industry faces. Trade
restrictions and subsidies are often applied by countries producing raw
materials. The industry incorporates a range of activities along the value
chain, including mining, smelting, recycling and refinery upstream, and second
processing and fabrication intermediaries further downstream. The products of
the industry, non-ferrous metals, are important inputs for a range of economic
activities, such as transport, mechanical engineering, aerospace, construction,
packaging, electricity and energy, consumer electronics, medical devices etc.

The inputs needed by
the non-ferrous metal sector include virgin metal ores and concentrates and
recyclates. The European non-ferrous metal industry is highly dependent on the
imports of these metals, including ores, concentrates and refined metals and
scrap. Raw material costs can range from 49% to 85% of total production costs
in the industry, depending on the subsectors and type of products. The balance
of supply and demand determines the price of the metals on the exchanges.

The non-ferrous metal industry, like the
steel industry is very often targeted by trade distortion measures, in the form
of export restrictions, trade subsidies and state support in non-EU countries.[38] These measures, coupled with
increasing global demand, have resulted in prices hikes and volatility on the
global market. They result in relatively higher input costs and higher levels
of uncertainty for the European non-ferrous metal industry. Several metal-producing
countries, such as China, Russia, and Ukraine have applied trade restrictions
on exports of many non-ferrous metals and their scrap, such as aluminium,
copper, nickel and tungsten[39].
Export quotas and bans reduced export VAT rebates have often been placed on
these materials. Export taxes on them typically range between 5 and 30%,
depending on the producing country and the type of raw material.

One of the most debated trade restriction
issues has recently been the export quotas, export taxes and VAT refund imposed
on rare earth exports from China. Rare earths are not non-ferrous metals,
though they are sometimes used as inputs for non-ferrous metal production. World
prices in these raw materials are currently typically 20-40% higher than
Chinese domestic prices.[40]

In addition, indirect or direct subsidies,
such as providing access to lower-cost energy for export-oriented smelters, or
stimulus packages, ensure competitiveness advantages for the raw material
producing countries, notably Russia and China.

·
Automotive industry

The automotive industry, as a downstream
industry, feels the indirect effects of limited access to raw materials. Due to
rising raw material input costs in the steel and non-ferrous metals industry,
it faces serious challenges, since cars are complex products consisting largely
of steel, non-ferrous metals, as well as polymers, rubber and glass. The
industry is also affected by the risk associated with the use of critical raw
materials. As a result of the future developments in car-design, the demand for
critical raw materials is expected to increase. Environmental standards and
requirements and customer convenience play an especially crucial role here.
According to the European Automobile Manufacturers Association (2010), the
demand for rare earths and lithium will rise, due to more use of advanced
electronics, magnetic materials, new surface treatment systems and alternative
propulsion technologies.

Rising prices of raw materials may have a
significant negative impact on the materials input costs of the sector, so
customers are expected to face higher prices for end-products. A study on
resource productivity[41]
points out that if the prices of more raw materials inputs used in the car
production go up, the product price for the final customer would also go up significantly.

·
Chemicals industry

The competitiveness of the European
chemicals industry is affected by rising prices for raw materials, and the
emergence of newcomers better placed to benefit from control of advantaged
feedstocks. The European chemicals industry is a significant supplier to other
sectors and its competitiveness is highly dependent on imported raw materials,
as these costs account for some 34% of manufacturing costs, while energy accounts
for 2%. Oil and gas are the main inputs for the industry, so new players from
oil-and gas- producing countries and emerging economies, especially China and
India create challenges for the European chemical industry. The Middle East
increasingly uses its favourable feedstock availability to develop its own
integrated chemicals production chain, thereby strengthening its position in a
wider range of basic petrochemicals. The European chemicals industry is gearing
up to face the emergence of companies in the Middle East and Asia, where
proximity of feedstock is considered is an advantage for chemicals producers,
while developed countries try to leverage their traditional strength in
technology and expertise.[42]

Trade barriers and unfair trade practices
imposed by non-EU countries such as export restrictions, export taxes for
ethylene feedstock, gas, palm oil, and key minerals (e.g. fluorspar), also
create a substantial burden for the European chemicals industry.[43]

·
Pulp and paper industry

The pulp and paper industry also faces challenges
stemming from a shortage of raw materials, even though wood, the primary raw
material for the industry, is widely available in Europe, especially in Finland
and Sweden. The competition for raw materials in this sector is not primarily
due to non-EU countries protecting their resources nor to the depletion of the
materials. For wood, the challenge is due to the bio-energy industry competing
for access to the material, facilitated by European environmental regulations,
and by the difficult mobilisation of wood due to the small ownership structure
of forests, biodiversity protection and varying efficiency levels in Member
States’ action plans. Furthermore, the rise in exports of recovered paper to non-EU
countries creates an additional pressure on the industry. Industry
representatives estimate that the supply of wood will not be able to meet
demand for both industries (biomass and paper) at current rates.[44]

Raw materials consumption in the last two
decades went through a significant change in the European pulp and paper
industry. Use of wood pulp decreased more than 10 percentage points during this
period, and was practically replaced by the use of recovered paper. In 2009
some 88% of wood came from EU sources (plus Norway and Switzerland), the remainder
originating mainly from Russia. CEPI sees a gap of more than 200 million m3
between supply and demand of wood by 2020 due to an increase both in
traditional demand (e.g. paper and construction) and non-traditional demand
(bio-energy).

4.3.2.2.
Responses to shortages of raw material at industry
level

Companies in different sectors have
developed various strategies to reduce import dependency and to mitigate the
costs and risks related to shortages of raw materials. These include more
efficient use of materials, increased use of recovered and recycled raw
materials, and use of substitute/alternative materials as well as organisational
strategies such as outsourcing or relocation of the production process. From
the long-term sustainability point of view, the first group of solutions are
beneficial, while the others may have rather negative effects on European's
growth and employment.

Resource efficiency, including raw material
efficiency, is one of the most important challenges for European industry.
Sustainable production has become an integrated part of EU industries’
competitiveness strategy, albeit to various degrees, depending on the
technological possibilities and the markets in which the industries are
operating (see Chapter 5).

Improving material efficiency is a constant
objective for companies, since it leads to cost reduction and increased
competitiveness. Material efficiency can be improved in the four main steps of
product manufacturing, i.e. production of raw materials (e.g. exploration and
extraction of raw materials); product manufacturing (streamlining different
stages of production, using new production methods); use; and end-of-life[45].

Use of recycled materials can contribute to
reducing dependency on primary raw materials, depending on the sector and
products. Many raw materials in process industries can be replaced by others. This
is especially important for critical raw materials, where abundant materials
can be a substitute for potentially scarce and critical ones (e.g. indium for zinc).[46] Minimising losses of raw
material, increasing the use of recycled and recovered materials, and
substitute/alternative materials are of key importance in reducing primary raw
material import dependency, thereby improving the competitiveness of European
manufacturing industries. All of these dimensions are supported by the European
Commission through initiatives such as the Factories of the Future Research
Programme, Sustainable Process Industry Public Private Partnership, and European
Green Cars Initiative, etc.

Insufficient supply and rising prices of
materials force companies to invest in more efficient modes of production,
which can reduce waste. Another increasingly used method, recycling has often
been identified as an important component of a better, sustainable resource
management. The European recycling industry is the most competitive in
international comparison. There is considerable potential to increase the share
of recyclates in European manufacturing sectors. However in the sectors selected,
the use of secondary raw materials is relatively high compared to third
countries. Recycled and recovered material has also been widely used in the EU
steel industry, car manufacturing, and pulp and paper. The chemicals industry
is different in the sense that the recovered and recycled chemicals and
especially polymers (plastics) cannot be used to replace virgin raw materials.
Focusing more on R&D efforts, substitute/alternative materials are being
increasingly used in some downstream industries.

Various organisational strategies can
ensure the supply of sufficient raw materials. These include integration along
the value chain, relocation of production or outsourcing. The most common
examples will be illustrated in the relevant sectors.

Below, these different responses to
shortages of the raw materials are discussed in more detail.

·
Steel industry

Resource
efficiency and increased use of scrap could be a solution for problems arising
from supply of raw materials for the steel industry. Steel is 100% recyclable Due
to the long life of steel products, approximately 45% of steel produced in the
EU comes from steel scrap. In comparison, Chinese recycled scrap steel accounts
for only 8% of total steel production, while for the U.S., the total is 33%.[47]. Increasing use of scrap steel
in the sector makes it possible to reduce dependency on imported iron ore and
contributes to sustainable production. However, the steel industry has to contend
with the increasing export of scrap from the EU-27, while non-EU countries
impose export restrictions on it. According to the criteria of the "End of
Waste Regulation", scrap metal is treated as a waste product, so there are
no export restrictions. EU-27 exports of ferrous waste and scrap more than
doubled during the last decade, generating a significant loss of resources for
the European steel industry.

There are several initiatives to increase
resource efficiency (including material efficiency) in the steel industry. The
European Steel Technology Platform (ESTEP), which brings together research and
other institutions, the European Commission and Member States, was set up with
the aim to give new impetus to European research into materials and processes. One
of the aims of the ESTEP Research Agenda is to ensure more sustainable and
profitable steel production in Europe through innovation and new technologies.

New production methods with electric arc
furnaces (EAF) can use up to 100% scrap as input for steel. However, as scrap
is scarce, partly due to European exports, its use is still quite low and the
possibility of boosting the amount of steel produced with EAFs is limited. At present,
research is being carried out into making use of secondary powder material
(resulting from primary steel making) as a raw material alternative in EAF
steelmaking. The breakthrough technology project of the steel sector (ULCOS)
receives funding from Research Fund for Coal and Steel (RFCS) and the EU 6th
framework programme.

Regarding organisational strategies to
mitigate the effects of the oligopoly in the iron ore market, vertical
integration is a possibility for steel makers to help tackle raw material
scarcity. Traditionally, control over mining activities has often been led by
smelters, and there appears to be a trend towards higher levels of vertical
downstream integration between the mining and refining stages of production.[48] Backward vertical integration,
investing in new mines or buying up existing ones, is often observed in the steel
industry outside the EU as a strategy to ensure better access to raw materials
and lower transaction costs.[49]
Chinese steel companies, for instance, have been actively investing abroad in
iron ore mining to secure supplies.[50]
This international presence is increasingly facilitated by state support. But
EU-based producers have also started to take initiatives for vertical
integration, e.g. Arcelor-Mittal, the world's leading steel company, has secured
in-house supply of almost half the company’s iron-ore needs. For the EU steel
industry, it is strategically important to ensure future access to raw
materials through increasing vertical integration through acquisitions, mergers
and joint ventures/partnerships. However, this option is possible only for
global players with the financial resources and the geological expertise to make
such investments.

·
Non-ferrous metal industry

Non-ferrous metals are infinitely
recyclable. However, primary resources are essential to cover total demand and
produce high-quality products. Recovery and recycling rates within the EU are
among the highest in the world. Secondary raw material use in the sector has
increased substantially. The two main sources of non-ferrous metal scrap for
recycling are industrial waste streams and end-of-life scrap. While industrial
waste is used efficiently, as regards the latter there is still much potential
to increase use of end-life scrap. Regarding the most important raw materials
in this industry, more than 70% of EU refined lead production stems from scrap
metal, along with, nearly 60% of aluminium and over 40% of refined copper.

Recycling of scrap metal is essential to
maintain the competitiveness of the EU non-ferrous metal industry. However
valuable resources have been shipped to developing and emerging countries. This
is one of the biggest problems the sector is facing. For example the EU has
lost a significant amount of its own copper scrap resources, almost 1.2 million
tonnes in 2009, of which nearly 80% has ended up in China. Rising demand for
aluminium scrap is even more striking.  In 2000, the EU was a small net importer,
while in 2009, more than 1.1 million tonnes of aluminium scrap were exported.
It is thus important to improve the Waste Shipment Regulation to reduce exports
of non-ferrous scrap metal, particularly aluminium and copper.

R&D and innovation have an important
role in improving material efficiency, developing new production processes and
substitutions in the non-ferrous metal industry. The industry is constantly
looking for cheaper substitutes with the same or better qualities than the
originals. The European Aluminium Technology Platform, set up in 2005, is a key
tool to ensure cost, eco- and material efficiency to support the competitiveness
and sustainability of the largest subsector in the non-ferrous metal industry.

·
Automotive industry

Since cars consist of numerous different
parts, the automotive industry is one of the best examples to illustrate how
soaring prices for raw material, along with lack of supplies and environmental
regulations, have led to more efficiency and more use of non-primary raw materials.
Resource-efficient technologies and the use of recyclates and substitutes are
the two main strategies the automotive industry is deploying to reduce
dependency on raw materials.

The industry is one of the most innovative
sectors in Europe. According to ACEA, the sector spent more than EUR 26 billion
or 5% of their turnover on R&D in 2009 and accounted for more than 50% of
the global patent applications in the automotive sector. The industry files
around 6,300 new patents each year in the following fields: materials
technology, recycling, ICT and telematics, energy and fuels, drive-train
development, aerodynamics and ergonomics. German auto manufacturers, a vital
part of the European automotive industry, spent almost 10% of their total
turnover on innovation purposes in 2009. Most of this was spent on improving
product quality and developing new technological solutions. According to
statistics, only 6.8% of the expenditures on innovation led to cost reduction[51].

Resource-efficient technologies are increasingly
being used in the automotive industry. Thanks to efforts by manufacturers to
reduce waste in the period between 2005 and 2009 the total waste per unit
produced (excluding scrap metal) went down by 9.9% (see Figure 4.20). The total
waste in the sector decreased, by 22.6% over the same period.

Figure 4.20: Waste: excluding scrap metal

Note: Data refer to passenger cars.

Source: ACEA,
2009.

The recycling of scrap cars is of key
importance, which is adequately regulated by the End-of-Life Vehicle Directive.[52] The Directive on Reusability,
Recyclability and Recoverability of motor vehicles[53]set new requirements for
vehicle recycling. In 2008 total reuse, recovery and recycling rates varied
between 79.8-92.9% in the Member States, with Germany having the highest rate
in Europe.

A technical approach to finding
substitutions is at the core of the automobile manufacturing industry's R&D
agenda.[54]
ACEA estimates that the first significant volumes for recycling of electrical
vehicles, which contain rare earths, cobalt and lithium, will come around
2025-2030 at the earliest. Demand for these materials is expected to boom
around 2015-2020, so the industry hopes to have a new generation of batteries based
on other materials by 2025-2030. To meet environmental, safety and price
demands, the use of light, smart and innovative materials, such as composites,
and the efficient use of high value-added metals will be inevitable in car
manufacturing. Research activity focuses on materials such as carbon fibres,
natural/glass fibres, high strength steel/aluminium, magnesium technologies,
and hybrid materials.[55]

The European automotive industry is
involved in a wide range of collaborative European research and development
projects. The European Council for Automotive R&D (EUCAR) plays an
important role and provides automotive manufacturers with a platform for
identifying common pre-competitive European R&D. Some innovative projects
in the field of materials and manufacturing are worth mentioning, see Box 4.1.

Box 4.1: EUCAR Projects in the field of materials and manufacturing

Multi-level protection of
materials for vehicles by smart nanocontainers The aim of the project is to develop
new active multi-level protective systems for future vehicle materials. A
multi-level self-healing approach will combine several damage prevention and
reparation mechanisms within one system.  These will be activated depending on the
type and intensity of the environmental impact.

Multi-functional
materials and related production technologies integrated into future industries: This project, which closed last year, aimed to introduce new
materials and processes, to reduce cost and development time and increase
customisation possibilities. The following achievements have been reported.

-
weight reduction of 18% through flange reduction for laser welding of mass flow
meter (MFMs)

-
single part roof bow by stretch bending to achieve scability and re-use

-
44% increase of MFMs utilisation rate

-
2.7 kg weight reduction with nano-composits for the rear spare wheel well

-
20% increase of frontal passive safety through integration of APM foam into
rails

MyCar Project enables an ultimate degree of customisation, which could allow
every customer to purchase a unique vehicle. The project will further develop
and integrate technologies that enable the vehicle assembly process to become
self-adaptive to any kind of market variation, capable of producing cars with
an extended degree of personalisation. MyCar aspires to integrate the customer
into the automotive industry's assembly processes.

Adaptive Control for
Metal Cutting project:  This project aims to
develop a generic modular adaptive control platform that will allow metal
cutting processes to respond to changing circumstances. The main goals are:

- Robust production processes
by optimizing the performance of machining processes;

- Reconfigurable production enabled
at process level;

- Development of Adaptive
Machining Systems for difficult metal cutting operations;

-Achievement of an online
quality control system for mass customisation and small batch production.

Source: EUCAR, http://www.eucar.be/projects-and-working-groups/projects-and-working-groups,
accessed on 06.07.2011.

However, from a general sector perspective,
current critical raw materials might be substituted for various raw materials
before they can be recycled. Yet the same materials might be in great demand
for applications in other industries, which will then definitely require
adequate recycling technologies as a valuable option to sustain future access
to critical raw materials.

As regards organisational strategies responding
to raw material challenges, outsourcing of manufacturing cars or car parts can
be seen as an option to secure access to raw materials. This concerns not only
rare-earths, but also aluminium where China has recently turned from net
exporter to net importer.[56]
Setting up part of the production in China and South-East Asia may enable
access to raw materials at better prices. The European car manufacturers have
increased production capacities in these emerging countries, which could enable
access to input materials at a lower cost by avoiding export restrictions.

·
Chemicals industry

Decreasing availability of raw material and
increasing prices require raw materials efficiency in the chemical industry too.
From economic and sustainability reasons, a decrease in raw material intensity
is unavoidable.[57]
R&D and innovation play a significant role. In general, the chemical sector
is the most innovative industry. Its share of all EU manufacturing patent
applications was 16% in 2007.

The industry is largely based on oil and
natural gas, but due to material and cost efficiency concerns, the share of
renewable raw materials[58]
used in the manufacturing process has increased substantially. A broader use of
renewable raw materials also contributes to reduce environmental impacts of the
use of fossil fuels. However, using renewable raw materials means a challenge
as regards competition for land use, due to increasing demand worldwide for
biomass, food, fodder and bioenergy.[59]
The chemical industry was estimated to account for around 8% of total feedstock
use in the industry. There is still significant potential to increase the share
of renewable raw materials in the medium and long term. Nonetheless, this
process is dependent on developments regarding the overall availability of
these renewable raw materials and the degree of economic viability of new
production technologies. New processes in the industry, such as chemical
leasing (see Chapter 5) or other new materials, such as CO2 and
other unconventional carbon sources open up new possibilities for the
sustainable production of fine chemicals.[60]
Furthermore, the European Technology Platform for Sustainable Chemistry
supports chemistry biotechnology and chemical engineering R&D and
innovation in Europe.

As regards organisational strategies the
chemical industry can provide interesting examples. Resource-seeking FDI,
securing raw material inputs at lower costs (though often coupled with other
investment motives) is often applied by raw material intensive industries.
Constraints for the further development of the chemical industry in Europe include
existing trade barriers and unfair trade practices. These barriers may in
certain cases prompt the relocation of activities from Europe to other parts of
the world. This strategy provides access to materials under similar economic
conditions to those enjoyed by he main global competitors.[61] Obviously relocation can be
profitable for companies, yet is sub-optimal from a European growth and job
perspective.

·
Pulp and paper industry

Raw materials efficiency is one of the key
drivers for the competitiveness of the EU paper and pulp industry. The European
paper industry is the leader in collection, sorting and recycling of paper. The
industry's recycling was 68.9% in 2010[62]
and has risen substantially over the last 15 years. Recycling is thus
relatively high in Europe compared to third countries (see Figure 4.21). Today,
recovered paper accounts for 44% of total raw materials used in papermaking.
This means a rise of over 16 percentage points, as compared to 2000.  However,
as is the case for scrap metal, paper recovered in Europe is increasingly
exported, notably to China, where demand for pulp and recovered paper has been growing
and the industry is subsidised. About 20% of the recovered papers go outside
Europe per year, creating a significant loss for the European industry. The
industry plans to increase the use of the recycled inputs within Europe instead
of exporting these for use in the rest of the world.

Figure 4.21: European paper recycling

Source: Adapted
from European Recovered Paper Council, Monitoring Report 2010, accessed on 29.06.2011.

Further improvement is now sought in the
eco-design of end products to improve the efficiency of the recycling process. The
Forest Based Sector Technology Platform was set up to assist the forest-based
sector, including the pulp and paper industry and its shareholders in
fulfilling their future research, development and innovation needs. For
example, new technologies are being developed to improve the material and
energy efficiency of recycling operations.

4.3.2.3. Policy implications at industry level

The selected European industries are facing
serious competitiveness challenges due to raw materials scarcity. They are
affected by the distorted global raw materials market and/or by EU legislation
and policy.

As regards the steel
industry, challenges for European policy in the near future are to make the
structure of iron ore supply more competitive, eliminate trade distortions in the
supply of raw materials, and create breakthrough technologies towards
low-carbon production. It is important that competition policy, including
merger control, continue to be enforced in the iron ore supply market where the
degree of concentration is already high. Continuing negotiations with
resource-rich countries in FTA and WTO may lead to a more balanced trade
situation. Furthermore, the EU should continue to promote recycling and to address
obstacles to the development of recycling industries. Finally, it is advisable
to continue and strengthen the support for investments in research through e.g.
RFCS, Research Framework Programme or other funding instruments.

One of the two main issues considered as
important for the non-ferrous metal sector is the quality of recycling, in
terms of the processes to ensure optimum output. Despite increased recycling,
another issue for the sector is access to primary materials (ores and
concentrates) so that can respond to increasing demand and provide the required
quality. For recycling, turnover time plays an important role. Policies that promote
the collection and treatment of scrap and end-of-life goods are welcomed in
this respect.

In a complex
industry such as car manufacturing, the competitiveness issues are driven by a
number of different factors. In the short term a greater and more immediate
effect can be achieved by policies to stimulate, increased resource efficiency
by improving production organisation and by promoting equal opportunity access
to critical raw materials on international markets. Depending on the
effectiveness of negotiations, trade policy can bear fruit as well in the
relatively short term. In the long term the competitive position of European
car manufacturing can best be promoted by supporting research and development
efforts to achieve more extensive and more effective use of substitutes for
critical raw materials and a greater general material efficiency in general. Policies
promoting the recycling of critical raw materials can achieve a positive impact
not only in terms of import substitution but also in terms of improving energy
efficiency and limiting the environmental impact of the industry.

The EU chemical
industry would benefit from further global tariffs dismantling and continued
support and promotion of general WTO rules to address trade problems related to
the discriminatory supply of raw materials. At bilateral level, the EU should
continue to address the issues of unfair trade practices that cause imbalances
in access to raw materials and world markets. It is desirable to continue to
support the R&D, innovation and the further expansion of infrastructure in
order to maintain and promote the technological advantage of the European
chemicals industry. In particular support should go in particular towards
increasing energy and resource efficiency, reducing CO2 emissions
and expanding the use of renewables. Although it is too early to envisage
considerable substitution of fossil-based feedstock by renewables, it is
desirable to support market developments towards renewable raw materials with
the focus on the sustainability of the markets for both inputs and outputs.
Steps should be taken to define standards and criteria for products, including
sustainability criteria.

Given the competing
use of wood and land by other industries and for other purposes, it is
advisable to stimulate integrated and prioritised land use policies at Member
States level. At EU level, a balanced approach embracing different policy
themes (waste, recycling, competitiveness and trade, raw materials and
management of natural resources) should be considered in order to prioritise on
objectives where overlaps occur and to clarify this towards all actors
involved, e.g. by defining a cascading order of use. The European Commission
has launched initiatives on these matters in the recent past. With respect to
exports of recovered paper, waste paper should be recycled close to the place
of consumption, keeping secondary materials within European borders.

4.3.3.
The role of the non-energy extractive industry

The main company strategies and possible
policy responses to tackle the scarcity of raw materials have been discussed in
the previous section. Besides these, as the second pillar of the Raw Materials
Initiative points out, the non-energy extractive industry has great potential
to mitigate import dependency on several raw materials. It is therefore it is
worth mentioning its role and the challenges it is faces in more detail.

The non-energy extractive industry can be
divided into three main sub-sectors, according to the different physical and
chemical characteristics of the minerals produced and on the downstream
industries they supply:[63]

·
construction minerals and aggregates

·
industrial minerals, and

·
metallic minerals

4.3.3.1.
Challenges in the non-energy extractive industry

The micro-economic analysis[64] revealed that the current EU
non-energy extractive industry is in a relatively good competitive position in
comparison to the rest of the world. Overall its apparent productivity is
higher and in contrast to most of the other industries, its profitability is
comparable. This suggests that the EU companies in this sector provide a viable
basis for further development and as such an avenue for alleviating some of the
raw materials pressure for the downstream industries.

It is estimated that Europe still has
significant extracting potential for non-energy raw materials.[65] In the past, given the low
prices of raw materials, it was sometimes more profitable to import these than
to extract them. That is why there are still several large deposits, and there
is potential to benefit from these. However, the EU cannot expect to be
self-sufficient in providing for its material resource needs.

A
number of concerns regarding the competitiveness of the non-energy extractive
industry are emphasised by the industry and the European Commission.[66] These issues include the need
for a more detailed and systematic monitoring of raw materials in Europe. Geological
surveys are carried out at Member State level, yet mutual consistency, as well
as the introduction of advanced techniques at EU level, such as GMES,[67] are essential for prioritising
and defining further actions and would facilitate a co-ordinated joint
knowledge base. Another challenge is the competing land use, mostly related to
stringent environmental regulations, such as Natura 2000. Start-up costs are relatively
higher compared to non-EU countries, due to relatively higher insurance
requirements, more administrative regulations, and administrative
fragmentation. The industry indicated that the EU financial sector is less
inclined to invest in mining projects than counterparts in e.g. the U.S.,
Australia and Canada, where more financial expertise and capital is available.

4.3.3.2. The role of innovation in the future of the non-energy extractive
industry

The non-energy extractive industry has
viewed innovation in resource-efficient and sustainable production technologies
as an important driver for its future competitiveness in Europe. There have
already been important policy initiatives have already been taken such as the
European Technology Platform on Sustainable Mineral Resources, which aims to modernise
and reshape the European mineral industry to secure the future supply of/access
to raw materials. It plans to do this by supporting the revival of exploration
of Europe’s mineral potential; developing innovative and sustainable production
technologies; implementing best practices; reuse, recovery and recycling as
well as new product applications; and creating European added value through
RTD-based technology leadership, education and training.

New technology innovations help to overcome
environmental and social objections to non-energy materials extraction in the
EU. For example, through subsea mining exploitation of raw materials located
deep offshore would contribute to solving the complex worldwide equation linking
security of supply, sustainable development and industrial competitiveness.
Intelligent Deep Mine provides eco-innovative and intelligent exploration and
extraction. Optimising extraction and processing of resources throughout their
lifecycle or using mines for geothermal energy production at the end of their
life are all expected to contribute to sustainable raw materials extraction.

4.3.3.3. Policy implications

One of the major policy issues is working
towards an integrated policy vision on developing of the EU non-energy
extracting industry, to make it consistent with land use and environmental
policies. The industry would expect this to improve the investment climate,
especially since investments are typically long-term.

Much of the authority on mining and land use lies with the Member
States. This is a barrier to the creation of a common policy on these matters. A
clear European vision could steer Member States in their own policy choices in
a coherent manner. That is why the European Commission sees its current role as
a facilitator for the exchange of best practices.[68] A European Commission report
entitled, ‘Exchange of best practices in land use planning and permitting’ (2010)
presented best practices in the field of land use planning policies for
minerals, the geological knowledge base and networking, and integrating
subsurface information in GMES. In this respect, three practices are considered
important in promoting investment in extractive industries:

–
Defining a national minerals policy, to ensure
that mineral resources are exploited in an economically viable way, harmonised
with other national policies, based on sustainable development principles and
accompanied by a commitment to provide an appropriate legal and information
framework;

–
Setting up a land use planning policy for
minerals comprising a digital geological knowledge base, a transparent
methodology for identifying mineral resources, long term estimates for regional
and local demand and identifying and safeguarding of mineral resources (taking into
account other land uses), including their protection from the effects of
natural disasters;

–
Putting in place a process to authorise mineral
exploration and extraction which is clear and understandable, provides
certainty and helps to streamline the administrative process (e.g. the
introduction of lead times, permit applications in parallel, and
one-stop-shops).

On the operational side of mining, the "time
to permit" is a hindering factor. Continued dialogue between Member States
to align the permitting process according to best practices in other countries
is necessary. The system of one-stop shop system, for example, could be
elaborated in all Member States.[69]

Insurance requirements are another concern.
Aligning these with the actual size of the mine or quarry, rather than the
eventual full size, to be reached only in the future, would considerably reduce
capital requirements upon start-up.

Finally, promoting for R&D and
innovation for sustainable extraction is crucial for this industry’s (future)
competitiveness.

4.4.
Conclusions and policy discussion

The goal of this chapter was to gain a
better insight into five aspects of access to non-energy, non-agricultural raw
materials and the challenges involved:

1. global demand and supply

2. the competitiveness effects in the
selected industries

3. the responses given at industry level to
raw materials challenges (including the role     of recycling, R&D and
organisational strategies)

4. the EU policies that can be developed

5. the role of the EU non-energy extracting industry in alleviating
the EU industry’s raw materials vulnerability.

The approach in the original research was
mainly qualitative in nature, drawing on existing literature and data, and
using inquiries among representatives of a selected set of EU sectors for which
competitiveness effects were identified. The selection of the sectors was based
on insights from the literature review, experts in the field and from the
overarching EU association Business Europe. In contrast with existing studies, the
specific focus of the present study was on the sectoral and competitiveness
angle.

4.4.1.
Competitiveness effects

The analysis made clear that the prices of
raw materials have been increasing significantly over the long term with a dip
during the financial crisis. For the industries surveyed, the share of virgin
raw materials was significant ranging from one third in the steel sector to
more than two thirds in the paper and pulp industry, chemicals and car
manufacturing. Here, non-energy raw materials include not only metals and
minerals, but also crude oil, gas and wood.

In comparison with the rest of the world,
the micro-economic analysis[70]
indicated that steel, non-ferrous metals and chemicals in the EU typically have
higher productivity levels, yet end up with lower profitability rates. The trends
along the (global) business cycle were usually similar. This suggests that EU
companies on average face with relatively higher costs, which makes the issue
of increased raw materials prices particularly sensitive. For other sectors
such as the EU paper and pulp industry and EU car manufacturing, the
profitability, patterns were more complex. In both sectors, a positive
productivity gap with the rest of the world could be observed. Yet the EU paper
and pulp industry showed a gradual decline in profitability while the EU car
industry improved its profitability over time, unlike the companies in the rest
of the world. In the car industry, raw materials issue has a different impact
than in the paper and pulp industry. A potential explanation might be that
there is more scope for the EU car industry to invest in R&D and innovation
in trying to find substitutes for expensive raw material inputs. Moreover, the competitive
use of wood by less regulated sectors (e.g. waste incineration) and the ‘export
leakage’ of recovered paper due to high demand in the BRIC countries indirectly
add to the costs of the paper and pulp industry.

Sector interviews confirmed that market
concentration on the supply side contributed significantly to the price
increase in raw materials, especially in the case of commodities such as iron
ore, copper, zinc and lead. In the case of iron ore, one can observe an
increased market power of the global mining companies. This is reflected in
their imposition of short-term supply contracts on the steel mills, which in
turn try to pass the resulting risks and price increases through to their
customers, some of which are large players, such as car manufacturers, though
the others are mostly small players, such as the metal working industry. The
effects of market concentration can nonetheless be bypassed through company
strategies such as vertical integration. Yet such a strategy that is not
feasible for all companies in the EU, and certainly not for most SMEs.

An important aspect for the competitiveness
for all selected sectors is the absence of a global level playing field in
trade. Virtually all manufacturing sectors surveyed depend to a large extent on
imported raw materials. Export restrictions on certain materials in BRIC
countries, implicit subsidies, and soft loans place EU companies at a relative
cost disadvantage. However, a switch to EU raw materials is often not possible,
even though the EU is a global leader in the production of certain minerals.
This is because the materials are not available in the EU or not in the specific
grades required for product quality process efficiency.

4.4.2.
The potential of recycling and innovation

In the investigated industrial sectors two
main drivers for reducing dependence on primary raw materials can be
identified. The first driver is purely economical, related to economic gains
from material efficiency, reuse of recycled materials (such as in the steel,
non-ferrous metals, pulp and paper and the car manufacturing industries) and
use of cheaper substitute materials. The second driver originates in
requirements imposed by safety and environmental regulations, which primarily
stimulate recycling activities and resource efficiency, particularly in the
chemicals and in the automotive industries.

When the industries described in this
report are considered in terms of their relative performance in recycling, the
steel, non-ferrous metals and paper and pulp industries are clear leaders. This
is mainly due to two facts. First, metals and paper are highly recyclable
products, where the quality and utility of the recycled material is almost the
same as that of the virgin raw materials. Second, one should note the relative
upstream position of these industries in the whole production value chain. There
are a number of other downstream industrial sectors (such as car manufacturing,
electronics, printing and publishing, etc.) whose end products are subsequently
recycled. In the automobile industry, for example, the high degree of reuse and
recycling is mainly driven by the high recycling capabilities of the upstream
steel and non-ferrous metals industries.[71]

A more complicated situation with recycling
is observed in the chemical industry. It possesses quite substantial chemical
processing capabilities, which should allow it to perform many of the
operations required for the recycling of chemicals. Nonetheless, the intensity
of recycling in this industry is primarily driven by safety and environmental
regulations, rather than by reuse and cost-saving factors.

What is the potential of the EU recycling
industry in alleviating EU industry’s raw materials vulnerability? Looking at
the current situation with recycling in the EU, economic gains from raw
materials recycling are relatively high in most of the industries considered.
The additional efforts currently undertaken in Europe to expand the recycling
activities are primarily driven by the environmental and safety concerns. Additional
stimuli for recycling are created by regulations to reduce the CO2 and improve efficiency.

The untapped potential seems to lie more in
improving framework conditions, which are linked with policy, and in applying
the latest methods and techniques to increase resource efficiency. Examples are
materials recovery from municipal solid waste, self-disassembling joints, and
specialised plants for complex recycling. Also, promoting the use of
product-service systems improves material efficiency and recycling performance
as well as reuse. Another interesting avenue for achieving sustainable
production is the organisation of local production activities within a setting
of industrial symbiosis.

Regarding the potential of the EU recycling
industry to reduce vulnerability with respect to raw materials likely promising
developments may come from adjusting production technologies to ensure greater
reuse and recyclability of raw materials, especially rare earths and
energy-intensive materials. It is also worth stressing once again the
importance of R&D and innovation, which play an important role in the
future development of efficient production processes, recycling processes and
substitute materials. Substitute materials are increasingly used in many
sectors, such as the chemicals and car industries, and further development is
expected, partly due to various research programmes.

One observation is the apparent dichotomy
between the solutions presented in the, mostly academic, literature about
sustainable production and the implementation and perceptions of industry.
Close interaction between industry and research laboratories is therefore very
important. However, case studies can be found on successful pilot projects for
sustainable raw material use, there is still a wide gap between research
findings and concepts and profitable implementation in a market
economy/business context.

4.4.3.
Policy discussion

Access to non-energy, non-agricultural raw
materials can be facilitated by different policy tools. Based on the analysis
and EU policy documents on the topic, some important policy conclusions can be
identified.

Firstly, the internal consistency of
existing regulations and directives at EU level should be ensured. This would
promote better operational and regulatory environment for industries affected
by the scarcity of non-energy raw materials. Otherwise pursuing one policy goal
might hinder reaching another one. Internal consistency should be in line with
sustainability objectives and policies, e.g. competing uses of materials or
waste incineration versus recycling.

Secondly, in line with the first pillar of
the Raw Materials Initiative, fostering a global level playing field in trade
and investment is essential in order to ensure the fair and sustainable supply
of raw materials from international markets through strategic partnerships and
policy dialogues. Developing strategic partnerships, such as the Africa-EU
Joint Strategy Union, can contribute to the sustainable supply of raw materials
from third countries while at the same time assisting these countries in
reaching development goals. The EU can play a crucial role in creating win-win
situations where both developing and developed economies benefit from the
sustainable supply of raw materials. Alongside the European Commission, the
European Investment Bank and other European development financing institutions
will continue to support creating better conditions (e.g. infrastructure).

Pursuing policy dialogues as well as
strengthening ongoing debates in pluri – and multilateral fora (e.g. G20,
UNCTAD, WTO, OECD) is of key importance in order to tackle existing trade
barriers. It is crucial to include raw materials issues, such as export
restrictions and investments aspects, in ongoing and future trade negotiations.
Speeding up the establishment of a mechanism for monitoring export restrictions
and raw materials strategies in other countries outside the EU is essential. In
particular, increased state intervention in former centrally planned economies,
most notably China and Russia, is a concern. Here, industry interests are
pursued at the level of diplomacy, rather than at company level on the market.
European industry representatives therefore often call for a ‘raw materials
diplomacy’ at the level of the EU, or the Member States. On the other hand
however, fears are also expressed about overregulation and the side effects of
policy intervention on the internal EU market.

Thirdly, regarding the second pillar of the
Raw Materials Initiative, intelligent development of the further exploration
and exploitation of European raw material resources can play an important role in
obtaining certain materials for production. In this connection, building an
innovative knowledge base of European resources and standardising geological
data are of key importance. In the short term, it is feasible to increase
synergies between national geological surveys. In the medium term, such
synergies will help improve the European raw materials knowledge base.
Furthermore, basing national mineral policies, based on sustainable development
principles and an appropriate legal framework will facilitate access to
European reserves. The exchange of best practices in land use planning policy,
national mineral policy and mineral exploration and extraction authorisation
processes is expected to contribute to the sustainable supply of raw materials within
the EU.

Regarding the third pillar of the Raw
Materials Initiative, encouraging and supporting R&D and innovation for
substitutes, better recycling techniques and sustainable production (material
efficiency) is of key importance in tackling the lack of raw materials for EU
manufacturing in the longer term. Here the upcoming European Innovation
Partnership on Raw Materials will play a crucial role. Developing new
innovative materials can help reduce the use of critical, scarce or hazardous
raw materials. Improved conditions for recycling and better recycling
techniques, can reduce the cost of recycling, leading to the more efficient
reuse of recyclable and renewable materials. Higher recycling rates will reduce
the pressure on demand for primary raw materials. To achieve all this, better
implementation and enforcement of existing EU waste legislation is crucial.
Furthermore, strengthening the Waste Shipment Regulation is essential in order
to prevent the illegal dumping of waste products, and reduce the transport of
important secondary raw materials to developing countries, in particular.

From the competitiveness point of view, it is important to
strengthen the industrial base in Europe. Specific skills development, R&D
and innovation play a central role along the entire value chain, including
extraction, sustainable processing, eco-design, substitute and new materials,
recycling, resource efficiency and land use planning, in addressing the challenges posed by the lack of raw materials.
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Interviews

Mr Alexandre Affre – Business Europe –
Brussels.

Dr Gerhard Angerer – Fraunhofer-Institut für
System- und Innovationsforschung (ISI) – Karlsruhe.

Mr Erik Bergelin – ACEA – European
Automobile Manufacturers’ Association -  Brussels.

Prof. Dr. Raimund Bleischwitz – Wuppertal
Institut für Klima, Umwelt, Energie – Wuppertal.

Dr Peter Buchholz – BGR - Bundesanstalt für
Geowissenschaften und Rohstoffe – Berlin.

Dr Stefan Giljum – SERI – Sustainable Europe
Research Institute – Vienna.

Mrs Corina Hebestreit – Euromines – European
Association of Mining Industries – Brussels.

Mrs Monique Jones – Eurometaux – European
Association of the non-ferrous metals industry – Brussels.

Mr Peter Kunze – ACEA – European Automobile
Manufacturers’ Association – Brussels.

Mr Ulrich Leberle
- CEPI – Confederation of European Paper Industries – Brussels.

Mr Bernard Lombard
– CEPI – Confederation of European Paper Industries – Brussels.

Mr Klaus Nottinger
– APAG - European Oleochemicals and Allied Products - Neuss, Germany.

Mr Lionel Platteuw
– EUCETSA – European Committee of Environmental Technology Suppliers
Association – Brussels.

Dr Claudia Schöler –
VDMA - Verband Deutscher Maschinen- und Anlagenbau - German Engineering
Federation – Brussels, Frankfurt am Main.

Mr Karl Tachelet –
Eurofer- European Confederation of Iron and Steel Industries – Brussels.

Mr Guy Thiran –
Eurometaux - European Association of the non-ferrous metals industry – Brussels.

Mr. René van
Sloten - CEFIC – European Chemical Industry Council – Brussels.

Mr Andrian
Vandenhoven - Business Europe – Brussels.

Mr. Jeroen Vermeij
– Eurofer – European Confederation of Iron and Steel Industries – Brussels.

Mr Marc Vermeulen
– CEFIC - European Chemical Industry Council – Brussels.

Dr Michelle Wyart-Remy –
IMA-Europe – Industrial Minerals Association – Europe.

Annex

Table 4.1: Crosscutting sectoral competitiveness issues related to
non-energy raw materials

|| Extractive industries || Steel || Non-ferrous metals || Paper and pulp || Chemicals || Car manufacturing

Mining & quarrying || Industrial minerals

Competitiveness layers

Market structure / price setting || Mix of small, medium and large enterprises according to their role in the exploration, development and operation process; Global price setting || Large number of SMEs but also international leaders present in the sector Price negotiated between buyer and seller High transportation costs || Oligopolistic structure of the supply of iron ore Price setting of iron ore by 3 main suppliers Price of steel directly dependent on price of iron ore || Heterogeneity in terms of size of companies and vertical or horizontal integration of their production activities Price taking: companies cannot negotiate prices The industry operates in a totally international market || Small ownership structure; Global price setting || Prices for outputs in their majority are competitive. For many raw materials prices are distorted. || Prices for outputs and most of the inputs are competitive.

Position in the supply chain || High upstream position; Supplier to all industries and products || Supplier to a variety of industries and sectors || Important supplier to other industries (construction, packaging) || Supplier to a large variety of industries and sectors || Close to the end market; Integration of activities such as recycling || Important supplier to other industries. || Can be considered a real downstream producer.

Share of NEIRM in cost structure || NERMs are output of this industry || NERMs are output of this industry || Very important: iron ore 34% on average ; scrap metal 10% on average || Energy-intensive  and raw-material intensive industry || Very important: 63,8% of operational cash || The price of raw materials can comprise a substantial share of the end product’s price (up to 60%) || The share of NEIRM is substantial: more than 80%.

Framework conditions and policies

Administrative barriers || Long and sometimes complex authorization process for extractive activities;  Compliance with environmental regulations and assessments needed || Legislation controlling exploration/extraction activities is often different depending on private- or state- ownership Large differences in land use  policies and practices among MS || Sometimes difficult to distinguish good from bad quality on imported scrap metal; quality standards || || Regulations (IPPC, REACH) || Mostly trade policy related restrictions: import and export duties, and quotas. ||

Financial barriers || High capital requirements for insurance at authorization; EU financial organisations are less geared towards investments in the mining sector, because of the inherent long-term risks (Euromines) || || Few players on the steel market are big enough to raise the funding needed for vertical integration (investments in iron ore mines) || || || ||

Trade || High import dependency for metallic minerals, also net importer for industrial minerals and aggregates Export of minerals with specific characteristics || The EU is the world’s largest producer of a number of industrial minerals and the second or third largest producer of a number of others For some Industrial Minerals, two other dominant producers are China and the USA || Export restrictions of raw materials (iron ore and scrap) by several emerging economies Free flow of good quality scrap metal from EU to emerging economies || Subsidies of third-country companies distort competition Illegal shipments (dubious export) should be systematically handled || Export of end products of high quality Net importer of pulp (raw material) Increased imports in China of raw materials (wood, pulp, recovered paper) EU trade hindered by costs of compliance with environmental regulation (CEPI) || The EU has an overall trade deficit for chemicals. CAP induced import rights for bio-ethanol 30-65% of its price || Export dependability; export duties and quotas

National policies || Integrated and prioritized land use policies needed at MS level Competing land use with more progress in environmental regulations || || || Differences in environmental-related and other regulation among also EU MSs || Integrated and prioritized land use policies needed at MS level || Import duties for bio-based raw materials for industrial use in the chemicals industry should be comparable to those for the fossil-based feedstock ||

EU policies || Balanced policies needed; Sensitize MS on land use for extractives activities || || Prevent further horizontal integration of the iron ore market Research through Research Fund for Coal and Steel (RFCS) || || Balanced policies needed; Sensitize MS on land use and mobilization of wood || The EU industry should be prepared for the emergence of the Middle East as a very important player in the petrochemicals market ||

Risks

Supply risks || Certain raw materials are critical due to the combination of lack of resources within EU, increased use in developing economies and their strategic importance for products like future environmental technologies; The NEEI has a potential to alleviate the pressure on imported NERMs, but EU mining does/cannot always  produce what EU industry needs. || The fact that an Industrial Mineral is extracted in the EU does not necessarily mean serving that market too due to the natural variability in the quality and characteristics of a particular mineral found in different parts of the EU and the location of different markets Often very few suppliers || Risk of limited access to most important raw materials (iron ore and scrap) because of protectionist measures of emerging economies || With respect to raw materials the EU industry is highly dependent on third countries for imports || Competing use of the raw material wood by less regulated industries; Export of and global price setting for recovered paper || Losing in the race with China in terms of demand for raw materials. || Higher dependency on foreign rare earth as electrical vehicles become more wide spread

Trade practices || || || Export restrictions reduce the supply on the world market and aggravate increases in iron ore spot price Export of valuable scrap as waste || Hidden subsidies in some exporting countries  distort the competition in these markets creating unfair competition among EU companies and foreign states || || Cost disadvantage for imports of industrial bio-ethanol ||

Emerging Technologies || || || || || || Intensified R&D effort towards development of more efficient production processes for renewable feedstock || Research  towards niche support for ‘domestic mining’ industry mostly for the rare earths

Solutions

Trade (Pillar 1) || Reduction of import dependency especially for metallic minerals || Dependency especially on China and the US for some materials should be reduced. || || Application/optimization of waste framework directive Ιmproved market access for the EU non-ferrous metals industry exports world-wide Level playing field access to raw materials || Costs of compliance with environmental regulation (CEPI) are hindering EU trade || Trade deficit for chemicals is a point of attention. || Export dependability  to be reduced

R&D, innovation (Pillar 2) || Research for modern technologies to overcome public and local resistance to extractive activities, to comply with higher safety and environmental standards and to reach ‘difficult’ deposits more efficiently e.g. ETP SMR || || Most R&D concentrates on CO2-reduction (e.g. efficient use of coal), not on recycling or efficiency of other resources. || The location where raw materials are found is important especially if resulting in the relocation of R&D activities impacting the R&D that takes places in EU vs. non-EU countries. || Eco-design for efficient recycling || Breakthrough technologies needed towards more efficient production || R&D for substitutes should be supported

Recycling (Pillar 3) || || Not recyclable; highly recoverable || Scrap steel widely used and amounts to 10% of total costs in steel sector Use of scrap steel widely suboptimal because of lack of availability. Steel making procedures with electric arc furnaces (EAF) can use 100% scrap as raw material. || Unique recycling properties Substitution is very important for this industry: improper dismantling (recycling all special metals in the product) should be handled || High recycling rate in EU || Chemicals are needed in order to recycle chemicals. Recycled chemicals not always substitute the raw materials used in production. Recycling of chemicals can have negative environmental impact. It is not always an evident positive strategy. || Steps should be taken to provide for recyclability already during production process.

Resource-efficiency potential (Pillar 3) || Efficient processes of extraction Efficient approach of deposits that are more difficult to reach || The full life-cycle of the end-applications from cradle to grave should be considered: a holistic approach in the implementation of resource efficiency is required rather than fragmented approaches focusing only on parts of the process. || Research is carried out in order to make use of secondary powder material (resulting from primary steel making) as a raw material alternative in electric arc furnaces (EAF) steelmaking. || Location matters: besides recycling, access to primary raw materials is crucial as demand is increasing. || Limited growth potential of recycling rate, but more efficient recycling process; Intention of increased use of recycled products within EU instead of export || Positive effects can be obtained from greater energy efficiency and greater use of bio-feedstock. || Focus should be put on material substitution

Policy and further research || Integration of policy on environment, safety, raw materials and management of natural resources, land use To prioritize on the competing use of land || Industrial mineral may be critical locally but not globally: in terms of data availability for policy monitoring, the geographical factor should be taken into account at the level of countries and even regions Data on the differences of criticality among the different grades of the same raw material also needed. || Policy may pursue a higher use of scrap metal in steel making, as technologies are able to use more in practice More funding will be needed (e.g. in RFCS) to obtain fundamental breakthroughs, together with better cooperation between public and private research institutions || A capital-intensive industry where investments have a long-term nature: it is important for investment decisions that there is a relative ‘stability’ in the regulatory framework so that planning (especially of innovation activities) becomes viable. || Integration of policy on waste, recycling, competitiveness and trade, raw materials and management of natural resources To prioritize on the competing use of raw materials, the competing use of land and the export of recycled materials || Integration of policy on fossil and renewable feedstock materials. Special attention towards ensuring equal competitive access to raw materials in international markets || Market efficiency is the solution to reach resource efficiency targets, as opposed to regulatory incentives

Note: CAP: Common Agricultural Policy; ETP-SMR: European
Technology Platform on Sustainable Mineral Resources, IPPC: Industrial
Pollution Prevention Control, MS: Member States, NEEI: Non-energy extractive
industry, NERM: Non-energy raw materials, RFCS:  Research Fund Coal Steel.

5.
EU Industry in a Sustainable Growth Context
5.1.
Introduction

The eco-performance of the EU economy is
increasingly at the forefront of policy discussion. On the one hand, this
reflects the impact of economic activities on the environment (e.g. climate
change, environmental degradation, etc.). On the other, it mirrors deep
concerns about resource scarcity, coupled with the EU’s reliance on external
supplies of energy and of raw and critical materials. In this context,
policy-makers – along with industry and citizens – face the dual challenge of
delivering economic growth and ever mounting demands to improve energy and
resource-utilisation efficiency within the economy, on both the production and
consumption sides.

This chapter examines
the progress made on moving EU industry towards a more sustainable growth path by analysing economic and environment performance
trends in industry over the last 10 to 20 years. Particular attention is paid
to developments in resource efficiency and in carbon and energy intensity over
recent years at country and sector level, to the extent to which economic
growth is being decoupled from resources used and environmental impacts and to
the potential of the different public policy instruments and industry
initiatives to facilitate sustainable growth and promote a strong industrial
base in Europe.

This chapter is organised as follows:
section 2 provides a brief overview of the policy context and the economic
performance of EU industry in the last 10 to 15 years. Against this general
background, section 3 presents a general assessment of the advances made in the
eco-performance of European industry relative to the trends and developments in
its economic performance. This empirical analysis is illustrated by selected
case studies, with the aim of obtaining a more detailed understanding of the
motives, drivers and effects of particular policy initiatives. Section 4 examines evidence of the levels of investment made in
environmental protection and eco-innovation as an indicator of mitigation
efforts by industry and future decoupling. A few examples of new ‘green
business’ models are highlighted. Finally, the
conclusions are presented in section 5, focusing on the relative strengths and
weaknesses of the policy instruments available and the general lessons learned
about the optimal design of sustainable growth policies.

5.2.
Policy and economic context
5.2.1.
EU policy context

The European policy debate has evolved over
the last ten years. Initially, the 2000 Lisbon Strategy (relabelled in 2005 as
the Growth and Jobs Strategy) and the 2001 Gothenburg Strategy (relabelled in
2005 as the EU Sustainable Development Strategy) continued to move along
parallel tracks. Although both these EU policy frameworks aimed to be
all-embracing and comprehensive, they allowed some room for interpretation in
the balance between economic and environmental performance.

Since 2007, increasing attention has been paid
to further development of EU energy policies with the aim of reducing
dependence on external fossil fuel resources and promoting energy efficiency and
renewables. The cornerstone of this policy is the Industrial
Emissions (Integrated Pollution Prevention and Control – IPPC – recast)
Directive (EC, 2010) and the EU Emission Trading System (EU ETS) (EC, 2003).
Recent amendments to the EU ETS (EC, 2009a) and Directives on carbon capture
and storage (CCS) (EC, 2009b) and on renewable energy sources (EC, 2009c) are
all part of a wider package of reforms directed towards meeting the EU’s target
of reducing its overall emissions to 20% below 1990 levels by 2020 and increasing
the share of renewable energy to 20%. Other important initiatives in the energy
domain are the National Energy Efficiency and Renewable Energy Action Plans
(NEEAPs and REAPs), which Member States are required to
submit under EU directives.

At EU-level, progress has been partial in a
broad range of areas. The Progress Report on the EU Sustainable Development
Strategy pointed to limited improvements in the area of sustainable transport –
at least in the years 2000-2007. Beyond that, a lack of direction was seen in
the area of sustainable consumption and production (European Commission, 2007,
p.32).

In 2008, the Communication from the
Commission on the Sustainable Consumption and Production and Sustainable Industrial
Policy Action (European Commission, 2008) was published. It provided a
framework for improving the energy and environmental performance of products
and fostering their take-up by consumers. The Communication highlighted the
challenge of improving the overall environmental performance of products
throughout their life-cycle, of stimulating demand for better products and
production technologies and of helping consumers to make better choices with
the aid of labelling (specific examples of regulatory-driven and voluntary
eco-labelling schemes are presented in Boxes 5.2 and 5.6, respectively).
Further action was launched to promote cleaner and leaner production and to address
international aspects of the production process. The 2008 Sustainable
Consumption Action Plan on Green Public Procurement includes references to
various regulatory initiatives, such as extension of the Energy Labelling
Directive, the Eco-design Directive and the Eco-label Regulation – the later of
these being voluntary. Other green public procurement (GPP) measures
were also voluntary, as were aspects of the Open Method of Coordination such as
cooperation between Member States on common GPP criteria for products and
services and on preparation of national action plans. A separate Communication
on green public procurement gave fuller details of these measures.

The Europe 2020 Strategy presents a new
all-embracing policy framework promoting a strategy for smart, sustainable and
inclusive growth. Sustainable growth is understood to mean ‘building a
resource-efficient, sustainable and competitive economy, exploiting Europe’s
leadership in the race to develop new processes and technologies, including
green technologies, accelerating the roll-out of smart grids using ICT,
exploiting EU-scale networks and reinforcing the competitive advantages of our
businesses, particularly in manufacturing and within our SMEs as well as
through assisting consumers to value resource efficiency’ (European Commission,
2010a, p.14).

This concept of sustainable growth has been
further translated into a number of ‘flagship initiatives’. The most relevant
are found under the heading ‘Sustainable Growth’. They include the Sustainable
Industrial Competitiveness and the Resource Efficiency flagships. The
Sustainable Industrial Competitiveness flagship addresses issues such as
industrial innovation, access to raw materials and critical products or
resource, energy and carbon efficiency (European Commission, 2010b). The flagship
initiative on the Innovation Union is also aligned with these goals: it states
that stricter environmental targets and standards establish challenging
objectives but ensure long-term predictability, thus providing a boost to
eco-innovation (European Commission, 2010c).

Even more recently, the flagship initiative
on a Resource-Efficient Europe aims to create a framework for policies to
support the shift towards a resource-efficient and low-carbon economy which
will help to ‘boost economic performance while reducing resource use; identify
and create new opportunities for economic growth and greater innovation and
boost the EU’s competitiveness; ensure security of supply of essential
resources; and fight against climate change and limit the environmental impacts
of resource use’ (European Commission, 2011, p.3). This flagship initiative
aims to make use of regulatory, voluntary, communication and information
instruments. It also takes account of public investment, by aligning
this initiative with the proposed reforms on the future of the EU’s own major
spending programmes, including the Common Agricultural Policy, the Common
Fisheries Policy, Cohesion Policy, energy grids and trans-European electricity
transport networks.

In conclusion, building on the earlier
partial success of previous policy frameworks, EU-wide policies relevant to
economic and environmental performance can be seen to have evolved in at least
three directions over the last ten years. EU-level policies:

·
tend increasingly to treat economic and environmental
performance as dual objectives (intrinsically linked through
e.g. ‘green growth’, ‘green’ skills and jobs, eco-innovation); the latest
Europe 2020 framework appears to have provided greater clarity, reducing the
degree of room for interpretation in the balance between economic and
environmental objectives, that emerged over time during implementation of the
Lisbon and Gothenburg Strategies;

·
make use of an increasing array of policy
instruments, recognising that a policy mix of all instruments
available is needed in order to achieve the objectives set. This includes not
only regulatory, voluntary, communication and information but also public
investment instruments. This is a clear evolution from the earlier Lisbon and
Gothenburg Strategies, with the Community policy pillar and country
surveillance of the Europe 2020 Strategy clearly more based on quantitative
objectives and having more binding elements;

·
recognise increasingly the role of other
governance layers and players, notably Member States, but also
regional and local authorities, businesses, social partners and civil society, plus
the global level (e.g. via the WTO and G20). This is particularly important as
such a ‘multi-governance’ approach allows alignment of goals at all levels and
mobilisation of all policy instruments and resources – thus adding to the
effectiveness of policies. Another reason why this approach is important is
that policies promoting economic and environmental performance are not always
clearly aligned between governance layers.

Finally, building upon the points set out
above, before shifting attention to the Member State level, it is important to
recognise the difference between the level at which policy decisions are taken
and the level where they are implemented. As will be seen later, a growing
range of policy measures – though implemented at Member State or sub-national
level - are directly or indirectly induced by the above- mentioned EU policy
frameworks and action plans.

5.2.2.
Economic context: industry gross value added
(GVA) and employment

The overall economic trend over the last 10
to 20 years, until the recent financial crisis, had been one of steady and
continuous growth. Overall, industrial GVA was increasing in every country,
although at a slower rate than GVA for the whole economy, reflecting a decline
in the relative importance of industry (for the purposes of this chapter,
defined, wherever possible, as sectors A to F under NACE revision 1.1, see Annex
I).

Figure 5.1 depicts industrial GVA trends at
constant prices for the EU, the USA and Japan from 1995 to 2007. Industrial GVA
in the EU-25 increased by 22.1% over this period, ahead of the 10.2% increase
in Japan in the same period, but behind the 31.6% increase in the US.

Figure 5.1: Industrial GVA in the EU-25[72], USA and Japan, 1995-2007 (indexed at 1995 prices[73])

Source: Ecorys analysis of EU KLEMS datasets.

Figure 5.2 shows contrasting industrial GVA
trends across different Member States over the years 1995-2000, 2000-2007 and
2007-2009. In the period 1995-2000, Ireland recorded total growth of over 50%,
supported to a large extent by attracting industrial FDI.

In the period 2000-2007, only Portugal and
Malta suffered a decline in industrial GVA: in the case of Portugal this was due
mainly to a significant (-15.3%) decline in construction. The Baltic states,
together with Slovakia, reported the highest growth in this period, each with
total growth over 60%. Other Central and Eastern European Member States also recorded
faster and above-average industrial growth, seizing the opportunities brought
by EU membership and access to the single market.

Many EU-15 Member States – including the
ones with the largest industrial GVA, i.e. Germany, France, Italy and the UK – achieved
relatively modest total growth over the full period. Notable exceptions were
Finland and Sweden where industrial GVA grew by over 20% in both periods (i.e.
1995-2000 and 2000-2007). The expansion of the telecoms sector and the
innovative success of these two economies played a leading role in this (the
GVA data show increases in the electrical and optical sectors [NACE rev.1.1 –
codes 30-33] of over 750% in both countries over the whole period).

The recent recession following the
financial crisis has had a significant impact on EU industry. However, the EU
KLEMS datasets are only partially available at the moment, which could only be
partially redeemed for some countries for the years 2008 and 2009 with data
from the OECD STAN database. Figure 5.2 shows that every country for which data
are available suffered a decline in industrial GVA. In total, these 12 Member
States reported an 11.5% decline in industrial GVA in this period, with the
situation contrasting from one Member State to another. Slovakia, Slovenia and
Greece saw the smallest declines, of less than 5%, whereas the biggest, of more
than 10%, were in Finland, Sweden, Austria, Germany and Italy (see Box 5.1).

Figure 5.2: Total % changes in industrial GVA EU-25, 1995-2009

Note: 2007-2009 data available for only 12 Member States (data missing
from LT, EE, LV, SE, IE, PL, CY, ES, NL, FR, MT, UK and PT) and produced from a
different dataset than data up to 2007, which could account for some of the
differences.

 Source: Ecorys based on EU KLEMS, OECD STAN

The decline in the relative importance of
industry was matched by a decline in industrial employment across the developed
world, both in total employment in industry and also as a proportion of total
employment.

Figure 5.3 relates changes in industrial
GVA to changes in industrial employment in the period 1995-2007. Industrial
employment increased in this period in only eight of the countries selected.
Ireland and Spain recorded the biggest expansion in employment, driven
primarily by rapid expansion of the construction sector. Finland and, to a
lesser extent, Sweden saw strong GVA and employment growth fuelled by expansion
of their electrical and optical sectors. Germany, Japan and the UK all suffered
a significant decline in industrial employment and among the lowest rates of
GVA growth. In Germany this was caused by a decline in mining, textiles and
construction. In the UK it was attributable to a general decline in
manufacturing and a particularly severe contraction in the textiles industry. In
Poland, Slovakia and the Czech Republic, although GVA growth was much more
vigorous, there was also a significant decline in industrial employment, mostly
concentrated in agriculture and the mining and extractive industries but also
including manufacturing.

Figure 5.3: Change in industrial employment and industrial GVA, 1995-2007

Notes: Bubble size represents relative total
industrial employment in 2007 for each Member State – except for the EU-10, EU-15
and EU-25 aggregates or the USA or Japan, where for visual reasons these have
been set to a uniform size.

Data points are unlabelled where visually it was not
possible to name all the Member States.  Unlabelled points include NL, PT, CY
and MT (they cluster with EU15).

Source: Ecorys based on EU KLEMS database, release November
2009.

Within the EU as a whole a decline in
industrial employment of 5.7% was seen, at the same time as industrial GVA grew
by 22.1%. Similar proportions were reported by the USA and Japan, but Korea was
able to secure greater industrial GVA growth, despite a higher decline in
employment (-11.1%), while Australia saw a significant expansion in industrial
employment (+16.6%), concentrated, as with growth, in construction and mining.

The EU-15 recorded a lower decline in
employment (-2.4%) than the EU-25 but also lower GVA growth, related to
relatively mature industrial sectors and labour market differences (e.g.
stronger employment protection overall). On the other hand, the EU-10 (EU-12
minus Bulgaria and Romania) reported a sharper decline in employment (-14.1%)
but a much higher increase in industrial GVA (+74.6%).

Changes in GVA and employment also varied
significantly across sectors. Figure 5.4 presents the changes for the EU-25
sector by sector. The biggest GVA growth was achieved in the electrical and
optical sector, almost doubling over the period. Transport equipment also
recorded significant growth. The figure shows that, among the sectors where
employment declined, textiles and mining and quarrying saw the biggest falls, losing
over 40% of employment between 1995 and 2007. Falls of approximately 13 to 14%
were recorded in agriculture, pulp and paper, electricity gas and water and
other non-metallic minerals. In other sectors employment declined by between 3
and 10%. The construction sector, due to its labour-intensive nature, made by
far the biggest contribution to employment growth and remained much closer to a
one-to-one relationship between employment and GVA growth.

Figure 5.4: Change in industrial employment and GVA per sector in the
EU-25, 1995-2007

Notes: Bubble size represents
relative total employment per sector in 2007.

Data points are unlabelled for
the other NACE rev. 1.1 manufacturing sectors, where visually it was not possible
to name them all – including wood and wood products, food, beverages and tobacco,
other non-metallic minerals and manufacturing not elsewhere classified and recycling.

Source: Ecorys based on EU KLEMS database, release November 2009.

Significant increases in productivity per
worker have been achieved for the generality of countries and sectors (as
reflected by the decline in employment and GVA growth). They are the result of
factors such as the technological progress in interaction with the increased
globalisation, associated market developments, increasing specialisation by EU
industry in high-value products and value-chain segments, increasing levels of
innovation, production automation and technological intensity, etc.

At the same time as productivity and
specialisation has increased, increases in industrial GVA are being achieved in
tandem with proportionally higher increases in the consumption of intermediate
inputs. This is particularly evident in the manufacture of transport equipment.
This point to lower marginal added value per unit of output, reflecting longer
and more complex value chains often involving greater global competition and a
complex blend of inputs needed to meet consumer demands. Only two sectors
-electrical and optical equipment and agriculture- run counter this trend, and
then by only a small amount.

The structural change taking place in
traditional industry is particularly noticeable in terms of employment, with an
average of almost 250 000 jobs per year being lost. At the same time, eco-innovation
efforts and the transition to a more sustainable economy and industry can
offset part of the general industrial relative decline. The potential for
sustainable growth and direct and indirect job creation can be particularly
significant in specific sectors and areas. The EU is a market leader in  the
so-called ‘eco-industries’, a set of eco-related sectors and activities that
have been expanding rapidly in the recent years, growing to become a sector
equivalent (in terms of employment) to chemicals or electrical and optical
equipment in the EU. Annual employment growth in ‘eco-industries’ averaged
approximately 179 000 jobs per year between 1999 and 2008, equal to over 7%
annual growth. In 2008 ‘eco-industries’ employed an estimated 3.4 million
people across the EU (Ecorys et
al., 2009, see also GHK et al. 2007). However, sustainable growth is not the
exclusive domain of certain sectors. Rather, it has the potential to create new
jobs and increase efficiency and productivity in every firm and sector across
the whole economy.

Box 5.1: The impact of the recent financial
and economic crisis

The latest recession was unusually severe,
provoking dramatic falls in industrial production and employment. Industries
producing durable consumer goods were hit harder: capital goods and intermediate
goods suffered most with production losses of around 26% relative to EU
pre-recession peaks (European Union Industrial Structure 2011). The sharp fall
in industrial activity has led to deep job cuts. The reduction in GVA and
employment has been particularly evident in the two biggest industrial sectors
-manufacturing and construction. For example, manufacturing registered a drop
of 15% in GVA and 4% in employment over the period 2007-2009 (for a set of 11 EU
Member States for which figures are available, accounting for around half of
total industrial employment in the EU-25). Patterns of employment decline
appear consistent across sectors but are uneven between countries. Member
States affected by housing bubbles or other macroeconomic imbalances suffered
most in terms of output and, in particular, job losses (see chapter 1 of this
report).

The incomplete data currently available show that
declines in industrial GVA began to be felt in 2008 in most sectors, though
growth was still seen in manufacturing of electrical and optical equipment,
chemicals, rubber and plastics and machinery not elsewhere classified (NEC). In
2009 the impact of the crisis on industry was more significant, with declines
gaining pace in most sectors. They were particularly sharp in industrial GVA in
the electrical and optical equipment, basic and fabricated metals, machinery
NEC, transport equipment and other non-metallic mineral sectors. These changes
are evidence of both consumer and business purchases of equipment being postponed
(electrical and optical, machinery NEC and transport sectors) and of the
drying-up of demand from industry as a whole and the construction sector (basic
and fabricated metals and non-metallic minerals). In the case of the transport
sector, the reaction is instructive as in many Member States there was a strong
focus on scrapping and other schemes to support vehicle purchases.

In addition, many
governments, both European and non-European, have
emphasised the importance of a ‘green recovery’ by investing in, for example, renewables and energy efficiency in
their recovery packages (OECD, 2009). The total ‘green’ part has been estimated to represent 10% of the
EU’s economic recovery plans (HSBC, 2010, see table 7
in annex for an overview of the stimulus plans adopted in the EU, USA, Japan,
South Korea and China, their estimated ‘green component’ and thematic focus). However, this percentage is highly sensitive to how ‘green
investments’ in, for example,
infrastructure, are defined and
is difficult to interpret in terms of environmental impact (European Commission,
2009a). The aggregate spending on and stage of implementation of the ‘green’ elements in European Recovery Packages are currently under review
by the European Commission. However, some examples of mid-term evaluations
exist. Car scrapping schemes, for example, were carried out in 13 Member States
to boost car sales and take
fuel-inefficient vehicles off the roads. The total injection of capital adds up to 7.9 billion Euros and significant environmental benefits are expected, e.g. removing
1.06 million tones of CO2 and pulling down average emissions from the whole
market to 145 g/km (IHS Global Insight, 2010).

5.3.
Eco-performance of the EU Industry

This section analyses the main summaries of
eco-performance and tries to draw the main findings together to form a coherent
picture of EU industry’s move to sustainability. Eco-performance and
sustainability are assessed on the basis of the evidence available in the key
areas of energy, greenhouse gas emissions, other emissions, resource use and
water (see Annex I for the full list and a description of the indicators used).
Sustainability is most closely associated with decoupling of production (and to
a lesser extent consumption) from environmental impact. Two forms of
decoupling, as levels of eco-performance, can be identified:

–
Relative decoupling of resource utilisation (or
production of harmful outputs) from economic activity: while overall
utilisation of resources may increase, the intensity of use falls relative to
the quantity of output produced.

–
Absolute decoupling of resource utilisation (or
production of harmful outputs) from economic activity: the intensity of use of
resources falls relative to output along with a reduction in the overall
quantity of resources used.

5.3.1.
Energy consumption and intensity

Whole economy

Figure 5.5 displays the overall final
energy consumption for the major international economies. As can be seen, since
1990 there has been huge growth in energy consumption in China, particularly since
2001. The USA and India have also exhibited strong growth, whereas in the EU-27
energy consumption has grown slowly over the same period. Analysis shows that
the main source of growth in energy use in the EU-27 over this period has been
in the transport sector, with overall energy consumption in industry
decreasing.

Figure 5.5 Change in final energy consumption in million toe from 1990 to
2008

 Source: OECD Factbook 2010, toe = tonnes of oil equivalent.

Energy intensity trends (final energy
consumption in toe relative to GDP at constant prices, see Annex I) show that
in recent years the EU-27 has closed the gap with Japan, the leading (i.e.
least energy-intensive) major economy. The USA and other countries such as
Australia have been able to narrow the gap on the EU-27, but remain
significantly more energy-intensive. In particular, looking at the relative
improvement in percentage terms, the EU-27 outperforms these countries.

Industry

Energy is a critical input for industry. Changes
in energy consumption, both headline and relative to output, are therefore
important measures of eco-performance. The industrial energy intensity data
presented in figure 5.6[74] show that final energy consumption (FEC) by industry in the
EU-23[75]
as a whole increased by 2.1%, while industrial GVA increased by 24.4%. The
increase in FEC was higher in the EU-15, for a lower increase in GVA. An
overall decline in FEC was recorded in the EU-12(-4)[76], whereas industrial GVA
increased by 95%. This reflects a ‘catch-up process’, specifically the shift to
more energy-efficient processes and less energy-intensive sectors in these
countries.

Large differences in performance were observed between Member States, with Poland,
for example, achieving 88% growth in industrial GVA and a 22% reduction in FEC,
but Ireland recorded 157% growth in GVA and a 37% increase in FEC. In countries
such as Ireland and Spain, the large increase in final energy consumption is mostly
due to the rapid growth of energy-intensive industries, across manufacturing
and including construction. The Baltic region – plus Slovakia – achieved the largest increase in GVA without
substantially increasing final
energy consumption and, in the case of Estonia, even decreasing it.

The data at Member State level point to a
decoupling of energy use by industry from GVA growth in every Member State
except Italy. In ten Member States (AT, ES, IE, FI, SI, LT, SK, LV, EL and PT)
this decoupling was relative, with GVA increasing faster than FEC. In the
remaining twelve (DE, UK, NL, FR, BE, DK, LU, CZ, PL, HU, SE and EE) an
absolute decoupling of FEC from GVA growth was evident.

Figure 5.6: Energy intensity of EU industry (manufacturing and
construction, % change in final energy consumption versus % change in GVA), 1995
and 2007

Notes: Bubble size represents relative industrial FEC in 2007. Dashed
lines represent the trend of all data points and the 45 degree line one-to-one
changes. Bulgaria
and Romania are missing (because the latest EU KLEMS database release has no
GVA data for these two countries). For Portugal, Poland and Slovenia the EU
KLEMS database has GVA data until 2006 only. Therefore, for these three Member
States the % change has been calculated over 1995-2006. EU-23=EU-27
– minus BG, RO, CY and MT; EU-12(-4)=EU12 – minus BG, RO, CY and MT.

Source: Eurostat
(final energy consumption) and EU KLEMS database (GVA).

Energy intensity improved within most of
the individual industrial sectors (see figure 5.7). Overall, the picture was
favourable and some of the sectors with the highest initial energy intensity
achieved some of the largest improvements. The basic and fabricated metals
sector (i.e. the iron and steel and non-ferrous metals industries) saw an
improvement of 22.2% from 1990 to 2008, with the downward trend continuing until
2007-2008 when a significant fall in GVA led to an increase in energy intensity.
The chemical industry recorded a 25.7% improvement over the whole period, which
has levelled off somewhat in recent years. The biggest improvement over the
period, (38%), was achieved by the ‘other non-classified industries’ (i.e.
electrical and optical equipment and wood products), again a product of rapid
increases in GVA. GVA stands out as the dominant variable in intensity trends,
with the increases in intensity recorded in 2007-2008 a result of falls in GVA
greater than the decline in energy consumption.

Figure 5.7: Energy intensity sector by sector (final energy consumption (in
toe)/GVA in million euros (1995 constant prices)), 1995-2008

Source: Eurostat
and EU KLEMS data (Ecorys calculations)

Changes in energy use and efficiency across
sectors and their impact are affected by the fuel or energy mix used, choices of
fuels and, within any given energy mix, by many factors, including local
resource availability, energy prices and public policies. Public policies can
promote energy efficiency and sustainable growth by means of a broad range of
instruments (such as energy taxes and subsidies, regulations and standards,
eco-designs, eco-labels, see section 5.5). Box 5.2 describes the specific case
of mandatory energy labels for light bulbs in the EU which has produced
significant economic and environmental benefits.

Box 5.2: Energy labelling for
light bulbs: linking sustainable consumption, production and eco-innovation

Energy labelling is a mandatory requirement for light bulbs, cars,
and most electronic appliances in the EU. These EU initiatives illustrate how consumer-oriented
approaches to improve sustainable consumption and production can have far-reaching
implications for the economic and eco-performance of industry. The regulatory
energy-efficiency labelling scheme for light bulbs is an example of a labelling
scheme with clear positive effects on both eco-performance (energy-efficiency
improvements) and economic performance (higher value-added products and
stimulating innovation). The labelling scheme has been primarily a regulatory
initiative with the aim of informing consumers and supported and anticipated by
industry.

The mandatory
energy labelling scheme for light bulbs (under Energy Labelling Directive
92/75/EEC and Implementing Directive 98/11/EC on household lamps) is an example
of a compulsory method for informing consumers and setting minimum thresholds the
level of eco-performance of consumer products. Since December 2008, minimum
energy-efficiency requirements for light bulbs are in force with the goal of
phasing out incandescent bulbs by 2012. The energy label for light bulbs shows
their energy efficiency level on a scale from G to A+++ plus the number of lumen
and watts used, indicating the power of the light and the energy consumption
per second. Compared with incandescent bulbs (levels E to G), compact fluorescent
lamps (CFLs) (level A) can save up to 80% of energy for the same light output
and have a service life six to fifteen times longer.

The development and market penetration of compact fluorescent lamps
(CFLs) – the main sustainable alternative to incandescent light bulbs – has kept
partly ahead of regulation. Sales of CFLs increased by 340% from 2003 to 2007
(Bertoldi and Atanasiu, 2009). Industry has taken on a proactive role in
developing and marketing more sustainable lighting alternatives. Nonetheless,
there seems to be consensus among policy makers, industry and consumer
organisations that similar levels of energy efficiency would not have been
achieved without these regulatory schemes, e.g. if the scheme had been
voluntary[77].
This is mainly because consumers are concerned foremost about the quality
(colour) of the light and price of the bulb and do not believe that they can make
a bigger impact by buying energy-efficient appliances.

In general, awareness and willingness to act as a ‘sustainable
consumer’ are increasing in the EU; more than 80% of Europeans believe that a
product’s environmental impact in general is a significant factor when deciding
which product to buy (Eurobarometer, European Commission 2009b). However, when
making a purchasing decision, a large majority of consumers consider quality
and price more important than environmental impact. EU consumers see minimising
waste and recycling as the ways in which they can have most influence on
solving environmental problems, more so than by purchasing energy-efficient
appliances or products that were produced using environmentally sustainable
methods. Differences in consumer attitudes exist between Member States; for
example, eco-labels play a larger role in purchasing decisions by consumers in
Malta, Austria, Portugal and Italy than in the Czech Republic, Hungary,
Estonia, Slovakia and Bulgaria.

Even though the general level of consumer recognition of the A-G
energy label is high across Europe, ranging from 81% in Poland to 95% in the
Netherlands, France and Denmark (Ipsos MORI, 2008), this can mainly be
explained by the mandatory nature of the scheme. Consumer awareness of ‘cost of
ownership’ arguments – i.e. that over the entire lifetime of the light bulb,
energy saving costs can outweigh the initial higher purchasing price – is still
assessed relatively low.

Energy prices and policies or market
conditions affecting their level or volatility, (such as taxes, subsidies,
liberalised markets and competition) can also induce significant changes in
industrial energy use and efficiency. For example, the relatively higher
increase in gas prices against electricity prices over the last decade has been
reflected by a shift in the relative industrial energy mix, from gas to
electricity, in the majority of Member States.

The way changes in energy use make an
environmental impact is also affected by the energy mix in the country or
industry concerned. Low-carbon (i.e. nuclear and renewable) energy sources play
a leading role in this, as do factors such as fuel switching. The proportion of
renewable energy in the energy mix in the EU increased from 13.8% in 2000 to
15.6% in 2008 (EEA, 2010, page 36) with improvements evident across almost
every Member State, in line with policy goals on climate change. The EU as a
whole remains ahead of Japan, the USA and many other countries on the use of
renewable energy but countries such as China are also rapidly developing their
technology and capacity.

5.3.2.
Greenhouse gas (GHG) emissions and intensity

Whole economy

The environmental impact of changes in the
energy mix is better reflected by changes in emissions. Mirroring changes in
energy consumption, the biggest mover in global GHG emissions since 1990 has
been China (see figure 5.8) which has surpassed the EU-27, and now also by most
estimates the USA too, to become the world’s biggest emitter. For both the EU
and USA, the trends in total GHG emissions differ from final energy
consumption, with the EU-27 recording a decrease in emissions while FEC was
increasing and the USA also recording lower increases in emissions than FEC.
This is a result of measures in these economies to promote use of renewable
energy sources and energy efficient processes and to switch the fuel mix away
from coal, the most carbon-intensive energy source.

Figure 5.8: Total GHG emissions in million Gg of CO2 equivalent, 1990-2008

Note: Data for China and Korea are based on
CO2 emissions data only, as CO2 equivalent data are not
reported to the UNFCCC by these two countries. Estimates suggest that CO2
equivalent data would increase their emissions by approximately 8%, based on the
proportions of the other countries.

Source: UNFCCC.

Analysing overall GHG trends within the
EU-27, a marked difference emerges over time. In the early part of the period
1995-2000, significant reductions in GHG emissions were reported across the
EU-12 countries, again tied to economic transition. The picture in the EU-15 at
the same time was more mixed, with most countries decreasing emissions as more
renewables came online and fuel mixes switched from coal to gas, but rapid
economic expansion meaning that in countries such as Ireland, Portugal, Spain
and Greece, GHG emissions also increased rapidly in this period. From 2001 on,
this situation was reversed, with most of the EU-15 countries reducing
emissions. At the same time, rapid economic growth in the EU-12 Member States increased
their total emissions by 1.2% from 2001 to 2008. This increase was not
universal, with Hungary, the Czech Republic and Slovakia managing to continue
reducing their emissions.

Figure 5.9 presents GHG emissions at whole
economy level against GVA changes in the same period. It reveals a variety of
interesting findings:  firstly, that the variation from the average trend is
significant, demonstrating that there appears to be no strong correlation
between changes in emissions and changes in GVA. While changes in GVA are
likely to be a factor in emissions, the energy mix and transport both play a
significant role at whole economy level.

Secondly, 12 EU economies achieved an
absolute decoupling of GHG emissions from GVA growth during this period. This
is interesting, as it includes both EU-15 and EU-10 Member States, showing that
EU-10 Member States are capable of a more sustainable economic transition in
terms of emissions.

Thirdly, every country in the analysis
achieved at least relative decoupling of economic growth from GHG emissions
growth over the period. Various factors lie behind this, including improved
efficiency, cleaner power generation and more renewables in the energy mix. A
further factor is the exporting or ‘offshoring’ of emissions: as heavy
manufacturing is relocated outside these countries, domestic emissions decline,
but the products, despite being produced offshore in places such as the BRIC
(Brazil, Russia, India and China) countries, are still consumed in the EU and
the developed world.

Finally, related to this, an international
comparison of GHG emission intensity shows that the EU achieved the biggest
proportional reductions and, similarly to energy intensity, is closing the gap
on Japan. The USA and Australia lag behind in comparison. Since 1995 the EU has
gained on Japan, while the USA and Australia have also closed on the EU.

Figure 5.9:
Change in EU GHG emissions and GVA – Whole economy, i.e. all NACE rev. 1.1
sectors (GHG emissions (Gg CO2 equivalent)/GVA (in million EUR at 1995 constant
prices), 1995-2007

Note: Bubble size relative to 2007
emissions, except for EU aggregates, US and Japan, which are set to uniform
size for visual reasons.

Source: Ecorys based on UNFCCC and EU KLEMS data.

Industrial emissions

Focusing solely on the role of industry is
difficult, as the emissions data reported to the UNFCCC are not directly
aligned with the standard NACE industrial classifications and, consequently,
GVA. This study matched the closest sectoral definition for industry in the
emissions data – Manufacturing and construction emissions – to the appropriate
economic sectors to form an analysis, but the match between the data sources is
not perfect.

Figure 5.10 presents the trends in
industrial GHG emissions for individual Member States against changes in GVA.
This shows little clear correlation between changes in GVA and emissions from
manufacturing and construction. GVA growth over the period was positive in
every Member State, with 17 of the 23 for which data is available, achieving
absolute decoupling of emissions from GVA. At the same time, six Member States
– Spain, Ireland, Austria, Greece, Estonia and Portugal - saw emissions
increase in this period. One conclusion is that the construction bubble in some
of these six countries contributed disproportionately to emission increases per
percentage point of growth. However, looking at GVA growth in just the
construction sector, Lithuania (+146.1%), Slovakia (+99.2%) and Latvia
(+293.9%) show  growth rates at least as high as in these six countries and
Portugal recorded only 6.5% growth in construction in this period. The
construction sector is, therefore, unlikely to be the only explanatory factor.

The figure also gives an indication of the
relative trends in emission intensity internationally. These show that over the
full period the average EU emission reductions exceed those achieved in all
non-EU countries. The USA has achieved absolute decoupling of emissions, but
not to the same extent as in the EU. This reflects a long-term trend over the
period for the USA to close the gap on the EU, although this is more a result
of faster increases in industrial GVA than of emission reductions.

Figure 5.10: Change in GHG emissions from manufacturing and construction
(UNFCCC) and GVA in the EU-23 (NACE rev. 1.1 D + F), 1995-2007

Note: Bubble size is relative to GHG emissions in
2007, except for EU aggregates, USA and Japan, which are set to uniform size
for visual reasons.

GVA is measured in constant 1995 euros, using EU KLEMS
industry-specific price deflators.

Countries omitted from the analysis due to missing
data are: CY and MT (no GHG data) and BG and RO (no GVA data).

Source: Ecorys based on UNFCCC and EU KLEMS data.

Box 5.3: Sectoral emissions in the EU based on the
CITL database

It is possible to form a more nuanced view
of sectoral emissions in the EU by drawing on data from the CITL database,
compiled as part of the EU emission trading scheme (ETS). This records and
verifies emissions from the largest energy-generating and industrial
installations across the EU, which generate around 40% of total EU-27
emissions. Data are available from 2005 to 2010, with 2009 and 2010 data still
showing some variability in the quality in the data for specific sectors.
Generally, the CITL data show a decline in emissions of 1% across all
installations covered by the EU ETS between 2005 and 2008. At the same time, a
3.6% decline in overall EU-25 emissions was reported to the UNFCCC.

Going beyond 2007, the data from the CITL
show that between 2007 and 2010 emissions declined by around 14% across the EU
(see Figure 5.11), with particularly significant declines in Spain, Portugal
and Romania. This is consistent with expectations, based on the impact of the
financial crisis and contraction in economic activity in 2008 and 2009 in most
Member States. Yet the decline was not felt everywhere, with three Member
States – Sweden, the Netherlands and Lithuania – seeing emissions increase in
this period. In Sweden the increase was tied to problems in the energy sector,
with the shutdown of nuclear reactors increasing the demand for energy from
gas-fuelled plants, combined with increased emissions from large chemical
facilities and metal smelters. In Lithuania and the Netherlands the increases
are a result of increased emissions from existing and new chemical
installations and fuel refineries.

Figure 5.11 Change in EU-25 Member
States' industrial GHG emissions, 2007-2010

\* - 2007-2009 data only – due to reporting gaps in
2010 data.

# - Dataset for 2007-2010, but some concerns over
completeness, with – estimates pointing to 5 to 10% potential additional
emissions. This is based on an estimate of the emissions from installations
that have not yet reported data or for which the data are still provisional,
for 2008-2010. An assessment of potential additional emissions still to be
reported has been made for all Member States in every year, based on emissions
in the latest year from each installation. Only in Ireland and Lithuania does
this estimate exceed 5% of total emissions in one or more year. In most Member
States and years the proportion is less than 1% of the total.

Countries missing due to no or incomplete datasets: CY
and MT.

Source: Ecorys based on CITL data (2009 and 2010
data provisional).

The CITL data also allow a more comprehensive examination of
sectoral emissions over the same period, as shown in figure 5.12. This shows
that EU industry under the ETS was able to achieve a 19% total reduction in
emissions between 2007 and 2010, although a significant portion of this is
likely to be related to the fall in economic activity. The biggest emitter by
far is the electricity, gas and water supply sector, accounting for around 65%
of all emissions under the EU ETS. The 19.6 % decline in emissions from
this sector is therefore a major contributor to the overall decline in
emissions. The move to partial auctioning of EU ETS permits for the energy
sector and continuing expansion of renewable energy are among the factors at
work. Two sectors saw emissions increase in this period: mining and quarrying
(+3.4%) and manufacture of transport equipment (+6.3%). Together these account
for only 1.9% of total emissions. Increases in emissions are centred on the oil
and gas extraction industries and a significant increase from a major German
vehicle manufacturer.

Figure 5.12: Change in industrial GHG
emissions in the EU-25, 2007-2010

\* - Significant data concerns (estimated >5% of
installations/emissions non-reported) in all years.

# - Data concerns in 2009 and 2010.

^ - Data concerns in 2010 figures.

Note: In 2007, approximately 98.7% of total emissions
were allocated to a specific sector: in 2010 92.9% were allocated.

Source:  Ecorys based on CITL data, unless stated, all data
estimated to be within 5% margin of error.

The role of the energy generation mix in
determining emission levels and changes in emissions was mentioned earlier. Figure
5.13 presents the change in GHG emissions from industry against the changes in
final energy consumption (FEC) by industry for the period 1995-2007. This
demonstrates that in the EU-25 (EU-27 excluding CY, MT) FEC by industry
remained largely unchanged, whereas emissions declined by 14%. This indicates
an overall decarbonisation of the energy consumed by industry.

All but four Member States – indicates –
are below the 45 degree line, indicating that most Member States were able to
decouple industrial energy consumption from industrial emissions. In these four
Member States, the recent changes suggest that the energy mix has become higher
carbon, due to retirement of low-emission nuclear capacity and expansion of
coal -or gas- fired plants. Equally, the nature of the data and the potential
for differences in classifications[78]
between the two indicators means the comparison might not be exact. Differences
due to this could change the position as regards decoupling in these four
countries. Five countries achieved only relative decoupling of industrial
energy consumption from industrial emissions: Ireland, Spain, Portugal, Greece
and Austria.

Figure 5.13: Change in industrial GHG emissions (manufacturing and
construction) and final energy consumption by industry in the EU-25, 1995-2007

Note: Countries missing due to no or incomplete datasets: CY and MT (no
industry-level GHG data).

Bubble size represents scale of FEC.

Source:  Ecorys
based on UNFCCC and Eurostat data.

In summary, by most measures of performance
with regard to emissions the EU outperforms the USA and is closing the gap on
Japan. Emissions show a marked trend towards decoupling from GVA growth. In around half of the countries this
trend is heading towards
absolute decoupling. This trend is evident for emissions for the whole economy but
also holds when the best available evidence for emissions
from industry, manufacturing and construction, is
considered. The best performers come from across the EU, with EU-12 Member States
performing particularly well. Indeed, the weakest performers are found in the
EU-15. The other EU-15 Member States generally report emission reductions of up
to 20% combined with GVA growth rates of up to 40%.

5.3.3.
Material flows and resource efficiency

The way in which industries use and dispose
of raw materials is a critical component of their environmental impact and
performance. . It is important to consider the impact of material flows in all lifecycle
stages, namely: how raw materials are extracted (as this places environmental
pressure on the locations from which they are sourced); how they are used (resource
efficiency); how resources or materials are finally disposed of or reused.

Domestic material consumption (DMC) is a measure of the volume (in tonnes) of materials directly
consumed in an economy. It is the sum of all materials extracted domestically
plus the materials in physical imports, minus the materials in physical
exports. As a volume measure, DMC does not differentiate between the type of
material consumed, although it is important to note the differences between,
for example, consuming one tonne of wood versus one tonne of mercury, as they
obviously differ in mass density and the potential environmental implications
of the latter are far more serious. Figure 5.14 shows that within the EU-27,
DMC increased by 7.9% between 2000 and 2007.

Figure 5.14: Domestic material consumption (DMC) in the EU-27 by components
(in million tonnes)

Figure 5.15 presents an analysis of the
change in DMC against the change in industrial GVA over the same period, though
due to data limitations DMC is for the whole economy and not just industry. The
figure shows, how in terms of material consumption, six economies - Italy,
Germany, the UK, the Netherlands, Luxembourg and Hungary - all achieved what
may be regarded, to some extent, as absolute decoupling, by reducing material
consumption while increasing industrial GVA. Eleven other – France, Poland,
Czech Republic, Sweden, Austria, Belgium, Slovakia, Finland, Lithuania, Latvia,
Slovenia –demonstrated what could be regarded as relative decoupling, with
industrial GVA increasing faster than DMC in this period. In the other Member States
below the 45 degree line – Spain, Greece, Denmark, Ireland, Estonia, Cyprus,
Portugal and Malta – DMC grew faster than GVA, pointing to a reliance on
resource use to fuel economic growth. In Spain and Ireland this is understood
to be consistent with expansion in the construction sector with its high
material needs (see figure 5.18).

Figure 5.15: Change in DMC and industrial GVA by Member State, 2000-2007

Note: Bubble size is relative to 2007 DMC, except for EU aggregates.

Source: Ecorys
from Eurostat and EU KLEMS data.

Figure 5.16 presents DMC over the four main
categories of material: fossil energy (carrier) materials, biomass,
non-metallic minerals and metal ores. It shows that consumption of biomass
declined by 0.4%, but metal ore consumption increased by over 10% and
non-metallic mineral consumption by 13.9%. Fossil fuel consumption grew by
3.2%, in keeping with overall growth in FEC in the EU-27 over this period.

Figure 5.16:
Domestic material consumption in the EU-27 by main material categories,
2000-2007

Source: Eurostat

Developing this further, figure 5.17
presents the material productivity for each Member State in 2007 as a factor of
euros of GVA from industry, at 1995 constant prices, per tonne of DMC for the
whole economy. Material productivity for the EU-25 was 0.32 euros of industrial
GVA per tonne of DMC and improved by EUR 0.02 or 5.2% from 2000 to 2007. This
small improvement provides evidence of a limited relative decoupling of industrial
GVA from material use.

A distinct difference is evident between
the EU-15 and EU-10 economies, with material productivity more than three times
higher in the EU-15 (0.36) than in the EU-10 (0.10). The countries with the
highest material productivity levels are Luxembourg, the Netherlands and
Germany, broadly consistent with the data on DMC. Spain and Ireland rank among
the countries with the lowest levels, again reflecting the role of the
relatively high material consumption of the construction sector.

Eight Member States recorded a decline in
material productivity – Malta, Denmark, Spain, Ireland, Greece, Portugal,
Cyprus and Estonia – mainly a trend in the Member States with strong expansion
in the construction sector, rather than a divide along EU-15 and EU-10 lines,
as was evident in the changes in figure 5.15. The change in the EU-10 marked a
relatively bigger increase in material productivity than that achieved in the
EU-15. The biggest absolute increase in material productivity came in
Luxembourg, the Netherlands, Germany, Italy, Sweden and Slovakia, each
recording increases of 0.05 EUR or more over the period. The biggest relative
increases in material productivity (greater than 20% over the period), came in
Luxembourg, Italy, Slovakia, Czech Republic, Hungary and Poland, illustrating
the catching up process in some of the EU10 countries.

Figure 5.17:
Material productivity in the EU-25 in 2007  – Industrial GVA in EUR (1995
constant prices) per tonne of DMC in 2007 and change in material productivity,
2000-2007

Source: Ecorys based on Eurostat (DMC) and EU
KLEMS (GVA) data.

5.3.4.
Waste generation and treatment

The production process in industry creates
waste at various stages. Examining trends in the volume of waste generated by
industry provides insights into changes in the absolute and, by relating back
to GVA, the relative impact of industry. The coverage and quality of waste data
restrict the extent to which analysis is possible, as so far data have been
collected for only 2004, 2006 and 2008 and are not directly comparable between
industries.[79]

Total waste generation data for industry[80] in the EU-27 are presented in
figure 5.18. This shows clearly that the two sectors that appear to generate
the largest amount of waste are construction and mining and quarrying. The
overall trend is interesting, with a 4.8% rise in the total from 2004 to 2006,
fuelled by an increase in waste generation from the electricity, gas and water
sector (+42.7%) and construction (+7.9%). Over the same period there were
decreases in the volume of waste generated from mining and quarrying (-14.1%)
and manufacturing (-5.2%). According to the same data source, from 2006 to 2008
there was a significant decline (-11%) in the volume of waste generated, with
the biggest arising in agriculture (-41.4%) and electricity, gas and water
(-20.8%).

Figure 5.18:
Total waste generation by industry in the EU-27 (NACE rev.2 A-F), 2004-2008

Source: Ecorys based on Eurostat data.

Figure 5.19 presents the change
in waste generation by sector, against the change in GVA over the period
2004-2006.[81]
This demonstrates an absolute decoupling of waste generation from GVA growth in
this period for all sectors in the upper left quadrant, including manufacturing
as a whole and electrical, optical and transport equipment, basic and fabricated
metals, food, beverages and tobacco (FBT), chemicals and wood and wood products
(WWP).

Relative decoupling, with generation of
waste increasing at a slower rate than GVA, is evident in all but four of the
other sectors. The four sectors that counter the trend are construction, agriculture,
electricity, gas and water and paper and publishing. In each case the change in
GVA was exceeded by the change in waste generated, apparently pointing to
negative trends in eco-performance in these sectors. There is no clear
explanation for the increase in waste generation in these sectors is not clear.
Box 5.4 presents a brief assessment of the impact of the End-of-Life Vehicles
Directive (which imposed binding targets for reuse, recovery and recycling) on
the eco-performance of the automobile industry in the EU.

Figure 5.19:
Change in total waste generation by industry (NACE rev. 2 A-F) and GVA in the
EU-27, 2004-2006

Notes: Bubble size represents relative waste generated
in the sector, except for whole economy and industry (A-F). E&O, Trans
represents the combined totals for the electrical and optical and transport
sectors.

Source: Ecorys based on Eurostat data.

Box 5.4: Measures to support sustainable performance in the EU
automobile industry: an assessment of the ELV Directive

The End-of-Life Vehicles (ELV) Directive (EC, 2000a) was introduced
in 2000 in order to achieve a number of environmental benefits (and is thus
based on Article 192 of the Lisbon Treaty). It covers the whole lifecycle of
a vehicle, including the design, re-use and recycling stages. Above all, it
regulates a major sector of European industry that is facing considerable
competition from around the world. This is perhaps why the Directive has attracted
considerable attention, and at times criticism, from the different industries
involved in the product chain.

The headline provisions of the Directive are its binding targets for
re-use, recovery and recycling of ELVs. By 2006, 85% of the weight of each
vehicle had to be either reused or recovered (e.g. bumpers, tyres, etc.) and
80% had to be reused or recycled. Moreover, these targets will rise to 95% and
85% respectively by 2015. Before the ELV Directive some countries had already managed
to achieve high levels of reuse, recovery and recycling thanks to effective
voluntary agreements with industry (for example, in Sweden and the
Netherlands). However, this was not the case throughout the EU, which was one
of the reasons for introducing the Directive.

The 2006 targets have been reached in nineteen Member States, though
reporting has been problematic because of the different methods employed by the
national authorities (EP, 2010). There is, however, some concern that the 2015
targets cannot be achieved because of the extra proportion that needs to be
recovered or recycled, as every additional percentage point becomes more
difficult. A large proportion of each ELV has significant value, which is why dismantling
cars has long been a profitable business all over Europe. However, the parts of
an ELV with less value make reuse and recycling less commercially attractive. By
way of illustration, the average value of the ferrous metals in an ELV (steel
and iron) is €128, whereas the plastic is worth only €1 (ARN Recycling).

The different industries in the automobile supply chain have been
forced to make considerable changes in order to meet the requirements of the
Directive. Significantly, the principle of extended producer responsibility
has been introduced whereby manufacturers assume responsibility for the final
use of their products, which had previously not been considered part of an
industry’s core business (Gerrard and Kandlikar, 2007). Some of the specific
challenges which the EU industry has had to face are described below:

- Vehicles now need to be designed for recycling in addition to
normal commercial considerations. Use of plastics is problematic, because of
their low value and mixture of types, which makes them difficult, and therefore
more expensive, to recycle. However, changing the design of a vehicle for
recycling purposes can increase its weight which has a negative impact on energy
efficiency and emission reduction efforts. In this regard the increasing use of
aluminium is encouraging, since it is a light material with a high end value.
Although it is expensive, use of aluminium could help to reinforce Europe’s
tradition of making quality cars. Even closer coordination between suppliers
and manufacturers and the recycling industry is needed to make sure that the
whole life cycle of the vehicle is taken into account. Some interesting and
useful research was conducted with these different partners in the EU-funded
LIRECAR (‘Light and recyclable cars’) project just after the Directive was
introduced. More investment in similar research is needed to ensure that
vehicles are designed for both the environment and recycling, while remaining
competitive on price.

- Manufacturers and, consequently, their suppliers have also had to stop
using four heavy metals (lead, cadmium, mercury and hexavalent chromium) which
are damaging the environment. The industry has largely achieved this (ÖKO
Institut, 2010) but at a considerable financial cost. These heavy metals were
being gradually phased out by industry but future vehicles such as battery-powered
or hydrogen cars will need other raw materials (European Commission, 2010e). To
remain competitive, more resources have to be invested in research for
the future (e.g. into long-term substitutes that do not rely on access to
critical raw materials; see the previous chapter of this report), which should be
given equal priority to regulation of cars designed today.

- The recycling industry has had to innovate in order to meet
the targets set by the Directive, notably in use of post shredding technology
(PST) that separates materials even further so that they can then be recycled
or used for energy production. ARN Recycling recently completed a large plant
in Tiel (Netherlands) with support from the automobile industry and new
facilities have also been opened in Austria and Germany. Volkswagen, in
partnership with the recycling company Sicon, has produced the first car that
meets the recycling targets set in the Directive, mainly by means of investment
in PST.

However, overall, industry has been expressing some concerns about
whether imposing headline targets is the best strategy to create sustainable
growth. This is illustrated by its much larger investment in R&D on
emission reduction, fuel efficiency and energy consumption technologies
(Gerrard and Kandlikar, 2007). The environmental benefits of the Directive have
to be weighed against the costs and the need to concentrate on the future of a
rapidly changing industry. Greater understanding of the different stages of
the supply chain helps to ensure that the whole lifecycle of the product
is taken into account. Legislation certainly has a role to play in this, but so
do research and intra-industry cooperation. Consequently, the right combination
and the establishment of well functioning markets for recycled materials are
needed in order to create the conditions for sustainable growth.

Waste can have a significant environmental
impact, particularly if it is hazardous or otherwise contaminated, but even
simple biological waste can also be a significant source of GHG when disposed
of in landfills. It is becoming increasingly important to view waste as a
potential resource stream, rather than a problem that needs to be disposed of
in the cheapest way possible.

Figure 5.20 illustrates the most recent
trends in waste treatment across the EU-27, giving details of the process used
to dispose of the waste. In keeping with the waste hierarchy of reduce, re-use,
recycle, recover or dispose (in that order of preference), the waste treatment
methods span the last three stages. Recovery other than energy recovery means
recycling or other more environmentally friendly treatment of waste. Energy
recovery means using waste to produce energy, typically by means of
incineration, but also via other processes. The three other categories cover
forms of disposal, from incineration without energy recovery to disposal of
waste on land (landfill) or into water.

The total quantity of waste treated increased
from 2004 to 2006 before falling from 2006 to 2008. Overall, from 2004 to 2008
the total volume of waste sent for treatment increased by 1.6% from 2 353
million tonnes to 2 391 million tonnes. Changes between the main treatment and
disposal methods over the period were limited primarily to a move towards
greater recycling in the ‘recovery other than energy recovery’ category, which
increased its share of waste treatment from 41.7% to 45.7% between 2004 and
2008. At the same time, disposal of waste via landfill or ‘deposit onto or into
land’ decreased from 51.9% to 47.3%. An increase in energy recovery from 3.1%
to 3.4% was also recorded (see also chapter 4 of this report on waste stream
recovery and recycling of non-energy materials).

Figure 5.20:
Total waste treatment in the EU-27, 2004-2008

Source: Eurostat.

The waste treatment data do not allow sectoral analysis. Nevertheless, it is
clear that the way in which waste can eventually be treated is a factor in how
industrial processes enable or restrict the options by which products can be recycled
or disposed of safely. If targets are to be met and the environmental impact
reduced, it is important for industry to design products with cradle-to-cradle
life-cycle processes in mind. Although not evident at macro level, several
initiatives have been launched to increase resource efficiency, but they are
still not widespread among all industry. Collection systems’ bottlenecks and
the lack of incentives to use recycled material are major barriers to enhancing
the waste recycling markets.

The overall eco-performance of industry in
terms of material and resource use is more mixed than for other environmental
variables. With material consumption increasing as a whole, but at a slower
rate than GVA growth, there is evidence of relative decoupling of the impact
for the EU as a whole. At Member State level the picture is more mixed with
only a few countries providing strong evidence of absolute decoupling of
economic growth from material and resource use - Germany, Italy, the
Netherlands and, to a lesser extent, the UK, Hungary and Luxembourg. A more
worrying trend is that nine Member States (Spain, Greece,
Denmark, Ireland, Slovenia, Estonia, Cyprus, Portugal and Malta) exhibit no decoupling of resource consumption from GVA growth,
demonstrating that, in some Member States at least, efficient and sustainable
resource use is some distance away.

Within industry there were more positive
trends in most sectors, with waste generation being decoupled from GVA growth
to some extent in all but three. Manufacturing as a whole and many of its
sub-sectors exhibit absolute decoupling. Notably, there was relative decoupling
in the construction sector, the biggest waste generator. The second biggest
waste-generating sector, mining and quarrying, was among the poorest relative
performers.

Positive eco-performance trends were
exhibited in waste treatment in general, with energy recovery and recycling
slowly displacing disposal to landfill. The role of policy in initiating this
change should not be underestimated.

5.3.5.
Water

Europe has abundant water resources, but
they are not distributed evenly. In some regions water is becoming an
increasingly precious and scarce resource. Therefore, efficient use and
management of (waste)-water resources is important to prevent and/or adapt to
water scarcity. The Water Framework Directive was designed to safeguard a
sufficient supply of good-quality fresh surface water and groundwater within a
sustainable, balanced and equitable water use scheme in each Member State (EC,
2000b).

The efficiency with which industry uses
water is important, although agriculture and residential users are the largest
sources of demand. Water is crucial to many industrial processes. It is
therefore important to balance industrial needs against agricultural and
domestic requirements, knowing that losses of water in the supply network are
often substantial, particularly in Member States with severe water scarcity, as
in southern Europe. Water has a number of other environmental impacts,
including indirectly via the energy used in processing, supplying and treating
it.

It is hard to draw robust conclusions on
the eco-performance of industry in terms of water use (both as input and as
destination for its emissions) as the data are weak and incomplete on a yearly
and Member State basis. Comparing total water abstraction with abstraction for
industry, the latter has fallen faster than total abstraction over the same
period. Figure 5.21 provides some evidence of an absolute decoupling of
industrial water abstraction from industrial GVA growth. A particular
improvement is evident in Germany over the whole period. The one exception according to the available data is Austria,
where water abstraction increased over the period. As regards water as
destination for industrial emissions, see Box 5.5.

Figure 5.21: Water abstraction by EU manufacturing industry by
Member State, 1995-2007

Note: Countries missing due to no or incomplete data:
UK, MT, IE, LU, PT, FI, IT, NL, LT, DK and EL.

Source: Eurostat.

Box 5.5: Eco-expenditures on waste-water
management

Wastewater management is a major item in industrial environmental
protection expenditures (EPE), which is presented in section 5.4.2. In 2006,
wastewater management accounted for 17% of public EPE. Figure 5.22 presents an
analysis of the extent to which increased EPE on wastewater by manufacturing
industry could lead to decreases in industrial water abstraction. It
demonstrates that the correlation between the two variables could be weak: in general,
EPE on wastewater has been increasing faster than water abstraction. In
addition, aside from Poland and Lithuania, the five other Member States where EPE
on wastewater by manufacturing industry increased, also saw their water
abstraction for manufacturing decline. Austria saw the biggest increase in
water abstraction. As mentioned previously, this was due to above-average
growth in water intensive manufacturing sectors such as food, drink and tobacco
and chemicals.

Figure 5.22: Change in EPE on wastewater and in water abstraction by
manufacturing industry in selected Member States,  2003-2007

Note: Bubble size represents relative industrial EPE on
wastewater in 2007. Member States missing due to incomplete data: BE, DK, IE,
EE, EL, ES, FR, IT, CY, LU, MT, NL, FI, PT and UK.

Source: Eurostat data – Ecorys analysis.

As shown by figure 5.23 in general there appears to be a correlation
between increased industrial GVA and increased industrial EPE on wastewater. This
is strongest in newer Member States in Central and Eastern Europe, as a result
of lower relative starting points than in Member States such as Germany and
Sweden

Figure 5.23: Change in EPE on wastewater and GVA in industry in
selected Member States, 2003-2007

Note: Bubble size represents relative
industrial wastewater EPE  in 2007. Member States missing due to incomplete
data: BE, BG, DK, IE, EL, IT, EE, ES, FR, CY, LU, MT, NL, PT, RO and UK.

Source: Eurostat data – Ecorys analysis.

There are various other aspects affecting
the sustainability of industry including its impact on land use, biodiversity
and air pollution (see also subsection 5.4.3 and Box 5.8 below on environmental
protection expenditures). Measures of these are of mixed quality. For air
pollution there has been a significant improvement in industrial emissions in
the last 10-20 years, closely following the trends in energy and GHG emissions
as the emission source points are often the same. Since 1995 there have been
falls of around 50% in particulates (PM10), which are responsible for human
respiratory problems, and over 50% falls in nitrogen oxide (NOx), ammonia (NH4)
and Sulphur dioxide (SO2), the main pollutants responsible for acid rain
(Ecorys et al. 2011). Reductions in these emissions are continuing, although
they have slowed since the early impetus given by EU air pollution legislation
(see also Commission 2002).

5.3.6.
Summary and tentative discussion on the impact
of the recent crisis

The overall picture emerging of the
eco-performance of EU industry is
one of significant progress towards decoupling economic growth from
environmental impact over the last two decades. The specific role played by industry within this setting is not always clear from the data,
as it is not always possible to separate out which part of the changes is the result of growing efficiency in
industry and which is due to other improvements. A case in point is that many
of the most positive aspects of industry's eco-performance stem from improvements in emissions from the
energy sector. However, the evidence points to these improvements being based
on wider policy intervention in the energy generation sector, rather than on action taken by industry. While not all
the improvement could be claimed by industry for these reasons, the evidence
does support the view that on the whole industry has improved its
eco-performance over the period covered and that these trends are continuing in
most sectors and Member States. Policy has played a prominent role in many of these developments, particularly in improvements in
emissions to air and in waste and resource efficiency.

Overall, there remains strong evidence of,
at least, relative decoupling of GVA from environmental impact across the
majority of industry, particularly in respect the cases of energy, GHG or other
emissions and water use. Relative decoupling is also apparent in material
consumption, but not to the same extent as in the other aspects. The evidence
suggests that absolute decoupling is also taking place, with eco-performance
improving in absolute terms, not just proportionally, while economic
performance is also improving. This is most visible in the cases of energy use
and emissions, but, as noted above, any absolute decoupling is the product of a
variety of factors to which actions by industry alone makes only a small
contribution.

Throughout the text references are made to
the recent economic crisis. Unfortunately, however, 2007 is the latest year for
which most indicators of industrial eco-performance are available. Nevertheless, whenever more recent
observations are available, a steep decline in the eco-indicators over the last two years tends to be
observed. These drops are likely to have been influenced by the dramatic fall
in economic activity. The crisis is also the probable reason for the reductions
in emissions and resource use in the short-term (European
Commission, 2010f). Early estimates from the EEA (EEA, 2010) point to a:

·
5.5% drop in fossil fuel consumption (oil, coal
and natural gas);

·
6.8% drop in GHG emissions compared with 2008,
which implies a 17.3% reduction from 1990s levels;

·
12.7% drop in coal use;

·
8.3% increase in use of renewables;

·
11.6% reduction in emissions from sectors
covered by the EU ETS.

On a global scale, however, the drop in GHG
emissions was limited to 1.3%, which is significantly less than predicted at
the dawn of the crisis (Friedlingstein et al., 2010).

There is a growing body of evidence showing
a short-term (beneficial) impact on some of the indicators for sustainable
growth. The medium and long-term impact is more difficult to estimate. As
economies rebound emissions are expected to increase. Friedlingstein et al. (2010)
suggests that if global GDP increases by 4.8% (as projected by the IMF in 2010)
then carbon emissions would follow with a 3% increase, assuming that
improvement trends for carbon intensity remain stable. With the recovery of the European economy (which
experienced an uneven and fragile economic growth of 1.8% in 2010 and is
projected to maintain the same growth rate in   2011, EC, 2011a), GHG emissions
from the power sector and industry appear to have increased by 3.5% in 2010, as
indicated by preliminary figures (DG CLIMA, 2011).

The scattered evidence and data presented
in the previous paragraphs can provide a starting point for analysing the effects of the economic
crisis on sustainable growth. Comprehensive analysis will, however, have to
wait until data are published for 2008-2010 and the effects of the economic
rebound are better known.

5.4.
Eco-expenditure and eco-innovation

This section analyses the evidence on the
levels of investment made in environmental protection and eco-innovation as a
marker of mitigation efforts by industry and future decoupling. New
"green" business models are also briefly discussed.

5.4.1.
Eco-innovation

Eco-innovation is often regarded as pivotal
for achieving sustainable growth (see, for example, Aghion et al. 2009a).
According to the Eco-Innovation Observatory (EIO, 2010), ‘eco-innovation is
the introduction of any new or significantly improved product (good or service),
process, organisational change or marketing solution that reduces the use of
natural resources (including materials, energy, water and land) and decreases
the release of harmful substances across the whole lifecycle’.

Data on eco-innovation are relatively poor
and researchers rely heavily on patent statistics (see e.g. Oltra et al., 2008,
Dechezleprêtre et al., 2011, Johnstone et al., 2010), single case studies (Technopolis
Group, 2008) or scattered surveys (Kemp, 2008). Using survey, patent and
venture capital data, Aghion et al., (2009b) argue that the speed of
eco-innovation in technologies is slow compared with other emerging
technologies. The authors see some momentum but claim that support from tax
rates on energy, the ETS and public spending on R&D is still too low and/or
fragmented. Patent data are also used in case studies on the state of
eco-innovation in particular countries. Dechezlêprete and Martin (2010), for
example, look at how the UK performs in terms of eco-innovation by identifying
19 technologies they claim are ‘clean’. The study singles out certain
technologies (such as marine technologies) where the UK holds a comparative
advantage.

This section examines the environmental
benefits of innovation using micro-level and firm data from the Community
Innovation Survey (CIS 2008) and a Eurobarometer study based on a survey of
managers of European SMEs (‘Attitude of European entrepreneurs towards
eco-innovation’, Flash Eurobarometer 315). CIS 2008 provides some insight into
whether innovation generally leads to environmental benefits for firms, in
addition to the perceived economic benefits.

Table 1 presents an overview of the
environmental benefits reported by firms with innovation activities in CIS
2008. There are marked differences between countries but, overall, lower energy
use is the most commonly reported benefit. This might be related to the fact
that it is a general target relevant to every enterprise in every sector. Other
prominent environmental benefits include ‘Recycled waste, water or materials’
and ‘Reduced material use per unit of output’.

There clearly appear to be big differences
between some countries. The countries with the highest percentage of innovating
companies reporting environmental benefits are Ireland, Germany and Portugal.
Environmental benefits are clearly less present in Bulgaria, Cyprus and Czech
Republic. Up to two thirds of the Irish innovating companies report recycled
waste, water or materials, whereas only 15% of the Bulgarian innovating
companies report reduced energy use per unit of output in the form of
production of goods or services. One notable finding is that the three best and
three worst performing countries are each spread across the innovation typology
groupings (innovation "leaders", "followers", "moderate
innovators" and "catching-up countries", see the Innovation
Union Scoreboard 2010). This provides some evidence that typologies for overall
innovation may not be as appropriate for the analysis in terms of environmental
benefits of innovation. Looking at the underlying data, generally speaking,
industry reports more environmental benefits than services.

Table 5.1:
Percentage of enterprises with innovation activity reporting an environmental
benefit, 2008 – Industry (without construction)

|| Environmental benefits from production of goods or services within enterprise || Environmental benefits from after-sale use of goods or services by the end-user

|| Reduced material use per unit of output || Reduced energy use per unit of output || Reduced CO2 ‘footprint’ (total CO2 production) by your enterprise || Replaced materials with less polluting or hazardous substitutes || Reduced soil, water, noise or air pollution || Recycled waste, water or materials || End-user benefits, reduced energy use || End-user benefits, reduced air, water, soil or noise pollution || End-user benefits, improved recycling of product after use

Austria || 37 % || 39 % || 29 % || 34 % || 39 % || 32 % || 34 % || 26 % || 22 %

Belgium || 33 % || 40 % || 31 % || 30 % || 37 % || 44 % || 28 % || 23 % || 26 %

Bulgaria || 13 % || 15 % || 6 % || 10 % || 12 % || 9 % || 8 % || 8 % || 6 %

Cyprus || 16 % || 21 % || 13 % || 12 % || 21 % || 19 % || 8 % || 9 % || 8 %

Czech Republic || 37 % || 41 % || 20 % || 24 % || 32 % || 45 % || 34 % || 31 % || 30 %

Estonia || 26 % || 9 % || 14 % || 22 % || 9 % || 13 % || 18 % || 14 % || 13 %

Finland || 41 % || 38 % || 28 % || 29 % || 28 % || 40 % || 34 % || 23 % || 25 %

France || 30 % || 28 % || 18 % || 33 % || 29 % || 43 % || 23 % || 19 % || 23 %

Germany || 46 % || 54 % || 39 % || 31 % || 47 % || 48 % || 47 % || 37 % || 34 %

Hungary || 39 % || 44 % || 20 % || 37 % || 36 % || 29 % || 21 % || 20 % || 14 %

Ireland || 37 % || 43 % || 39 % || 40 % || 38 % || 66 % || 38 % || 29 % || 42 %

Italy || 16 % || 19 % || 15 % || 16 % || 28 % || 28 % || 24 % || 25 % || 24 %

Latvia || 21 % || 27 % || 10 % || 25 % || 36 % || 17 % || 24 % || 34 % || 11 %

Lithuania || 40 % || 42 % || 25 % || 33 % || 29 % || 26 % || 27 % || 21 % || 21 %

Luxembourg || 35 % || 39 % || 38 % || 38 % || 41 % || 61 % || 29 % || 29 % || 33 %

Malta || 32 % || 33 % || 14 % || 26 % || 22 % || 31 % || 18 % || 5 % || 14 %

Netherlands || 25 % || 29 % || 18 % || 30 % || 27 % || 31 % || 25 % || 20 % || 18 %

Poland || 31 % || 33 % || 19 % || 30 % || 35 % || 28 % || 28 % || 30 % || 19 %

Portugal || 42 % || 46 % || 33 % || 46 % || 54 % || 64 % || 40 % || 43 % || 45 %

Romania || 40 % || 41 % || 26 % || 26 % || 37 % || 37 % || 33 % || 33 % || 22 %

Slovakia || 27 % || 34 % || 12 % || 24 % || 29 % || 33 % || 31 % || 26 % || 25 %

Sweden || 32 % || 35 % || 24 % || 29 % || 27 % || 27 % || 30 % || 24 % || 20 %

Source: CIS 2008 (IDEA Consult).

These findings are consistent with the
analysis of eco-innovation in Flash Eurobarometer 315. According to Eurobarometer,
about 42% of the enterprises that had introduced at least one type of
eco-innovation in the last two years said that such innovations had led to a
reduction in material use. Furthermore, comparing CIS data with Flash
Eurobarometer 315, no direct correlation can be established between
eco-innovation and reporting an environmental benefit, as the countries
reporting the highest environmental benefits are not especially the ones
reporting high investment in eco-innovation investments. According to Flash
Eurobarometer 315, ‘there are only six countries where more than 20 %
of respondents estimated that 30 % of their innovation investments were
eco-related (Sweden, Greece, Austria, Cyprus, Luxembourg and Poland’). This
list of countries clearly does not coincide with the countries reporting high
percentages of environmental benefits (mainly Ireland, Germany and Portugal).

Figure 5.24 presents the CIS results on the
motives for eco-innovation. These are instructive, as they show that firms'
expenditure on environmental protection is primarily driven by compliance and
regulation and that in every case grants, subsidies and financial incentives
were the weakest motivation for environmental innovation.

Figure 5.24: Motives for environmental innovation (percentage of
enterprises with innovation activity), 2008 - Industry (without construction)

Source: CIS 2008 (IDEA Consult).

Some reasons can be put forward to explain
why government grants play a rather limited role in triggering environmental
innovation: firstly, that the available grants do not
provide a big enough incentive for European companies to invest in eco-innovation
or, secondly, that companies are unable to gain easy access to these grants. The Eurobarometer survey found some evidence
to support this latter point, stating that ‘barriers
related to financing and funds were very or somewhat serious barriers to an
accelerated development and uptake of eco-innovation. For example, insufficient
access to existing subsidies and fiscal incentives was considered a barrier by
6 in 10 respondents.’

Figure 5.24 also reveals that in Belgium,
Finland, Luxembourg and Portugal, companies tend to be relatively more
proactive, introducing environmental innovations in response to current or
expected market demand and because of voluntary agreements within their sector.
This contrasts with other Member States (such as the Czech Republic, Lithuania,
Malta, Romania and Slovakia) where firms report they mainly react to regulation
(existing or expected). This may still reflect the implementation of the acquis
as a driving force for innovation. The remaining countries have mixed profiles, with no clear dominant motive for
environmental innovation. The Eurobarometer survey also corroborates these
findings for SMEs. About two thirds of managers said that uncertain market
demand was a barrier to faster take-up of eco-innovation in their company. This
uncertainty would definitely play a role in defensive behaviour in
eco-innovation, with firms unwilling to take a lead in market demand and
voluntary agreements.

A detailed sectoral analysis reveals that
firms in some sectors tend to be more responsive to one or even all the motives
suggested for introducing an eco-innovation (such as electricity, gas, steam,
air conditioning, water supply or waste management), but that, overall,
existing regulation is the preponderant factor. See boxes 5.6 and 5.7 for two
sectoral case studies.

Box 5.6: Industrial initiatives: the
Marine Stewardship Council sustainable fishing labelling scheme

One example of a voluntary labelling scheme is the Marine
Stewardship Council (MSC) sustainable fishing labelling scheme, which certifies
and promotes well-managed marine wild-capture fisheries. MSC certification is
based on third-party assessment of sustainable use of resources and the environmental
effects of the activities from capture up until delivery on land.  To date, 105
fisheries around the world have been MSC-certified, of which 39 are in Europe.

Since the
MSC label was introduced in 2004, take-up has been strong. The total number of
MSC-labelled seafood products available increased from an estimated 1 000 in January
2008 to 7 362 in September 2010 and approximately 8 200 in January 2011. The
largest range of MSC-labelled fish products available is in Germany (2 018
products), the UK (791) and the Netherlands (727). In the Netherlands for
example, MSC-labelled products are estimated to have a share of 19% of total
wild-caught seafood products now available at retailers. In this case,
consumers also consider various other factors (freshness, health benefits and
price) to be more important than environmental impact (World Business Council
for Sustainable Development, 2008 and Seafood Choices Alliance, 2007).
Nonetheless, consumer willingness to buy sustainable products seems to be
slightly higher for food and fish than for other products.

Consumers have, however, not been the main drivers of take-up of the
MSC label. Looking at the fisheries value chain, industry, civil society and
retailers all play a central part. In 1997, the MSC was set up by a joint
engagement of a food brand (Unilever) and a civil society organisation (WWF),
in response to concerns about depletion of fish stocks (whether for reasons of
environmental protection or as a company response to input supply insecurity).
Retailers, although not the primary initiators, have been fast to take it up.
Operating in a responsive, fast-moving segment in close interaction with consumers,
retailers play a central role in the MSC scheme. Along the value chain
of the fisheries, there has been more resistance to the MSC labelling scheme.
For the fisheries economic considerations are the dominant driving factor and
the label has been perceived by some as an additional cost burden (on top of
fishery policies like quotas that influence this part of the value chain more
directly) – even though, for some fisheries, more sustainable fishing methods
have given rise to cost savings and economic benefits. For example, in a small
fishery in the Netherlands, a switch to sustainable practices led to a saving
of up to 70% in fuel expenses while catching higher quality fish and reducing the
by-catch and debris. Nonetheless, in general, fisheries’ move to MSC
certification has been pushed primarily by the next links along the value
chain, where brands have created demand for certified fish from the
fisheries. More recently, fisheries that claimed to have been using sustainable
practices before they receive certification have been using the MSC label as a
way to increase their exposure to the markets and legitimise their good-quality
practices (Potts, T. et al., 2011).

In short, both voluntary and mandatory (see Box 5.2) labelling
schemes can be seen as successful examples of enhancing economic and environmental
performance. In general, consumer awareness and responsiveness to eco-labels is
increasing in the EU (see Box 5.2), even though price and quality remain the
main factors in consumers’ purchasing decisions. Consumers tend to associate
fish products (food) more closely with sustainability than light bulbs
(consumer electronics), possibly as a result of their more direct perception of
scarcity and of the finite nature of natural resources. The voluntary MSC label
has attained a high take-up rate, especially in some perceptive countries. The
main drivers behind the high take-up rates for MSC have been food processors
and food brands, along with retailers. Industry plays a crucial role as a
driver for successful labelling and sustainable consumption and production. From
the specific cases analysed, consumers seem to accept rather than drive more
sustainable consumption and production.

Box 5.7: Industrial initiatives
and new more sustainable business models: chemical leasing

This case study takes the perspective of the chemicals industry in
the search for sustainable business models – models that can simultaneously
have a positive impact on the competitive position of a sector or company (e.g.
by means of ‘green’ brand positioning and /or cost reductions) and on the use
of natural resources.

The considerable move by EU industry towards more sustainable
chemistry over recent years has been mostly from within the chemical industry,
driven by considerations such as resource efficiency, costs and the
availability of raw materials. A strong focus has been placed on a substitution
approach, i.e. replacing substances by other less hazardous substances that
achieve the same or better results and/or diminish resource input requirements.
In addition to this trend of substitution and resource efficiency, a second
(partly overlapping) line can be observed with a stronger focus on processes,
i.e. a stronger (risk) management approach to chemicals, taking a more
service-oriented approach to management of chemicals all along value chains and
focusing on process optimisation. Chemicals suppliers have been induced to do
so partly by regulatory requirements (such as REACH), partly by the need to
regain market power on what have become buyers' markets. Users of chemicals are
motivated by the increase in regulatory requirements, no longer fully matched
by in house expertise, seeking to improve the performance of their production
processes by having chemicals inputs more finely tuned to their technical
requirements. This service-oriented approach, often encountered, either
implicitly or under the name of outsourcing, is a new more sustainable way of
manufacturing together with offering service packages for regular clients,
application of lifecycle and supply chain assessments, resource efficiency,
reduced waste, etc.

Chemical leasing (CL) is one clear example of such a
service-oriented risk management approach. Broadly, CL is a concept in which a
firm (the customer) that uses chemicals in its production process no longer
purchases the chemicals, including taking responsibility for how they are handled,
but purchases from the ‘chemical operator’ a service limited to the functions
(performed by the chemicals) that are needed for the customer’s production
process. The ownership and associated responsibilities during the life cycle of
the chemical remain with the chemical operator, i.e. the leasing company. This
model shifts the producer’s previous focus on increasing sales volume to
increasing value-added and the per-unit performance of the chemical (see the
following schematic representation of the incentives under CL).

Incentives under chemical leasing

CL is mainly a B2B (business to business) model suitable for
specific applications. Typical applications in which this model is applied
include: powder coating, solvents for cleaning, galvanisation, food processing,
pest control, anti-fouling services, detergents for water purification and
electroplating or lubricants for sugar production. Some of the ideas underlying
the concept of CL have been applied for longer, or implicitly, for example in
paint applications for the automobile industry. In the 1980s, General Motors (GM)
was one of the first companies to recognise the opportunities offered by
forming partnerships with chemicals suppliers. By transferring overall
management of the chemicals to the supplier, GM cut its costs by 30%
(Stoughton, M. and Votta, T., 2002). Since 2004, CL has been actively promoted,
mainly by UNIDO, which established a definition of CL and a set of quality
criteria.

In instances where CL is suitable, the improvements in economic and environmental
performance can be considerable. Several applications suggest that the model
can in some cases reduce the total chemicals input by 40 to 80% (Safechem,
2005). The optimisation of production and reduction of ‘spoilage’ may
considerably reduce not only the environmental impact but also costs. The CL
model ‘divides’ these gains between the players primarily involved: the
chemical service supplier and the (business) customer. For example, a customer
that  ‘outsources’ high-performance cleaning for medical devices now pays per
unit cleaned instead of for the chemicals and equipment to clean them. The
total cost of cleaning the same number of devices for the customer becomes
lower while, due to the more efficient resource input, the supplier now also obtains
a higher price per unit of chemicals used. In practice, the value added by unit
of chemicals used for cleaning has increased and this benefit is shared. Often,
the equipment is also provided and managed by the lessor (chemical operator),
thereby transferring the associated investment costs and financial risks for
the customer and including them in the overall service.

The main drivers behind sustainable chemistry and the trend to make
chemical-related business processes more sustainable, including CL, are
reduction of use of resources and the associated costs and input supply risks.
However, the CL model has been limited to specific sectors and applications. Some
companies have mentioned that issues regarding information transfer have complicated
application (trust is an essential part of the CL model as the purchaser of the
services needs to transfer information to the supplier so that the service can
be performed). Its impact on the chemical industry as a whole is therefore (as
yet) small. The model should nonetheless be seen as one positive example within
a much broader range heading towards sustainable chemistry that illustrate
industry’s search for substitution and/or risk management models that fit
companies striving to move to more sustainable business practices.

The drivers behind and barriers standing in
the way of eco-innovation and specific policy measures to promote it have been
analysed and proposed in the literature (see, for example, EIO, 2010). Aghion
et al. (2009b) suggested combining a carbon price with high initial subsidies for
R&D into clean-innovation. In a modelling exercise, Conte et al. (2010)
addressed the market failure of low carbon prices to act as an incentive for
eco-innovation, investigating different policy mixes and the design of policies
which reallocate revenue from the carbon market to target "green"
R&D in the short run and labour market support.

5.4.2.
Eco-innovation and R&D on energy

Policy measures in the field of
eco-innovation consist not only of regulating or encouraging adoption of
existing technologies, as regards e.g. increasing energy efficiency or waste
reduction. Discovery and development of new technologies are the cornerstone of
sustained "green" growth, including future improvement of eco-performance
in industry. Innovative technologies are costly in terms of investment, and
often create new markets for their products, with all the uncertainties
attached. Public support is therefore essential both for development of
existing "green" technologies such as renewable energy
technologies and to support new-born cutting-edge technologies such as hydrogen
and fuel cells. The EU is a market leader in the development of many of these
technologies (e.g. renewable energy generation, see for instance Box 3.2 in
European Commission 2010f). This report does not focus on the economic case for
financing these R&D projects. Studies analysing this problem are available
(Conte et al., 2010).

Limited data are available on total "green"
R&D expenditure. However, the International Energy Agency (IEA)
provides data on public support to all types of energy-related R&D for a
number of countries including the EU-15 and Hungary. Figure 5.25 clearly shows
the increase in the relative share of public support allocated to "green"
R&D into energy technology: from 22% in 1990 up to 48% in 2009. This
was manly at the expense of nuclear fission and fusion R&D. It should be
taken into account that, according to the IEA definitions, research into fossil
fuels covers all research conducted in the domain of CO2
capture and storage which, since 2003, accounts for
about 10% of total fossil fuels research. Another notable feature is the higher
share of public funding that hydrogen and fuel cells have secured since the
European Initiatives for Growth were adopted in 2003 and the Fuel Cells and
Hydrogen Joint Technology Initiative in 2008, both by the European Commission
as part of the 7th Framework Programme (EC, 2008b).

Figure 5.25: Relative share of public support to sub-fields of energy
R&D in the EU-16

Source: own calculations based on IEA data. EU-16 is AT, BE, DK, FI, FR, DE,
EL, HU, IE, IT, LU, the NL, PT, ES, SE and the UK. The original IEA data also
include Switzerland, Turkey and Norway.

A comparison at international level can be
made with other major players on the "green" R&D scene.
The EU has always played a leading role in public funding of renewable energy
research: in order to meet the 2020 targets for the shares of renewable energy
in final energy consumption, substantial resources have been invested in
further developing existing technologies. Looking at figure 5.26 public support
for renewable energy R&D increased more than twofold between 2000 and 2009.
However, the data do not include EU FP7 related spending, nor the part of the
Emission Trading System allowances allocated to innovative renewables The USA
doubled its funding in only one year, under the 2009 American Recovery and
Reinvestment Act. It is not yet clear whether this increase is sustained by a
long-term commitment, as it evidently appears to be in the case of the EU.

Figure 5.26: Public support for R&D into renewable energy
resources, international comparison (2009 prices and exchange rates)

Source: own calculations based on IEA data. EU16 is AT,
BE, DK, FI, FR, DE, EL, HU, IE, IT, LU, the NL, PT, ES, SE and the UK. The
original IEA data also include Switzerland, Turkey and Norway.

Major eco-innovation can be achieved not
only by conducting research into technologies based on renewable sources, but
also by increasing the energy efficiency and environmental impact of existing
technologies, production processes and techniques. Figure 5.27 shows that R&D
on energy efficiency is also heavily funded in the EU, with a more than twofold
increase between 2005 and 2009 (not counting FP7 related spending). Again, in
the USA the Recovery Act was the single cause for the doubling of funds. With
respect to industrial energy efficiency, disaggregated data are available for only
a subset of countries (labelled as EU-10), which account for 70% of public
funding of total R&D on energy efficiency.

Figure 5.27: Public support of energy efficiency (not only
industrial) R&D (2009 prices and exchange rates)

 Source: own calculations based on IEA data. EU16 is AT,
BE, DK, FI, FR, DE, EL, HU, IE, IT, LU, the NL, PT, ES, SE and the UK. For
industrial energy efficiency, EU10 is EU16 minus BE, EL, HU, IE, LU and the UK.
The original IEA data also include Switzerland, Turkey and Norway.

Box 5.1 above mentioned the importance that
many governments put in "green" growth as a way out of the economic
crisis. Figures 5.26 and 5.27 give a clear hint (for two sub-fields of
research) of the considerable effort put in by the US in green recovery,
leading to a noticeable change of pace concerning public support to green
R&D; all of this as a part of a wider stimulus plan. However, it is not a
coincidence that also many other major economies had stimuli plan that included
a considerable "green" components (see Table 5.7 in annex for an
overview of the stimulus measures adopted in the EU, USA, Japan, South Korea and
China).

5.4.3.
Environmental protection expenditures

Another key indicator of current endeavours
to reduce the long-term environmental impact is environmental protection expenditures
(EPE) by industries, which is the sum of investment and current expenditure on prevention, reduction and elimination of pollution resulting from
production processes. Expenditure on environmental
protection by industry within a Member State can give some insight into the
level of consideration given to eco-performance (although, strictly speaking,
not on the relative efficiency of these expenditures). As a proxy for
sustainability, it encapsulates all industry's efforts to protect the
environment, including pollution prevention, sustainable supply chains and
biodiversity protection. In 2006, the combined EPE of all industries in the EU-25
added up to 50 billion euros, a 1% decrease compared with 2001, with a trough
of 8 billion euros in between. However, as a percentage of GVA, industrial EPE
fell from 2.8% in 2001 to less than 2.5% in 2006 (Eurostat, 2010).

Data fragmentation issues similar as those mentioned for water abstraction also arise
with EPE, which limits the ability to draw robust conclusions on
eco-performance. Figure 5.28 shows positive trends in EPE at EU-27 level in the
most recent years for which data are available, particularly in EU-12 states.
The decoupling trends seen in many EU-12 states could potentially be related to
increased EPE, though the actual links to EPE are unclear. One final conclusion
to be drawn from the data is that EPE expenditure by industry is highly
variable, changing significantly from one year to the next.

Figure 5.28:
Total environmental protection expenditure by industry (NACE A-E, excluding construction)
in selected Member States, 2001-2006

Note: Countries included under ‘Other EU MS’ due to no or incomplete
data: BE, DK, IE, EL, LU, MT and FR.

Source: Eurostat
data – Ecorys analysis.

Box 5.8: Public-sector environmental protection expenditure One proxy for identifying the amount of public investment in the environment is the ‘public environmental protection expenditure’ figure collected by Eurostat. In 2006 such investments – including current account expenses – broke down as follows: 40% to waste, 17% to waste water, 1% to air and 42% to other domains. In the EU-25, most of this expenditure in 2006 went towards providing waste management services or to activities related to soil, biodiversity and landscape protection, protection against radiation and research and development. Spending was mostly related to current costs, rather than investments or subsidies/transfers. Figure 5.29: Public-sector EPE investment and current expenditure by Member State (% of GDP, 2008 unless otherwise indicated) Source: Eurostat 2010: Environmental statistics and account handbook. In most European countries, in 2006 the public sector spent between 0.2 and 0.6 % of GDP on environmental protection investments and current expenditure. In 2005, the Netherlands earmarked almost 1.4% of its GDP for this, but Latvia only 0.06 %.

By restricting the Member States taken into
consideration to those that reported in both 2003 and 2007,[82] it is possible to draw a more
detailed picture of the changes that have taken place in industrial EPE and to
relate them back to changes in GVA. Figure 5.30 presents these changes for the
Member States for which data are available. It shows a weak overall trend to
increase industrial EPE as GVA increases, lending some support to the idea of a
Kuznets curve for industrial EPE. The biggest increases in EPE were found in
Member States in the Baltic region and Central Europe (CZ, SK and PL). Relative
to GVA seven Member States (IT, HU, LT, FI, CZ, EE, and LV) increased their EPE
by more than their industrial GVA increased. Member States known for having
strong EPE records (DE, AT and SE) saw their EPE remain largely stable over the
period.

These relationships hold broadly across the
main industrial sectors (NACE rev. 1.1 A to E), with the exception of
agriculture, forestry and fishing, where there appears to be no clear
correlation between EPE and GVA, though this is likely to be a result of
incomplete data.

Figure 5.30: Change in industrial EPE and industrial GVA (NACE A-E,
excluding construction) in selected Member States, 2003-2007

Note: Bubble size represents relative industrial EPE expenditure in
2007.

Member States missing due to incomplete data: BE, BG, DK, IE, EL, ES,
FR, CY, LU, MT, NL, PT, RO and UK.

Source: Eurostat
data – Ecorys analysis.

5.5.
Conclusions and policy implications

The analysis of major trends and
developments has shown significant improvements in the eco-performance of
European industry. However, there are also signs that efficiency increases slow
down, as the higher the initial efficiency levels already are the more
difficult it becomes to achieve further improvements. Adopting the right mix of
policies, including the right measures and conditions to foster green
R&D, eco-technologies and eco-innovation, is of paramount importance in
this regard. Eco-performance improvements will be more easily sustained,
environmental problems dealt with more efficiently and European firms may fully
and more easily exploit new business opportunities and improve their
competitiveness. This section discusses briefly the available mix of policy
instruments in the light of their economic rationale
and past experience.

5.5.1.
Policy instruments for sustainable growth

Looking at the public policy instruments[83] currently in use to raise eco-performance and, at the same time,
facilitate industry’s transformation towards more sustainable methods of
production and greater competitiveness shows that, at EU level, policy has, in
the last decade or more, been focused on energy and on controlling GHG
emissions. The findings in section 3 illustrate that these policies have
contributed to an increase in energy efficiency and a significant reduction of
both GHG and other emissions from energy generation.

To date there has been less focus on
policies with an impact on resource efficiency and use of natural resources
such as water and land. This has been changing in recent years, with an
increase in the number of policy initiatives in this area and attention
shifting towards sustainable consumption and production, "green"
public procurement and, more recently, resource efficiency. The overall policy
framework is currently weaker than for energy and related emissions and the
performance on resource use appears to be much more mixed. The efforts to
develop a stronger policy framework in this area should draw on the lessons learned
from the implemented in the area of energy and emissions and their performance
against expectations and theory.

The policy instruments available differ by
government level: at EU level regulatory instruments are widespread and
powerful; fiscal instruments are strongest at Member State level while
subsidies are widespread at both Member State and subnational (regional and
local) level. Each instrument has its advantages and disadvantages in relation
to sustainable industrial growth and eco-performance.

Regulation

Overall, EU industry has shown that it
tends to respond well to regulatory policy measures, when these are carefully
designed and take a long-term perspective. Regulation tends to work well when it comes to performance
targets, once these are anticipated and gradually introduced. The introduction
of regulations on energy-efficient and incandescent light bulbs is one example
of successful regulation of this type. However,
standards which are over-ambitious and/or introduced too early run the risk of
being counterproductive, as they sometimes induce disruptions. Furthermore,
implementation can be unequal across the EU-27, thus affecting industry in one part
of the EU more or earlier than in other locations.

Regulation is one of the primary drivers of
eco-innovation activities in firms. In certain cases regulation can be the most
cost-effective solution, particularly when carefully designed and enforced,
allowing e.g. for a suitable level of freedom for business to innovate and in
finding the best way to achieve given targets. Most EU firms, particularly
SMEs, remain compliance driven rather than pro-active in pursuing
eco-innovation.

However, direct regulation can be
considered to be often less cost-effective than market-based instruments, as it
tends to impose uniform rules, targets or constraints that do not necessarily
take full account of the settings and competitive environment of industry. This
has been a key factor in the growing use of market based instruments.

Market-based instruments

While there are concerns about the
cost-effectiveness and competitiveness effects of regulatory measures there is
also mixed evidence about the effectiveness of
market-based instruments in the context of sustainable growth and
eco-performance. Here a distinction can be made between subsidies, tenders and
grants (‘bonus incentives’) on the one hand and taxes, penalties and
trading schemes (‘malus incentives’) on the other hand.

‘Bonus incentives’
such as subsidies, tenders and grants may be necessary to induce industry learning
curves, albeit they typically entail heavy budgetary costs. However, practical
experience has been mixed. As regards subsidies supporting innovation the
evidence suggests that grants and subsidies were among the least powerful
motivators for adopting environmental innovations. At the same time, subsidy
systems based on feed-in tariffs have proved very successful for deployment of
onshore wind energy and photovoltaic energy, yet they are typically also
expensive. Many feed-in tariff schemes have been scaled down in the light of
the financial crisis and resulting pressures on public finances and the costs
imposed on firms and households.

In principle, subsidies should be
time-limited, addressing temporary rather than structural market failures. This
time-horizon issue is also important for EU industry and long-term planning. EU
industry urgent needs a stable long-term policy framework, to provide greater
certainty for firms considering expensive long-term capital investment in
technology. The time horizon of many public policy initiatives - especially
subsidies and grants - is often too short and prone to fluctuations in terms of
continuity, eligibility or funding. Investments in eco-innovation and clean
energy technologies require longer time spans, in order to recoup such
investments over periods of 10 to 20 years.

‘Malus incentives’ like
taxes, penalties and trading schemes offer an alternative to ‘bonus incentives’. They send a direct
signal that works through prices to influence market conditions and bring about
the desired changes. By working through prices, tax instruments have an impact
on both supply and demand, which can be an advantage over regulation. Taxes can
have negative implications for competitiveness, but consumers and firms retain
the flexibility on how to respond to increased prices and costs. Hence, from a
welfare and environmental perspective, if targeted correctly, taxes can work in
accordance with the polluter pays principle and to the overall benefit of
society. Judging the level at which to set a tax is a complex matter and must
take into account relative tax systems in other economies.

Sometimes an argument is raised that tax or
tariff mechanisms are needed for imports produced in economies with weaker
eco-performance. It is argued that it would have an effect equivalent to
internalising the negative environmental externalities of these imports, thus
levelling the playing field for EU-27 producers in their domestic markets, by
imposing equivalent costs on all producers. Such a tariff would need to be
graduated, depending on the eco-performance of industries or firms in the
country of production. However, the practical and political feasibility of such
a scheme is debatable, as is its compatibility with international trade
agreements. Without a clear evidence base, it could open the door to
unwarranted protectionism in international trade. It cannot be excluded as part
of a wider package in case substantial ‘leakage’ effects from EU environmental
policies are to be expected. ‘Softer’ alternatives to this involve international
negotiations and persuasion and pressure to align environmental policies of the
EU and other countries in view of adopting and implementing more sustainable
production behaviour.

Permit trading schemes are favoured in some
situations as the most economically efficient way of achieving eco-performance
gains and for making the total environmental benefits known in advance, as caps
are chosen by policy-makers. They can maximise the competitive benefits to
firms that invest most heavily in sustainable practices, providing clear and
continuing incentives to improve performance over time. Permit trading schemes
are most effective for sustainability when the environmental impact can be
easily monitored and verified, when firms can adequately bear the transaction
costs, when a viable market can be created and when a move is made towards full
auctioning of permits. Where this is not the case, taxation and regulation may
be better alternatives to permits.[84]

Voluntary agreements and information

Voluntary agreements (i.e. self-regulation)
can be effective for both industry and policymakers. By anticipating changes in
consumer demand industry can stay at the cutting edge and also mitigate the
need for policy action and the associated costs and burdens. Experience from
the MSC scheme suggests that such schemes tend to be used more widely when
larger companies are involved, but can be more difficult to implement when many
SMEs are concerned. Furthermore, they appear to be more effective for final
product groups, where the interface with consumers is strong. One drawback of voluntary approaches is that their effectiveness in
addressing environmental concerns will depend on the perceived
benefits to the companies concerned. They could also reduce competition. Its
effectiveness can also suffer from information asymmetries between governments
and firms. Voluntary schemes can therefore be an effective instrument in
certain circumstances where policy has been unable to act effectively and/or
provides a framework for industry to go beyond compliance.

Information and communication can be useful
in situations where information problems exist (e.g. in household energy
consumption) or where enforcement costs are disproportionately high (e.g. small-scale
emissions creating air pollution). This area is
particularly important for consumer demand and consumer action to support improvements in eco-performance. The evidence clearly shows that price and performance (quality)
remain the primary demands of consumers. Products offering higher
eco-performance need to compete on these two fronts too and to offer something
more.

As regards influencing consumer behaviour,
it is important for the choice of instrument to take account of their
understanding of the environmental benefit in question. Voluntary schemes relying on consumer action appear less effective
when the environmental benefits are more abstract, as in the case of energy and
emission reductions. However, the successful take-up of
the MSC scheme and improvements in recycling efforts are examples where the
physical link to the environment is clear for consumers and of how this has
supported success in these areas. In these cases it is
important that other instruments, such as regulation or taxes, are also
employed.

5.5.2.
Policy design and implementation

As regards policy design and implementation,
a number of important factors must be considered and the findings of this work
have significant implications. Whilst developing such
policies, there is a need for comprehensive and robust
impact assessments, covering both economic and environmental aspects as well as
administrative costs and burdens.

The EU's growing practice of impact
assessment could be echoed more clearly in policy development at the level of
Member States, regions and local authorities. This is particularly important for the competitiveness of EU industry, to ensure
long-term predictability and that policy action remains proportionate to the
environmental benefits that result. Absolute bans and limits can place
significant burdens on producers, occasionally with high marginal costs for
only small environmental gains, after most reductions have already been
achieved. Duplication is also an issue: if industry is hit by multiple
regulations on a single product or input material, this adds to the complexity
and burdens of compliance, particularly for SMEs (Calogirou et al. 2010). Consideration
must be given to how a particular policy fits into the
wider framework and how compliance procedures could be integrated more
effectively.

Ex-post evaluation
and monitoring of policies and measures that promote economic and environmental
performance are vital in order to learn lessons that can lead to design
improvements during the policy lifetime and can also inform further developments.
Particular attention needs to be paid to the mechanisms by which such policies
influence EU industry and whether such policies are effectively doing what they intend to.

Complementarity and enforcement

Similar trends to those in EU policy are
also found at Member State level in terms of the issues addressed, with over half of all the major policy initiatives identified at
Member State level focusing on energy efficiency and climate change. The policy
instruments used by Member States tend to include market-based
instruments (taxes and subsidies) along with public investment and regulation
and self-regulation. Analysis of the cross-section of policies at EU and other
levels clearly showed that there are often tight links and complementarities between
the policies on various levels both within the EU and also across Member States’.
 Care needs to be taken to ensure that policy measures are not duplicated, that
overlaps and uneven implementation are minimised and that the scope for learning
and sharing of best practice are exploited wherever possible to reduce the
compliance burdens on EU industry.

The effectiveness of policy implementation
is closely related to enforcement. Implementation of regulations matters for
containing the general administrative burden. Evidence from the case studies
found that lax enforcement can have a negative economic impact on companies
that have complied with the regulation, creating undue competitive advantages
for non-compliant firms, either from within or outside the EU.

Policy as a supporting framework

As a final point, policy should provide a
predictable enabling framework for industry itself, creating the conditions for
and supporting moves by industry towards eco-performance benefits. The examples
of voluntary labelling schemes and chemical leasing (Boxes 5.6 and 5.7) show
how industry initiatives can create significant incentives for resource-efficient
behaviour, improving eco-performance. They illustrate the link between economic
competitiveness and eco-performance. The current limited scope of these types
of arrangements points to wider potential to deliver benefits in this way.

Establishing this link between economic
benefits and eco-performance is difficult, as the impact of policy is uneven
across industry. For the industry directly affected, policy-imposed changes are
initially felt to be negative. However, in many cases regulatory approaches can
help creating a market for new eco-friendly products. The light bulbs (Box 5.2)
is such an example, illustrating the engagement in the development of products
with significant environmental benefits, whose purchase by consumers was
facilitated by the energy labelling scheme. Overall, the case studies
demonstrated that considering the effects on industry along the entire value
chain is vital to securing competitive and sustainable industries.

Annex
: Definitions and concepts

Table 5.2: NACE rev. 1.1
classifications used in this report

Category || Sub-category

A and B – Agriculture, hunting, forestry and fishing ||

C – Mining and quarrying ||

D – Manufacturing || 15-16 – Food, beverages and tobacco

17-19 – Textiles, leather and footwear

20 – Wood and products of wood and cork

21-22 – Pulp, paper, printing and publishing

23-25 – Chemicals, rubber, plastics and fuel

26 – Other non-metallic minerals

27-28 – Basic metals and other fabrication of metal

29 – Machinery not elsewhere classified

30-33 – Electrical and optical equipment

34-35 – Transport equipment

36-37 – Manufacturing not elsewhere classified and recycling

E – Electricity, gas and water ||

F – Construction ||

Indicators of eco-performance

–
Energy consumption is one of the key areas for
measuring the environmental impact of industry, though the impact itself is
often indirect and based on the emissions into the air and water by energy
generators. Energy efficiency is an important policy goal and route to
decoupling. Final energy consumption and energy intensity indicators are
reviewed to provide both a nominal and marginal view on eco-performance in this
area.

–
Greenhouse gas (GHG) emissions are the primary
climate change impact associated with industry. They are closely related to
energy use. Decoupling emissions from economic growth is among the most
pressing drivers of sustainable production. The cumulative and global nature of
emissions makes the total level of emissions important, but as it is not always
clear if emissions have simply ‘leaked’ outside the EU it is important to
consider emission intensity too.

–
Other emissions into the air and water from
industry can also have a significant environmental impact. This study considers
the performance in terms of acidification potential – as a contributor to acid
rain – and also of particulate emissions to the air (PM10) which can damage
human health.

–
Material flows and resource efficiency are
essential components of environmental impact, both in the extractive (or
harvesting) process and when it comes to their eventual disposal as waste.
Indicators of these are vital to understand how process and product efficiency
has changed and are especially important to the issue of decoupling. Various
indicators relating to material consumption, use of inputs, productivity and
waste treatment are reviewed.

–
Water use is also considered as water is a key
resource used during industrial production processes (e.g. as cooling water)
and is also coming under increasing scrutiny as pressures on it mount from
population growth and expected reductions in supply from rainfall due to
climate change. Indicators on water abstraction are presented.

–
Environmental protection expenditure (EPE) gives
an indication of investment and expenditure on resource, energy and carbon
efficiency and, as such, is a useful indicator to measure eco-performance.

–
Eco-innovation provides insight into investments
and "green" R&D with the objective of improving eco-performance.
This is important as an indicator of industrial investment in current, but also
towards future, eco-performance. It is a new and complex area to define and the
relevant section reviews the major discussions around such an indicator before
presenting findings. Each of the indicators listed above has been analysed on
three different levels, determined by the data available. This approach has
been used to capture the relevant effects at each level to help explain the
changes observed. The first level taken into account is the international and
EU-27 level, since an understanding of overall economic performance and
eco-performance is needed in order to comment on the relative position and
developments of the EU-27 against its international trade partners, between the
Member States themselves and also intra-industry - between sectors.

Table 5.3: Entergy intensity of
manufacturing plus construction (NACE rev. 1.1 D+F) by Member State in selected
years

Industrial energy
use in thousand toe per million EUR industrial GVA at 1995 prices

|| 1995 || 2000 || 2005 || 2008

|| GVA || FEC || EI || GVA || FEC || EI || GVA || FEC || EI || GVA || FEC || EI

Austria || 42 923 || 6 199 || 0.14 || 51 528 || 7 019 || 0.14 || 55 256 || 8 367 || 0.15 || 62 674 || 8 831 || 0.14

Belgium || 47 368 || 13 612 || 0.29 || 54 395 || 15 762 || 0.29 || 55 959 || 13 555 || 0.24 || 59 341 || 12 036 || 0.20

Czech Republic || 15 637 || 12 450 || 0.80 || 18 026 || 10 077 || 0.56 || 22 245 || 9 762 || 0.44 || 27 338 || 9 112 || 0.33

Denmark || 25 801 || 3 040 || 0.12 || 28 031 || 2 938 || 0.10 || 27 212 || 2 867 || 0.11 || 30 125 || 2 765 || 0.09

Estonia || 674 || 836 || 1.24 || 905 || 571 || 0.63 || 1 316 || 718 || 0.55 || 1 863 || 770 || 0.41

Finland || 24 877 || 9 989 || 0.40 || 36 451 || 12 046 || 0.33 || 43 040 || 12 082 || 0.28 || 54 716 || 12 451 || 0.23

France || 238 838 || 37 119 || 0.16 || 269 989 || 36 887 || 0.14 || 284 386 || 35 728 || 0.13 || 288 256 || 36 334 || 0.13

Germany || 491 439 || 62 002 || 0.13 || 504 593 || 57 896 || 0.11 || 504 527 || 57 436 || 0.11 || 553 485 || 60 436 || 0.11

Greece || 14 323 || 4 114 || 0.29 || 16 606 || 4 445 || 0.27 || 17 957 || 4 143 || 0.23 || 19 696 || 4 238 || 0.22

Hungary || 4 862 || 3 797 || 0.78 || 6 759 || 3 446 || 0.51 || 8 339 || 3 422 || 0.41 || 9 217 || 3 358 || 0.36

Ireland\* || 16 929 || 1 853 || 0.11 || 30 852 || 2 339 || 0.08 || 38 969 || 2 595 || 0.07 || 43 550 || 2 544 || 0.06

Italy || 235 029 || 36 091 || 0.15 || 243 321 || 39 775 || 0.16 || 243 363 || 41 855 || 0.17 || 249 078 || 36 551 || 0.15

Latvia\* || 827 || 692 || 0.84 || 1 094 || 571 || 0.52 || 1 645 || 705 || 0.43 || 1 915 || 724 || 0.38

Lithuania\* || 1 822 || 1 017 || 0.56 || 2 312 || 780 || 0.34 || 3 843 || 994 || 0.26 || 4 694 || 1 064 || 0.23

Luxembourg || 2 756 || 1 214 || 0.44 || 3 389 || 957 || 0.28 || 3 798 || 940 || 0.25 || 3 778 || 876 || 0.23

Netherlands || 63 055 || 14 092 || 0.22 || 73 543 || 14 895 || 0.20 || 74 702 || 14 925 || 0.20 || 80 671 || 13 081 || 0.16

Poland || 19 931 || 22 790 || 1.14 || 28 111 || 18 882 || 0.67 || 32 436 || 16 413 || 0.51 || 48 615 || 16 560 || 0.34

Portugal\* || 18 591 || 4 974 || 0.27 || 22 547 || 6 244 || 0.28 || 21 770 || 5 689 || 0.26 || 21 740 || 5 782 || 0.27

Slovakia || 5 546 || 4 120 || 0.74 || 6 208 || 3 826 || 0.62 || 10 519 || 4 499 || 0.43 || 16 733 || 4 316 || 0.26

Slovenia || 2 712 || 1 178 || 0.43 || 3 544 || 1 421 || 0.40 || 4 304 || 1 653 || 0.38 || 5 416 || 1 480 || 0.27

Spain || 114 414 || 20 507 || 0.18 || 137 995 || 25 527 || 0.18 || 155 750 || 31 097 || 0.20 || 159 863 || 26 773 || 0.17

Sweden || 40 685 || 13 820 || 0.34 || 53 792 || 14 290 || 0.27 || 65 677 || 12 628 || 0.19 || 75 257 || 12 292 || 0.16

UK || 187 742 || 35 146 || 0.19 || 197 453 || 38 574 || 0.20 || 203 479 || 36 019 || 0.18 || 208 100 || 32 775 || 0.16

EU-23\* || 1 616 781 || 310 652 || 0.19 || 1 791 446 || 319 168 || 0.18 || 1 880 492 || 318 092 || 0.17 || 2 011 750 || 317 157 || 0.16

EU-15\* || 1 564 771 || 263 772 || 0.17 || 1 724 486 || 279 594 || 0.16 || 1 795 845 || 279 926 || 0.16 || 1 910 188 || 277 722 || 0.15

EU-12 - 4\* || 52 010 || 46 880 || 0.90 || 66 960 || 39 574 || 0.59 || 84 647 || 38 166 || 0.45 || 101 562 || 39 435 || 0.39

\* Figures for 2007.     EU-23 is EU-27 minus Bulgaria, Cyprus, Malta and Romania. EU-12 - 4 is EU-12 minus Bulgaria, Cyprus, Malta and Romania.

FEC = final energy consumption. EI = energy intensity, i.e. FEC/GVA. || || ||

Source: EU KLEMS, OECD STAN and Eurostat. || || ||

Table 5.4: Energy intensity of
industries, for EU-25, in selected sectors and selected years
Energy use in thousand toe per million EUR GVA at 1995 constant prices

|| || 1995 || 2000 || 2005 || 2008

|| || GVA || FEC || EI || GVA || FEC || EI || GVA || FEC || EI || GVA || FEC || EI

A-B || Agriculture and fisheries || 177 698 || 31 568 || 0.18 || 195 196 || 29 898 || 0.15 || 195 703 || 30 954 || 0.16 || 186 725 || 26 312 || 0.14

15-16 || Food, drink and tobacco || 150 772 || 30 383 || 0.20 || 156 421 || 30 622 || 0.20 || 162 818 || 30 400 || 0.19 || 135 024 || 29 103 || 0.22

17-19 || Textiles, leather and clothing || 81 044 || 10 522 || 0.13 || 75 604 || 10 780 || 0.14 || 61 877 || 7 951 || 0.13 || 55 258 || 6 276 || 0.11

21-22 || Paper and printing || 115 503 || 30 361 || 0.26 || 129 027 || 35 260 || 0.27 || 126 625 || 35 629 || 0.28 || 104 438 || 36 317 || 0.35

23-25 || Chemicals || 204 649 || 63 248 || 0.31 || 232 630 || 58 917 || 0.25 || 258 946 || 61 200 || 0.24 || 240 093 || 55 097 || 0.23

26 || Non-metallic mineral products || 60 965 || 42 195 || 0.69 || 67 081 || 43 638 || 0.65 || 70 480 || 43 664 || 0.62 || 64 801 || 42 944 || 0.66

27-28 || Iron and steel and non-ferrous metals || 171 166 || 82 756 || 0.48 || 190 610 || 78 088 || 0.41 || 196 602 || 74 911 || 0.38 || 189 365 || 71 191 || 0.38

20, 30-33 || Other non-classified || 170 907 || 39 000 || 0.23 || 236 040 || 41 044 || 0.17 || 276 612 || 45 642 || 0.17 || 316 928 || 44 838 || 0.14

29, 34-37 || Engineering and other metals || 299 723 || 29 318 || 0.10 || 339 082 || 29 293 || 0.09 || 366 824 || 29 522 || 0.08 || 356 581 || 28 918 || 0.08

C || Ore extraction (except fuels) || 53 202 || 3 889 || 0.07 || 48 313 || 3 745 || 0.08 || 41 042 || 3 326 || 0.08 || 23 436 || 3 053 || 0.13

|| || || || || || || || || || || || ||

EU-25 is EU-27 minus Bulgaria and Romania. Source: EU KLEMS, OECD STAN, Eurostat || || || || || || || || || || || ||

Table 5.5: GHG emission intensity of manufacturing plus construction (NACE rev.
1.1 D+F) by Member State plus USA and Japan in Gg CO2 eq. per
million EUR GVA at 1995 constant prices

|| 1995 || 2000 || 2005 || 2008

|| GVA || GHG || Intensity || GVA || GHG || Intensity || GVA || GHG || Intensity || GVA || GHG || Intensity

Austria || 42 923 || 13 593 || 0.32 || 51 528 || 13 864 || 0.27 || 55 256 || 16 143 || 0.29 || 62 674 || 16 161 || 0.26

Belgium || 47 368 || 32 495 || 0.69 || 54 395 || 32 923 || 0.61 || 55 959 || 27 930 || 0.50 || 59 341 || 26 669 || 0.45

Czech Republic || 15 637 || 32 964 || 2.11 || 18 026 || 28 364 || 1.57 || 22 245 || 19 093 || 0.86 || 27 338 || 16 097 || 0.59

Denmark || 25 801 || 6 042 || 0.23 || 28 031 || 6 213 || 0.22 || 27 212 || 5 807 || 0.21 || 30 125 || 5 393 || 0.18

Estonia || 674 || 794 || 1.18 || 905 || 569 || 0.63 || 1 316 || 707 || 0.54 || 1 863 || 985 || 0.53

Finland || 24 877 || 12 138 || 0.49 || 36 451 || 11 937 || 0.33 || 43 040 || 11 331 || 0.26 || 54 716 || 10 783 || 0.20

France || 238 838 || 83 843 || 0.35 || 269 989 || 83 371 || 0.31 || 284 386 || 80 714 || 0.28 || 288 256 || 75 660 || 0.26

Germany || 491 439 || 119 473 || 0.24 || 504 593 || 106 797 || 0.21 || 504 527 || 100 793 || 0.20 || 553 485 || 102 505 || 0.19

Greece || 14 323 || 9 274 || 0.65 || 16 606 || 9 785 || 0.59 || 17 957 || 10 227 || 0.57 || 19 696 || 9 303 || 0.47

Hungary || 4 862 || 10 996 || 2.26 || 6 759 || 8 486 || 1.26 || 8 339 || 8 748 || 1.05 || 9 217 || 7 034 || 0.76

Ireland || 16 929 || 4 318 || 0.26 || 30 852 || 5 588 || 0.18 || 38 969 || 5 743 || 0.15 || 5 652 || 5 548 || 0.98

Italy || 235 029 || 87 637 || 0.37 || 243 321 || 85 323 || 0.35 || 243 363 || 82 174 || 0.34 || 249 078 || 74 372 || 0.30

Latvia\* || 827 || 1 899 || 2.30 || 1 094 || 1 199 || 1.10 || 1 645 || 1 174 || 0.71 || 1 915 || 1 268 || 0.66

Lithuania\* || 1 822 || 1 532 || 0.84 || 2 312 || 997 || 0.43 || 3 843 || 1 272 || 0.33 || 4 694 || 1 445 || 0.31

Luxembourg || 2 756 || 2 726 || 0.99 || 3 389 || 1 755 || 0.52 || 3 798 || 1 718 || 0.45 || 3 778 || 1 630 || 0.43

Netherlands || 63 055 || 28 728 || 0.46 || 73 543 || 27 142 || 0.37 || 74 702 || 27 374 || 0.37 || 80 671 || 27 586 || 0.34

Poland || 19 931 || 63 286 || 3.18 || 28 111 || 47 968 || 1.71 || 32 436 || 32 469 || 1.00 || 48 615 || 32 624 || 0.67

Portugal\* || 18 591 || 10 292 || 0.55 || 22 547 || 12 030 || 0.53 || 21 770 || 10 973 || 0.50 || 21 740 || 10 769 || 0.50

Slovakia || 5 546 || 12 354 || 2.23 || 6 208 || 8 525 || 1.37 || 10 519 || 7 367 || 0.70 || 16 733 || 7 869 || 0.47

Slovenia || 2 712 || 2 615 || 0.96 || 3 544 || 2 269 || 0.64 || 4 304 || 2 486 || 0.58 || 5 416 || 2 305 || 0.43

Spain || 114 414 || 53 350 || 0.47 || 137 995 || 58 480 || 0.42 || 155 750 || 72 355 || 0.46 || 159 863 || 67 722 || 0.42

Sweden || 40 685 || 13 892 || 0.34 || 53 792 || 12 881 || 0.24 || 65 677 || 11 789 || 0.18 || 75 257 || 10 695 || 0.14

UK || 187 742 || 94 035 || 0.50 || 197 453 || 93 581 || 0.47 || 203 479 || 84 354 || 0.41 || 208 100 || 76 891 || 0.37

EU-23\* || 1 616 781 || 698 276 || 0.43 || 1 791 446 || 660 049 || 0.37 || 1 880 492 || 622 741 || 0.33 || 2 019 808 || 609 758 || 0.30

EU-15 || 1 564 771 || 571 835 || 0.37 || 1 724 486 || 561 672 || 0.33 || 1 795 845 || 549 427 || 0.31 || 1 872 434 || 521 689 || 0.28

EU-12 - 4\* || 52 010 || 126 441 || 2.43 || 66 960 || 98 377 || 1.47 || 84 647 || 73 314 || 0.87 || 109 619 || 72 586 || 0.66

United States || 1 539 230 || 868 908 || 0.56 || 1 925 722 || 858 514 || 0.45 || 1 977 696 || 831 850 || 0.42 || 1 453 932 || 825 210 || 0.57

Japan\*\* || 1 190 365 || 372 521 || 0.31 || 1 208 958 || 379 005 || 0.31 || 1 257 005 || 373 523 || 0.30 || 1 302 371 || 375 632 || 0.29

\* Figures for 2007.   \*\* Figures for 2006. || EU-23 is EU-27 minus Bulgaria, Cyprus, Malta and Romania. EU-12 - 4 is EU-12 minus Bulgaria, Cyprus, Malta and Romania.

Source: UNFCCC, EU KLEMS, OECD STAN. || || || || ||

Table 5.6: Materials productivity by Member State per million EUR of
industrial GVA (NACE rev. 1.1 A-F) at 1995 constant prices, per tonne

of DMC for the whole economy in
selected years

|| 2000 || 2003 || 2005 || 2006 || 2007

|| GVA || DMC || Produc tivity || GVA || DMC || Productivity || GVA || DMC || Productivity || GVA || DMC || Produc tivity || GVA || DMC

Belgium || 64 911 || 190 785 || 0.34 || 63 519 || 183 609 || 0.35 || 65 344 || 190 137 || 0.34 || 68 100 || 195 814 || 0.35 || 69 956 || 195 684

Czech Rep. || 23 384 || 182 901 || 0.13 || 23 523 || 178 430 || 0.13 || 28 169 || 187 906 || 0.15 || 30 783 || 193 804 || 0.16 || 32 946 || 196 649

Denmark || 37 511 || 134 757 || 0.28 || 36 071 || 129 539 || 0.28 || 36 373 || 151 203 || 0.24 || 37 851 || 158 447 || 0.24 || 37 572 || 155 530

Germany || 577 525 || 1 453 485 || 0.40 || 559 178 || 1 318 590 || 0.42 || 583 085 || 1 294 062 || 0.45 || 606 845 || 1 324 307 || 0.46 || 615 456 || 1 314 169

Estonia || 1 351 || 18 766 || 0.07 || 1 637 || 30 030 || 0.05 || 1 892 || 28 267 || 0.07 || 2 072 || 31 538 || 0.07 || 2 247 || 38 170

Ireland || 35 950 || 164 032 || 0.22 || 43 156 || 183 357 || 0.24 || 44 982 || 201 058 || 0.22 || 45 113 || 217 816 || 0.21 || 49 886 || 229 539

Greece || 26 525 || 156 648 || 0.17 || 28 724 || 188 009 || 0.15 || 27 606 || 186 343 || 0.15 || 29 355 || 185 778 || 0.16 || 29 255 || 186 334

Spain || 179 830 || 674 684 || 0.27 || 193 448 || 810 698 || 0.24 || 198 486 || 848 078 || 0.23 || 203 687 || 897 400 || 0.23 || 209 488 || 877 810

France || 336 466 || 876 917 || 0.38 || 341 485 || 799 263 || 0.43 || 354 756 || 852 238 || 0.42 || 356 490 || 871 816 || 0.41 || 359 825 || 907 955

Italy || 297 512 || 947494 || 0.31 || 292 394 || 749 037 || 0.39 || 297 947 || 831 976 || 0.36 || 305 197 || 835 104 || 0.37 || 309 028 || 804 257

Cyprus || 1 833 || 15 189 || 0.12 || 1 870 || 16 129 || 0.12 || 1 967 || 18 999 || 0.10 || 2 164 || 18 590 || 0.12 || 2 200 || 20 020

Latvia || 1 557 || 34 293 || 0.05 || 1 930 || 35 672 || 0.05 || 2 231 || 43 046 || 0.05 || 2 395 || 45 506 || 0.05 || 2 539 || 48 594

Lithuania || 3 493 || 27 638 || 0.13 || 4 629 || 40 536 || 0.11 || 5 333 || 41 181 || 0.13 || 5 702 || 41 351 || 0.14 || 6 207 || 48 613

Luxembourg || 3 785 || 7 886 || 0.48 || 4 028 || 7 896 || 0.51 || 4 247 || 7 860 || 0.54 || 4 116 || 9 085 || 0.45 || 4 233 || 6 821

Hungary || 8 963 || 111 703 || 0.08 || 9 802 || 125 713 || 0.08 || 11 277 || 165 919 || 0.07 || 11 604 || 138 310 || 0.08 || 11 472 || 109 684

Malta || 1 008 || 1 405 || 0.72 || 911 || 1 511 || 0.60 || 886 || 1 836 || 0.48 || 917 || 2 108 || 0.44 || 925 || 2 233

Netherlands || 95 397 || 192 689 || 0.50 || 94 190 || 174 735 || 0.54 || 98 078 || 182 109 || 0.54 || 99 725 || 178 117 || 0.56 || 102 727 || 184 299

Austria || 62 158 || 147 165 || 0.42 || 64 594 || 155 671 || 0.41 || 67 513 || 171 951 || 0.39 || 70 793 || 175 304 || 0.40 || 75 593 || 172 154

Poland || 38 994 || 564 980 || 0.07 || 39 890 || 515 314 || 0.08 || 44 225 || 558 071 || 0.08 || 48 678 || 572 096 || 0.09 || 55 919 || 642 107

Portugal || 29 846 || 189 630 || 0.16 || 29 344 || 171 606 || 0.17 || 29 285 || 186 390 || 0.16 || 29 724 || 213 377 || 0.14 || 29 724 || 218 109

Slovenia || 4 217 || 44 252 || 0.10 || 4 694 || 46 570 || 0.10 || 5 047 || 47 877 || 0.11 || 5 427 || 55 792 || 0.10 || 6 158 || 62 372

Slovakia || 7 942 || 54 003 || 0.15 || 10 141 || 57 702 || 0.18 || 12 692 || 71 300 || 0.18 || 14 533 || 67 943 || 0.21 || 16 792 || 67 800

Finland || 43 335 || 171 681 || 0.25 || 46 921 || 184 649 || 0.25 || 50 460 || 186 777 || 0.27 || 55 103 || 199 349 || 0.28 || 59 750 || 207 033

Sweden || 63 292 || 156 165 || 0.41 || 67 679 || 155 072 || 0.44 || 75 936 || 181 040 || 0.42 || 80 975 || 163 726 || 0.49 || 82 901 || 183 453

UK || 249 454 || 757 830 || 0.33 || 247 716 || 746 898 || 0.33 || 253 268 || 751 135 || 0.34 || 256 074 || 751 228 || 0.34 || 258 511 || 750 744

EU-27 || 2 196 241 || 7 597 803 || 0.29 || 2 211 476 || 7 406 528 || 0.30 || 2 301 088 || 7 848 070 || 0.29 || 2 373 423 || 8 041 963 || 0.30 || 2 431 309 || 8 200 293

EU-15 || 2 103 499 || 6 221 848 || 0.34 || 2 112 448 || 5 958 629 || 0.35 || 2 187 367 || 6 222 357 || 0.35 || 2 249 148 || 6 376 668 || 0.35 || 2 293 905 || 6 393 891

EU-10 || 92 742 || 1 055 130 || 0.09 || 99 028 || 1 047 607 || 0.09 || 113 720 || 1 164 402 ||       0.10 || 124 276 || 1 167 038 || 0.11 || 137 404 || 1 236 242

Source: Eurostat, EU KLEMS. || DMC = Domestic material consumption. Productivity is GVA/DMC. || || || || || ||

Table 5.7
– Green components in economic stimulus packages, 2009

Country || Stimulus package || Total amount package, (period) || Amount green component, (%) || Focus themes

USA || American Recovery and Reinvestment Act, 2008; Emergency Economic Stabilization Act 2008; Green allocation in US Budget 2010. || USD 787 bln (10 years); USD 185 bln (10 years); || USD 94.1 bln (12%); USD 18.2 bln (10%); USD 4.9 bln || Renewables; Building energy efficiency

China || NDRC stimulus package 2008; Budget 2009. || USD 586 bln (2009-2010); USD 61.4 bln (2009); || USD 201 bln (34%); USD 15.6 bln (25%) || Energy efficiency (rail, grid); Waste & water

Japan || Measures to Support People’s Daily Lives 2008; second stimulus plan 2009. || USD 486 bln (2009 onwards); USD 154 bln (2009 onwards). || USD 12.4 bln (3%); USD 23.6 bln (15%) || Building energy efficiency

South Korea || Green New Deal 2009 and subsequent Five Year Plan for Green Growth 2009 || USD 76 bln  bln (2009-2013); || USD 60 bln (79%); || Water & waste; Building energy efficiency

EU || Sum of stimulus packages from EU Member States and direct EU contribution. || USD 537 bln (mostly 2009-2010, some packages beyond) || USD 53.4 bln (10%) || Energy efficiency (building, rail, grid); Low carbon power (CCS)

Source: HSBC (2009), A Climate for Recovery – the
colour of stimulus goes green, Feb 2009; and HSBC (2009), Building green
recovery – governments allocate USD470bln – and counting…, May 2009 and HSBC
(2010), Overview of global green stimulus spending, Feb 2010.

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6.
EU industrial policy and global competition: recent
lessons and way forward
6.1.
Introduction

The EU economy faces long-term structural
challenges that necessitate a strategic response in order to meet the targets
set out in the Europe 2020 strategy. Improving the performance of the EU
economy, in particular maintaining and reinforcing the competitiveness of
European industry (competitiveness is defined in Chapter 1, Box 1.1), forms an
indispensible part of this response and requires close integration of all
relevant policies. This applies first and foremost to the core EU policies that
shape industrial competitiveness and their respective toolkits.

Nearly a decade ago, a European Commission
report pointed to ‘new challenges that emerge at an accelerating rate: new
markets, new ways of doing business, new drivers of growth and of dynamic
competition.’[85]
Since then, the speed at which these challenges have materialised and their
extent have exceeded all expectations. In essence, the macroeconomic trends
reshaping the global economy have forced the EU to move away from an
inward-looking focus on the Single Market to a broader and more global,
resource-oriented perspective. The old order, in which the EU determined the
pace and pattern of global growth and trade together with the US and Japan, has
been irreversibly overturned by the emergence of an as yet unfinished power
patchwork involving ever more players.

In addition, the economic and financial
crisis has triggered a debate about the strength and sustainability of the
institutional pillars on which the Western socioeconomic model rests. While it
is by now clear that this crisis has only temporarily exacerbated weaknesses
that already existed in the real economy, recent positive economic signals are
no reason to return to business as usual. On the contrary, identifying these
weaknesses and proposing practical solutions embedded within the EU’s
competitiveness policies is essential in order to ensure long-term industrial
competitiveness.

In this context, not only industrial and
competition policies but also trade, Single Market and other policies are
indispensible. In fact, in parallel to the shift in focus towards external
developments, the EU has undergone its biggest enlargement ever, resulting in
an internal market of 500 million citizens. As a consequence, the Lisbon
Treaty, which entered into force in December 2009, was designed to provide the
enlarged EU-27 with a workable governance structure. It also reinforced the
role of industrial policy at European level and prompted, in the context of the
Europe 2020 strategy, a new industrial policy for the globalisation era (cf.
section 6.3.2). These changes are of particular importance for the EU’s
competitiveness.

This chapter assesses the synergies between
industrial policy and other competitiveness policies, in particular competition
policy, building on an earlier analysis in 2002.[86] As such, the chapter is
intended to contribute to the debate on the way ahead for the Europe 2020
strategy. In order to remain concrete and concise, it largely focuses on
manufacturing industry.

Section 6.2 revisits the major developments
over the last decade and explains the main challenges for the EU. Section 6.3
summarises the institutional and policy toolkit so far available to address
these challenges. Section 6.4 then explores how the identified challenges
result in practical problems for European industry at different stages of their
production value chain. Section 6.5 suggests relevant solutions in the context
of EU policy making, based on the existing legal framework and a reassessment
of how it relates to the issues raised. Some concluding remarks in section 6.6
highlight the merits of a more integrated policy approach and complete the
chapter.

6.2.
Key challenges for the competitiveness of the EU
economy

Three major developments have marked the
last decade, each resulting in specific challenges for EU industry: enlargement
to form the EU-27, globalisation with the resulting relative rise in importance
of some EU trade partners, and the recent economic and financial crisis.
Overall, their effects overlap and create a dynamically changing economic
environment that forms the background for this chapter.

6.2.1.
Exploiting the full potential of the enlarged internal
market

The historically unprecedented enlargement
from the EU-15 to first the EU-25 in 2004 and then the EU-27 in 2007 has
triggered the most fundamental and visible change in the EU since the start of
the millennium. It has enabled the new Member States to complete the
adjustments they had already starting making to their political and economic
systems and has resulted in a massive extension of the EU internal market. The
EU now embraces about 500 million citizens and forms one of the most powerful
economic blocs in the world.

The resulting dynamics have created new
business opportunities and growth potential that is far from fully exploited.
The old Member States have benefited from increased trade with and investment
in the new Member States.[87]
In turn, the new Member States have experienced significant growth financed by
private investment and access to EU cohesion funds. Overall, trade integration has
triggered a more efficient allocation of productive resources, had a positive
effect on employment in the EU-27 and significantly improved the global
competitiveness of European companies.

The relationship between the enlarged internal
market and European industry is a mutually beneficial one. This was recently
highlighted when the Commission presented its new industrial policy in 2010:

‘Now more than ever, Europe needs
industry and industry needs Europe. The Single Market, with 500 million
consumers, 220 million workers and 20 million entrepreneurs, is a key
instrument in achieving a competitive industrial Europe’. [88]

In the past, the internal market has been
the main driving force behind European economic growth, based on the freedom of
movement of goods, persons, services and capital. Little by little, economic
integration has provided companies in Europe with a domestic market that goes
beyond national boundaries and a stimulating and competitive environment
conducive to innovation and increased productivity.

However, despite all past successes, the
shortcomings within the internal market and its unexploited opportunities
remain major challenges holding back the EU’s competitiveness. The smooth
continuation of the integration process cannot be taken for granted and remains
a formidable task, the more so in the face of future enlargements. It is a task
that has not been made easier by the emergence of external challenges, in
particular the recent economic and financial crisis and the pressures of
globalisation, both of which will be discussed further below.

In order to exploit the full potential of
the internal market, the Commission adopted on 13 April 2011 the Single Market
Act. This proposes 12 levers to strengthen confidence, each featuring one key
priority action and a number of additional actions to be implemented by the end
of 2012, in time for the 20th anniversary of the Single Market.
Actions include tasks particularly important from an industrial competitiveness
perspective, such as ensuring access to finance for SMEs, improving the
framework governing Intellectual Property Rights (IPRs), reforming
standardisation policy, extending high-performance European infrastructure
networks and modernising the rules governing public procurement.

Moreover, the challenge ahead is not limited
to consolidating and deepening the integration of the internal market. While
this is a prerequisite for improving competitiveness, addressing global
challenges cannot be achieved by merely extrapolating intra-EU policies beyond
Europe. Instead, all EU policies — and notably any attempt to preserve and
enhance competitiveness — need to take into account that not all trade partners
are market economies. Only a policy approach that takes into account the
economic realities faced by European companies outside the EU can establish a
powerful link between the Single Market and the rest of the world.

6.2.2.
Creating a global level playing field with
non-EU competitors

‘Europe is the right level for thinking
and action in terms of globalisation. Markets are global: Europe must defend
its interests and values with greater confidence, in a spirit of reciprocity
and mutual benefit. European policies must aim to ensure the greater
convergence of rules and standards at international level.’[89]

Progressing at an accelerating speed over
the last decade, globalisation has been reshaping the world economy. Newly
emerging economies, spearheaded by the BRICs,[90]
have established themselves as major economic powers. The main drivers behind
this process include economic liberalisation inside these countries, the
dismantling of regulatory and tariff barriers to trade between countries, and
falling transport and communication costs resulting from better logistics and
use of ICT.

The emerging countries have significantly
increased their share of output, raw material consumption, trade and capital
stocks. The share in world GDP held by China, India and the ASEAN countries, for
example, has risen by more than 60 % over the last decade. Their share in
world trade has increased by more than 50 % and in world foreign direct
investment (FDI) stocks by more than 15 %.[91] China overtook Japan as the
world’s second largest economy in 2010, and is expected by many observers to
become the largest economy within the next 20 years.[92]

Globalisation and the economic rise of Asia
have led to important changes to the business context in which European
companies operate, notably in the manufacturing sector:

·
The newly emerging economies present ever more
important markets for European products and thereby new business opportunities.
European imports from and exports to newly emerging economies in Asia have
doubled since 2000.

·
Access to these markets, including access to
public procurement, is crucial for the current and future world market position
and profitability of European companies, including SMEs,[93] but remains difficult and
often subject to restrictions unacceptable in and for market economies.

·
The structure of European industry has changed
profoundly. Competition especially from Asian companies has put intense
pressure on European companies to move up the quality and innovation ladder.[94] Some EU industries have
retrenched to niches of their former markets, while others have outsourced much
of their production outside the EU. Examples include the textile/clothing
industry, shipbuilding, and consumer electronics, joined over the last decade
by the clean technology and semi-conductor industries.

·
European companies face increasing competition
for energy resources and non-energy raw materials (cf. Chapter 4.). China’s
imports of fuels and non-fuel commodities have both increased by 500 %
over the last decade.[95]
Prices of most raw materials have risen significantly, e.g. the UNCTAD
composite price index for minerals, ores and metals has more than doubled since
2000. Key sectors in high technology are dependent on relatively rare raw
materials (e.g. lithium for batteries or neodymium for wind turbines and
electric cars) only mined outside the EU.[96]

One of the most important consequences of
these developments has been a trend towards internationally ever more
specialised and fragmented value chains.[97]
In the last decade, imports of intermediate goods in the EU (as a proxy for
value chain fragmentation) have increased by more than 80 %[98] and now amount to about 40 %
of world trade in manufactured non-fuel products.[99] Formerly vertically integrated
companies are concentrating on specific steps of the value chain and are
outsourcing many other activities. Making use of efficiency gains stemming from
specialisation along value chains is an important factor for the
competitiveness of European businesses but can create significant risks as
well, linked to security of supplies.

The last decade also saw increasing FDI
between the EU and the emerging countries. While European FDI in the developing
world has continued to grow, there is a recent trend for increased FDI to flow
in the other direction. This is partly the result of the revenues from the huge
trade surpluses built up over the last years by certain countries, most
importantly China. Furthermore, some companies from these countries have
emerged as globally active multi-nationals and have started to acquire assets all
over the world, including European companies.

Looking ahead, it seems fair to state that
improving the ability of European enterprises to fully capitalise on the
business opportunities offered by globalisation is one of the most fundamental
challenges ahead, if not the most important. As the EU has recognised the need
to maintain a strong, diversified and competitive industrial base,[100] it must ensure that its
enterprises maintain and reinforce their international competitiveness. A
particularly important element for achieving this objective is the creation of
a global level playing field,[101]
on which companies from around the world are able to compete on their
respective commercial merits. This includes all dimensions of economic
activity, be it access to inputs and markets, IPR protection, availability of
business services or choice of an optimal distribution network.

A continuing challenge to the creation of
such a global level playing field results from the fact that some of the new
economic powers are emerging from a planned economy model and have
started liberalising their internal and external economic activities rather
recently. The role of the state in these countries differs substantially from
the role of the state in Europe and other mature economies. This may bring
about distortions due to strategic macro-economic policy choices, such as fixed
exchange rates, or interventionist economic policy strategies. Moreover,
distortions other than classical tariffs or straightforward subsidies have
risen to the forefront over the last decade.[102]

Box 6.1: Offsets and forced technology transfers Offsets, notably in the form of forced technology transfers, are a particular interesting example of a non-classical distortion of the global level playing field. Offsets are a price a company is requested to pay to enter a foreign market or obtain a lucrative contract. The price can consist for example in the transfer of technology to a local partner. It can also be more indirect, such as an obligation to use a specific percentage of local inputs or to help local companies in selling a predetermined amount of goods within a specific timeframe. Designed to make up an economic shortfall for local firms and compensate for the backwardness of a developing country, they form part of firms’ bids, and their impact on the competitiveness of the European firms concerned can but need not always be negative. However, such offsets can present a policy dilemma. While the individual company may be willing to pay the price, a negative externality can arise for the sector as a whole, and there may be negative repercussions for policy objectives based on the European interest. The increased use of offsets in an ever greater number of different sectors could call for assessment of the need for a legal framework to govern them.

In this context, and in order to guide the
subsequent discussion in this chapter of the more detailed issues involved, a
number of fundamental observations apply:

First, creating a level playing field
implies a realistic assessment and monitoring of distortions. It can also
require bilateral or multilateral negotiations with economic policy makers in
the countries concerned. Further, case-by-case interventions may be required to
help European businesses as much as possible to overcome specific distortions.[103] This applies to the
activities of EU companies abroad but also to the activities of non-EU
companies within Europe.

Second, creating a global level playing
field implies neither ‘tit for tat’ acts of protectionism nor subsidy races
between countries. Consumers and tax payers would immediately lose from such an
approach, and any short-term benefits for enterprises would be rapidly
cancelled out by the longer-term loss of growth opportunities. A global level
playing field can therefore only be built on the principle that distortions are
minimised.

Third, creating a global level playing
field also does not imply a lowering of safety, labour or environmental
standards. Societal demand for such standards rises with income, and
differences in current levels are primarily a function of different income
levels, not of differing preferences. The economic growth observed in
significant parts of the developing world therefore goes hand in hand with
rising environmental, safety and labour standards. Efforts to create a global
level playing field are facilitated by this trend. This is compatible with
competition between regulatory regimes in terms of cost-effectiveness (and not
lowest standards).

Finally, the role of EU policy makers is
enhanced in this global environment. Creating a regulatory framework, in the EU
and globally, to address the changed reality of a globalised economy requires
significant resources and resourcefulness on the part of policy makers. Rules
must fit the needs of globally active businesses and their stakeholders, and
also take into account the ever increasing interdependence of companies working
in global value chains. Policy makers can also have an important role in
facilitating adaptation by enterprises and societies to the substantial
economic realignments caused by globalisation.

6.2.3.
Boosting the real economy in times of financial
trouble and fiscal constraints

The recent economic and financial crisis
was the most severe macroeconomic shock since the Great Depression in the 1930s
and has had a significant long-term impact on the competitiveness of EU
industry.

In the face of the economic crisis
originating in the United States, the EU took timely and coordinated policy
action to maintain the stability of financial markets in Europe and to avoid a
credit crunch by ensuring continued access to finance for the real economy. A
Temporary Framework for State Aid was adopted in October 2008 (Box 6.2). The
Commission subsequently adopted the European Economic Recovery Plan in November
2008 to coordinate a pan-European fiscal stimulus of about 2 % of EU GDP
in order to boost demand and structural change towards sustainable growth.

Box 6.2: State aid during the crisis

The Commission approved specific crisis-related national state aid
measures under exceptional temporary rules adopted in October 2008 in accordance
with Article 107(3)(b) TFEU, with a view to remedying a ‘serious disturbance in
the economy of a Member State’.

1) Support for financial institutions

Between 1 October 2008 and 1 October 2010, the Commission adopted
approximately 200 decisions on state aid measures for the financial sector,
authorising, amending or prolonging 41 schemes and addressing with individual
decisions the situation in more than 40 financial institutions, affecting 22
Member States.

In 2009, total state aid granted to the financial sector represented
€ 351.7 billion, or 2.98 % of EU27 GDP. However, not all of the
approved aid has been used by the Member States concerned.

2) Support for the real economy

Between 17 December 2008 and 1 October 2010 the Commission approved
73 schemes under the Temporary Framework and 4 ad hoc aid measures, amounting
to a total of € 82.5 billion (0.7 % of EU-27 GDP). The schemes comprised
aid of up to € 500 000 per company, subsidised guarantee measures,
schemes for subsidised loan interest, schemes offering reduced-interest loans
to businesses investing in the production of green products, risk capital
schemes and export credit schemes.

In 2009, the Commission approved measures under the Temporary
Framework amounting to approximately € 81.3 billion, including aid
estimated at € 2.2 billion, which represents 0.018 % of EU27 GDP.

Source: State Aid Scoreboard — Report on State aid granted
by the EU Member States- Autumn 2010 Update — 01.12.2010.

Due to the heavy reliance of European
enterprises on bank credit and bank intermediation of savings, instability and
lack of trust in the banking sector had an immediate impact on the financing of
the real economy and on the level of consumption.[104] Credit restraints and reduced
business and household demand had a particularly negative impact on those
sectors already in need of structural adjustments, as for them access to
finance had already been a bottleneck before the crisis.

By the end of 2008, production, demand,
investment and trade inside the EU had decreased drastically, with
manufacturing output falling by some 20 %. EU real GDP shrank by 4.2 %
in 2009, the sharpest contraction in its history.[105] The crisis also had an
immediate impact on the level of employment and bankruptcies, with social
difficulties aggravating the economic downturn and negatively affecting private
domestic demand. Since mid-2009, the EU economy has started to emerge from the
recession.[106]
Short-term economic data show a strong recovery in Europe, especially for
industrial output. However, output remains below its former peak. Employment
has also fallen significantly and manufacturing employment is on average some
10 % below its peak (see Figure 6.1).

Figure 6.1: Sectoral manufacturing output
and employment developments

Note: Percentage change, latest data compared to the
cyclical peak (Q1/2008), seasonally adjusted

Source: Eurostat

While the current economic outlook for
production and growth is now positive, the real economy remains exposed to
structural problems with access to finance, which has not returned to normal.
The continued high risk aversion of financial institutions, the current
uncertainties on the financial markets, the embryonic European venture capital
market and ever tighter fiscal constraints together constitute a potentially
lasting damaging consequence of the crisis on the EU’s economic performance.
Credit supply is in fact expected to be further affected by the introduction of
the CRD IV guidelines.

The crisis has in particular revealed the
need for further restructuring and better supervision of the banking sector. The
increasingly narrower scope for financial state intervention due to fiscal
constraints adds to the problem. As a result, many companies in the real
economy have been weakened by the crisis — not because they were uncompetitive,
but because of the failure of financial service providers to play their
supportive role. Some companies have thus reduced or delayed necessary investment
or R&D&I expenditure, while others are barely able to survive due to
lack of financing, making them vulnerable to any further cyclical change or
take-overs. This will have a negative effect on both competition and the
strength of Europe’s industrial fabric. In particular, non-financial
corporations, especially SMEs, are still facing difficulties. New loans to
enterprises in the euro zone have continued to fall over the past months, and euro
zone banks are still reporting a tightening of their credit standards for loans
to enterprises (cf. Figure 6.2 and Figure 6.3).

Figure 6.2: Change in new loans below and
above EUR 1 m — year-on-year change

Source: ECB

Figure 6.3: Changes in credit standards
applied to the approval of loans or credit lines to enterprises (net percentage
of banks reporting tightening credit standards)

Source: ECB Bank Lending Survey, April 2011

Overall, exposure of the European economy
to lasting problems of access to finance forms one of the main challenges in
the post-crisis context. The key task ahead is thus to restore trust and
stability in the financial sector. A move towards more stability and
responsibility in the financial system is already ongoing, through a series of
important European initiatives to reform financial markets (e.g. corporate
governance crisis resolution system, supervision of institutions, strengthening
of capital requirements). These are indispensible for improving the system as a
whole, as is the balanced restructuring of distressed banks.

A stable and business-oriented financing
market is essential not only for daily operations but also for the longer-term
investment needed for ‘modernising Europe’s industrial base and the
infrastructure on which it relies’. This also implies ‘more private capital for
productive investments, in particular through venture capital markets’ and,
more generally, ‘more resilient and efficient financial markets ensuring that
they have the right incentives to finance the real economy and investment.’[107]

It is moreover
essential to continue structural reforms in Member States, e.g. adjusting
labour or pension systems, and to create ‘incentive mechanisms encouraging all
forms of sustainable investment or investment supporting a long-term strategy.’[108] Facing these short- to
medium-term challenges will require innovative approaches, especially to address
the fiscal situation of many Member States, characterised by large structural
deficits and high levels of public debt. The search for better efficiency in
all policies will thus need to be placed high on the agenda.

6.3.
Fostering strategic European interests

The challenges identified above have
important implications for the EU policy framework. This is reflected in the
modernisation of the EU’s industrial policy with the specific objective of gaining
leverage for global competition. The following section discusses the
institutional framework where relevant from a competitiveness perspective.

6.3.1.
The Lisbon Treaty and competitiveness

The enlargement of the EU required a new
treaty to render governance of the EU-27 more operational. Decision-taking
would otherwise have become increasingly difficult. In order to achieve better
coordination, a clearer institutional structure and more effective governance,
the Lisbon Treaty was signed on 13 December 2007 and entered into force on 1
December 2009 (Box 6.3).[109]

Box 6.3: The Lisbon Treaty

The Treaty of Lisbon amended the EU’s two core treaties, the Treaty
on European Union (i.e. the ‘Maastricht Treaty’) and the Treaty establishing
the European Community (i.e. the ‘Treaty of Rome’). The latter was renamed the
Treaty on the Functioning of the European Union (TFEU). In addition, several
Protocols and Declarations were attached to the Treaty.

All legal provisions relevant for
competitiveness policies are contained in the TFEU. Industrial policy is a
field where action at EU level serves to support, coordinate or supplement
Member State actions, whereas establishing the competition rules necessary for
the functioning of the internal market is an exclusive competence of the EU. Although
there are three short references elsewhere in the TFEU,[110] the issue of competitiveness
is essentially covered by Article 173 TFEU on industry, which establishes
industrial policy as the main pillar of the EU’s competitiveness policy.

Article 173 keeps the main elements of its
predecessor, Article 157 EC.[111]
In particular, it maintains the overall objective that

‘[t]he Union and the Member States shall
ensure that the conditions necessary for the competitiveness of the Union’s
industry exist.’

The article then lists more detailed
industrial policy objectives, such as

·
speeding up the adjustment of industry to
structural changes;

·
creating a favourable business environment,
particularly for SMEs; and

·
fostering better exploitation of the ‘industrial
potential of policies of innovation, research and technological development’.

Any action by the
EU and the Member States must be in accordance with a system of open and
competitive markets. Moreover, Article 173 emphasises that industrial
competitiveness has various dimensions. This has broad implications for the
positioning of industrial policy in conjunction with other policies, such as
R&D, innovation, competition and trade. It also implies that industrial
policy is multifaceted, so that a single indicator will not suffice to measure
competitiveness in a comprehensive and operational manner.[112]

In addition, Article 173 TFEU includes
novel aspects that strengthen its relevance compared with Article 157 EC. Most
importantly, Article 173(2) gives the Commission more scope to coordinate
between EU level and Member States, for example by establishing guidelines and
indicators, exchanging best practice or performing periodic monitoring and
evaluation.[113]
The conclusions adopted by the Competitiveness Council on 1 March 2010
reconfirm this widened room for manoeuvre.[114]
Much of the subsequent discussion in this chapter serves to explain in greater
detail how this opportunity can be grasped in practical terms.

With a view to other policies, Article 3(c)
TFEU refers to competition policy as one of the EU’s exclusive competences, to
the extent necessary for the functioning of the internal market. Competition
policy thus remains a vital element of any competitiveness policy strategy. As
regards trade policy, the Lisbon Treaty introduced two major changes: a
clarification of the EU’s exclusive competence on all key aspects of trade
policy and an increase in the European Parliament’s powers vis-à-vis the
Council. Concerning the EU’s exclusive powers, the Lisbon Treaty explicitly
refers not only to trade in goods but also to trade in services, trade-related
IPRs and FDI.[115]
By extending the competence for FDI without explicitly mentioning investment
liberalisation or protection, the Lisbon Treaty has granted the EU an exclusive
competence for investment protection. Any new policy is therefore not confined
to granting access to trade partners and ensuring access for European companies
to the markets of third countries, but can also ensure that these investments
are duly protected. Multilateral fora and bilateral trade agreements could
serve to advance this approach further.

6.3.2.
A new industrial policy for the globalisation
era

In the wake
of the 1992 Single Market Programme, the EU pursued a horizontal[116] industrial policy aimed at
improving the framework conditions necessary to ensure the flourishing of the
newly constructed internal market. Strong competition policy was used to break
down remaining barriers. Interventionist economic policies were explicitly
avoided as likely to be incompatible with the internal market.

As the Single Market has become an
established reality, the importance of manufacturing industry in the EU economy
has been increasingly recognised. In 2002, with a view to the upcoming
enlargement, the Commission published a Communication on Industrial Policy in
an Enlarged Europe,[117]
which examined the future of EU industrial policy. It underlined the role of a
competitive industry and emphasised three key factors influencing industrial
competitiveness: knowledge, innovation and entrepreneurship. Two further
Communications followed in 2003 and 2004.[118] [119]

In the context of the revised Lisbon
Strategy,[120]
the Communication on industrial policy in 2005 confirmed industrial policy as a
key policy at EU level. The document set out an integrated approach to
industrial policy, maintaining a horizontal non-interventionist approach to
industrial policy that took full account of sectoral specificities. A detailed
set of horizontal and sectoral policies were set out based upon a systematic
screening of the opportunities and challenges facing 27 individual sectors of
EU manufacturing industry. Key initiatives included a legislative
simplification initiative, work on energy and environmental issues,
international market access, and intellectual property enforcement, together
with a series of High Level Groups, including CARS21 and LeaderSHIP, to review
the future of certain sectors. A mid-term review in 2007 further extended and
elaborated this policy approach, including working more closely with Member
States. Overall, the new policy framework has served the EU well.

When the global business environment
changed radically, as described above, the Commission designated industrial
policy as one of the key flagship initiatives under the Europe 2020 Strategy,
and adopted on 28 October 2010 a new Communication on ‘An Integrated Industrial
Policy for the Globalisation Era — Putting Competitiveness and Sustainability
at the Centre Stage’ (Box 6.4). Taking into account in particular the lessons
learnt from the crisis, the Commission agreed on a fresh approach to industrial
policy, which is to put EU economy on a dynamic growth path by strengthening EU
competitiveness, providing growth and jobs, and enabling the transition to a
low-carbon and resource-efficient economy. Most importantly, the Communication
recognised the need for an outward-looking global perspective with
competitiveness as the central element to help ensure consistency between all
other policies targeting enterprises.

While it is built on past experience and
continues some existing initiatives, this new industrial policy contains some
novel elements that strengthen the Commission’s role as the coordinator of
national policies. On substance, emphasis is placed on the whole value chain,
from access to raw materials to after-sales service, in recognition that any
focus on solely one part of this chain is detrimental to enhancing the competitiveness
of not only firms but the EU economy as a whole. At the same time, the EU has
set itself a new strategic objective: maintaining a strong, competitive and
diversified industrial base in Europe. In particular, it aims to provide ‘a
strategic framework for a new integrated industrial policy that will stimulate
economic recovery and jobs by ensuring a thriving world-class industrial base
in the EU’.[121]

In order to promote a successful industrial
policy, the new strategy requires that industrial policy is understood in a
wider sense, focusing on all policies that have an impact on the cost, price
and innovative competitiveness of industry and individual sectors, such as
standardisation, innovation policies or policies targeting e.g. the innovation
performance of individual sectors. It also entails consideration of the
competitiveness effects of all other policy initiatives.

The key challenge ahead is to create a
framework that accompanies firms through all phases of their life cycle and all
stages of their activity. The framework is also intended to provide the right
incentives for them to increase their competitiveness (this notion is further
discussed in section 6.4). The primary responsibility for doing this rests on
industry itself. Nonetheless, a modern industrial policy offers a toolbox that
combines the rigour and consistency of horizontal principles with the
flexibility of priority setting according to the specific needs of sectors.

In addition to these priorities, the
Commission has started reporting on EU and Member State competitiveness,
industrial policies and performance on an annual basis as part of the new TFEU
provision for it to coordinate competitiveness policies.[122]

Box 6.4: The five key priorities of the October 2010 Industrial Policy
Communication

Firstly, the Communication
emphasises the need to deliver the right framework conditions for industry and
ensure that EU policies all work together in the same direction. To achieve
this, all important policy proposals impacting on industry — for example, new
regulations for financial markets, environmental standards or new Single Market
and competition legislation — should undergo a detailed assessment of their
overall impact on industrial and sectoral competitiveness before
implementation. This should guarantee a genuinely integrated industrial policy
approach at EU level.

Secondly, the Communication
stresses the role that the Single Market plays in fostering industry’s
competitiveness and the need to address its shortcomings. For example, the
efficiency of the Single Market crucially depends on the quality and efficiency
of the energy, transport and communications infrastructure. The related
policies should therefore be considered integral parts of an integrated
industrial policy approach. Also, the provision of business services is
becoming ever more crucial for modern industry, and the Single Market needs to
be modernised in this area.

Thirdly, as Europe needs to
improve its ability to turn ideas into marketable goods and services, the
Communication puts forward a new industrial innovation policy, to ensure that
EU firms are first onto the market. In particular, it emphasises the role that
Key Enabling Technologies (KETs) can play in ensuring continuing technological
leadership by EU industry in both mature and emerging markets.

Fourthly, the Communication
insists that European industry must take advantage of the new markets opened up
by globalisation, and that it will only be able to do so if put on an equal
footing with its global competitors. This requires greater efforts to identify
and combat trade and investment barriers[123]
and also beyond-the-border practices, such as subsidies in specific sectors. As
access to raw materials is an increasingly strategic issue for Europe, the
Communication announced a comprehensive strategy, subsequently presented by the
Commission,[124]
with a strong external dimension to ensure, in particular, that access is
genuinely market-driven and that restrictions and constraints in third
countries are removed.

Finally, industry must be
accompanied in its transition to a low carbon resource efficient economy.
Indeed, combating climate change and increasing resource efficiency should not
be seen exclusively as a burden on companies, but also as an opportunity for
sustainable growth and gaining competitive advantage. This implies in
particular initiatives targeting energy-intensive industries – such as metals,
chemicals, and paper and pulp – so that new low-carbon technologies can be
developed and disseminated.

6.3.3.
A European policy approach to serve strategic
European interests

In line with
the principle of subsidiarity, the appropriate level to design policy is the
lowest that can effectively provide a solution for the problem at hand. Action
at EU level is thus only justified where the target of such action comprises a
significant part of the EU and where a response only at a lower level would
create risks of fragmentation, underperformance or inconsistency.

These conditions are met for a policy
response towards the challenges discussed above:

·
Globalisation affects all Member States, and the
strategic response to it is a task with clear economies of scale. In the face
of non-EU competitors with swiftly expanding home markets of a potential size
much larger than that of any EU Member State, political and economic leverage
can be higher at European level.

·
There is a strong need to maintain the Single
Market across an enlarged EU-27, a much less homogenous economic bloc than the
earlier, smaller EU. In a number of sectors, manufacturing is concentrated in a
minority of Member States, whereas resources, suppliers and markets encompass
all of them. Maintaining and extending the Single Market benefits all
businesses and consumers.

·
Limited state finances in the wake of the
economic and financial crisis call for pan-European solutions, including new
ways of financing large-scale demonstration projects (as exemplified by Carbon
Capture and Storage or KETs) and supporting infrastructure.

The Europe 2020 strategy provides the basis
to implement such a European approach. As discussed in section 6.3.1, the TFEU
provides new tools for the ‘integrated industrial policy for the globalisation
era’ flagship to enhance competitiveness, for instance by strengthening the
Commission’s role as coordinator of national efforts. In this context, it is
important as a starting point to clarify some concepts, notably ‘European
interest’, ‘strategic’ at European level, and ‘European company’, to the extent
relevant for an industrial policy context.

6.3.3.1.
European interest

The notion of European interest figures in
the TFEU only once, in Article 107(3)(b) on state aid. Financial support
measures by Member States ‘may be considered to be compatible with the internal
market’ if they constitute

‘aid to promote the execution of an
important project of common European interest or to remedy a serious
disturbance in the economy of a Member State’.

However, the related term ‘common interest’
appears ten times. In particular, two subsequent provisions on state aid,
Articles 107(3)(c) and (d), state that other forms of aid must not distort
trade (and competition) to an extent ‘contrary to the common interest’. A
common European interest is thus recognised in the TFEU itself.

Beyond these references, the European
interest also figures in secondary law:

·
In the competition context, the conditions for
considering ‘[a]id for R&D&I to promote the execution of an important
project of common European interest’ as compatible with the internal market are
laid down in the 2006 R&D&I state aid framework.

·
In another field, the notion already exists as
well. In trade policy,[125]
the ‘Community interest’ is defined on the basis of various interests taken as
a whole, including the interests of domestic industry, users and consumers. It
thus serves to combine diverse — and sometimes opposed — specific interests to
arrive at the common good.

·
The notion of European interest is used in EU
transport or energy policy for establishing the right framework conditions and
financial means to ensure the building or operating of efficient trans-border
infrastructures. It can be extended to large research infrastructure projects,
e.g. the ITER fusion energy demonstration project in Cadarache.

From the perspective of industrial
competitiveness policy, a legitimate European interest could be assumed to
exist where an action would benefit industrial competitiveness across national
borders without its benefits being either limited to one Member State or the
Member States implementing it or confined to the industry directly concerned,
or where the implementation of a project or policy at Member State level would
result in wasteful duplication of efforts (i.e. inefficient use of resources),
would act against similar efforts in other Member States, or would not happen
at all. Reasons for the latter include costs that exceed benefits at national
level due to externalities, too large a project size or myopic behaviour, all
of which is aggravated in the face of tighter fiscal constraints.

Factual developments underpin the need to
rapidly fill the notion of European interest in the competitiveness context
with content. The evolution of cross-border industry value chains is one of
them. This was prominently highlighted in the 2010 Industrial Policy
Communication:

‘Delivering the new industrial policy
calls for more effective European governance. The concepts of national sectors
and national industries with little interaction with other sectors or the rest
of the world are becoming less relevant. It is now increasingly important to
identify strategic European industrial interests, and uncoordinated national
policy responses must give way to coordinated, European policy responses.’[126]

The ongoing changes in the global
configuration of industries and countries add a new dimension to the notion of
European interest in the field of competitiveness policy. In some areas where
the level playing field for all companies is distorted, and where Europe 2020
aims to ‘maintain a strong, competitive and diversified industrial base’,
defining the European interest with regard to non-European trade partners could
be done in a more pro-active way.

6.3.3.2.
Strategic nature of such interests

The paragraphs above, including the
quotation, refer to the concept of ‘strategic’ interests. Of course, a sector,
company or activity is never strategic per se but can only be so in
specific circumstances. Such circumstances can change over time. This explains
why lists of strategic actors or activities differ, depending on their origin.
Furthermore, many EU Member States have defined strategic sectors at national
level, e.g. relating to national security, which have then received specific
support. This need not be in contradiction with EU law, notably on the free
movement of capital.[127]
However, such definitions can differ profoundly across the EU.

However, a European interest deemed to be
strategic must be so at European and not national or sectoral level. The focus
should be on criteria that are objective while flexible enough to cope with the
relative nature of what is strategic at a given moment in a given context. Accordingly,
two such criteria can be singled out: public policy relevance and indispensability
for specific economic activities.

1.           An activity and its driver
— in many cases firms — are the more strategic the more they are indispensible
to achieve an acknowledged public policy objective. An example is road safety.
If the objective is to reduce the number of fatal accidents in passenger
transport, on-board safety systems are essential. If it turns out that the
number of producers of state-of-the-art technologies is very limited, any of
them is strategically important — not per se, but in this specific context.

2.           Many economic activities
rely on specific inputs produced by innovative firms with cutting-edge
technology and/or on time by highly specialised producers. Indispensible
inputs, such as certain raw materials found in few countries, are another
example. The less they can be substituted and the more disruptive for global,
fine-tuned value chains their temporary non-availability would be, the more
they are strategic. Examples here include lightweight, high-resistance materials
or electric batteries in road transport or energy-saving propulsion systems in
maritime transport.

When one considers these examples in
greater detail, similarities become visible. Much of this looks unspectacular,
and the companies concerned may in fact be small — and few. They can be prone
to weaknesses, including the financial issues that SMEs often face, and can
therefore be vulnerable to takeovers. Nevertheless, their strategic value far
exceeds their absolute size because of their bottleneck function, not only for
production as such but for public policy needs that depend on such production.

If the European interest is to enhance
competitiveness, as outlined above, a systemic analysis of how to achieve this
must continue to focus on the most strategic elements within the industrial
fabric, including both large and small enterprises, whose removal from the
market-driven economic system the EU promotes would have an appreciable effect
on competitiveness across national borders.[128]
This is the notion of ‘strategic’ pursued in the following sections.

6.3.3.3.
European companies

These considerations lead to the third
element of the EU competitiveness paradigm: European companies. While
references to European companies abound and are pertinent in many industrial
contexts, notably strategic contexts at national level (for instance in
defence), a clear definition proves particularly difficult. Similar exercises
in other countries, such as the US two decades ago, have proven equally
difficult, but have ultimately contributed to a better understanding of how
companies, regardless of their origin, can help to add value to specific
regions of the world. The exercise here has to be understood in a similar vein
as a starting point for discussion.

Box 6.5: European companies

Many attempts to define a European enterprise have been made,
leading so far to inconclusive results. It has sometimes been defined as a
transnational group, in contrast with national companies from Member States or in
contrast with third countries. The criteria used to define a European
enterprise in economic terms have also been widely discussed: European
shareholding, dominant market in Europe, added value created in Europe,
headquarters, main production sites, R&D or jobs located in Europe. Some
criteria used are identified in sociological terms, such as methods of
governance, relations between shareholders and management, importance of
employee participation in management, closeness to legal and institutional
framework, etc. Debates are still ongoing but seem to add little value to the
discussion in this chapter.

Despite these definitional ambiguities a
more pragmatic approach would be to say that a company founded in Europe that
has its R&D department, production sites and headquarters in Europe is
obviously European, whereas a company where none of this applies equally
clearly is not. The usual market reality lies in between and need not be
further described in many (if not most) cases. For example, whether a producer
of final products in a homogenous global market with low transport costs and no
capacity constraints is European or not is at best of academic but not
practical relevance.

At the same time, this would be an example
of a firm that neither merits nor deserves public policy attention. The market
reality is usually different. The more a company adds value to the European
economy, the more it is entwined with European policies and the more it can
become a vehicle for such policies. This is obvious in some contexts, such as
employment. In fact, a widely recognised definition of ‘competitiveness’
includes jobs[129]
and thus stresses this particular dimension of economic activity.

Even if one were to challenge the
significance job creation might have for core competitiveness, companies that
are strongly rooted in the European economy may produce a series of other
beneficial effects in Europe. They often form part of innovation systems within
Europe, in which proximity and local or regional spillovers are crucial and
where distance matters when it comes to the success or not of such systems.
Furthermore, they may be more familiar with the legal and socioeconomic system
and the culture in Europe, which may reduce frictions and make it simpler for
them to operate and for others to deal with them. Again, this is a success
factor not to be underestimated, and is one which is too often absent in
investors purely operating from outside the EU.

The objective of any definition of European
companies is recognition of the simple fact that the policy of any jurisdiction
is primarily targeted at the economic subjects living and operating in it. At
the same time, there is a European interest in maintaining a strong presence of
companies with strong roots in the European economy in a variety of strategic
contexts, as industries or companies that exit the European market cannot
return at short notice and without significant cost. In fact, both the time and
cost are often prohibitive, and exacerbated by the loss of knowledge and
support factors within the system.

6.4.
Industrial competitiveness throughout the
production value chain

The challenges defined in section 6.2
necessitate the design of a European response that takes into account the
institutional framework and the policy principles presented in section 6.3. It
is of paramount importance to base this response on the EU’s strategic
interests. As noted above, these strategic interests depend on the context. In
what follows, in order to place the discussion within a more practical context,
such interests are exemplified for different stages of the production value
chain: access to resources, innovation, access to markets, and restructuring.
Each stage is affected differently by the challenges, and each requires a
different form of response. Overall, however, all these responses need to be
coherent to optimise policy leverage at European level.

6.4.1.
Access to resources

European companies can only thrive on the
global market if they have reliable access to essential inputs. This
particularly applies to raw materials, some of which are subject to trade
restrictions, concentrated in few non-EU countries and prone to becoming the subject
of strategic leveraging. As the 2010 Industrial Policy Communication put it, ‘secure,
affordable, reliable and undistorted access to raw materials is essential for
industrial competitiveness, innovation, and jobs.’ However, fluctuations in
both quantities and prices render such access difficult. Increased prices for
raw materials in principle reflect increased demand and signal relative
scarcity. This is a normal and useful incentive in a market environment to
search for alternatives and to increase efficiency (See Chapter 4.). At the
same time, such price increases can be partly due to government intervention
for strategic reasons, e.g. to give preference to domestic producers.

The response to this is threefold, as
identified in the recent Raw Materials Communication:[130]

First, the availability of intra-EU
resources should be stepped up. This starts with better knowledge and
identification of the EU’s indigenous resources, the development of
technologies for intelligent mining, and the increased exchange of best
practices between Member States in the area of land use planning and permitting
of exploration and extraction.

Second, respect for multilateral rules should
be enhanced through increased cooperation in global fora, such as the WTO, to
address external supply problems, tackling trade barriers through dialogue but
also through judicial action, where appropriate. Action at multilateral or
bilateral level can also be taken in the development field in order to
diversify access to raw materials by creating win-win situations.

Third, recycling (e.g. through ‘urban
mining’) and technological substitution can reduce the pressure on access to a
certain extent. In both cases, the concept of the sustainable use of natural
resources is the driver of EU action.

Box 6.6 Critical raw materials

In order to develop priority actions, the Commission has identified
a list of critical raw materials, based on the risk of a supply shortage in the
next ten years and the importance for the whole value chain. In all, 14 such
critical raw materials figure on this list: antimony, beryllium, cobalt,
fluorspar, gallium, germanium, graphite, indium, magnesium, niobium, platinum
group metals, rare earths, tantalum and tungsten. These critical raw materials
have or should become a core strategic dimension of industrial, trade, research
and competition policies.

Strategies at firm level can complement
these efforts. Long-term contracts are a particularly useful tool to steady
prices and hedge risks. In specific circumstances, such contracts can become
anti-competitive, for instance if resources are obtained from a dominant player
on the basis of exclusive contracts that result in only minor quantities being
available on the market each year, or in general if the long-term contracts
lead to market foreclosure. The specific circumstances are now well-established
in antitrust case law. In general, however, long-term contracts are often
pro-competitive and work even better if their pricing is constrained by spot
markets that cater to supplementary short-term needs.

Second, firms can reduce scope for
strategic leverage by relying on several suppliers. This proves difficult at
times, as bottlenecks emerge in complex supply chains. Moreover, many suppliers
are small and prone to risks inherent in cyclical businesses. The financial
crisis has exposed such problems and weakened parts of industrial supply
chains, which has prompted responses that have not always been pro-competitive,
e.g. takeovers that have privatised assets that had formerly been accessible to
all buyers.

Recent events, such as the global
repercussions of the Japan earthquake and tsunami, have added to these concerns
and made supply chain management a number one priority for many global
businesses. In fact, the old wisdom of the undisputedly beneficial effects of an
enhanced global division of labour cannot be maintained any longer. Greater
strategic state intervention, supply chain interruptions for an increasing
number of reasons (e.g. natural disasters, piracy), and increasing market
concentration are strong disruptive factors. Proximity starts to matter more,
not only for innovation — where this principle has been long established — but
also for access to resources as such.

6.4.2.
Innovation

Maintaining and strengthening a competitive,
low-carbon and resource-efficient industrial base in Europe depends upon an
appropriately designed research and innovation policy. In particular, a pro-active
industrial innovation policy is a key driver for efficiency gains in production
processes and services, improved performance of products and the creation of
new markets.[131]

Such a policy
should take into account the specific research and innovation profile of each
Member State and focus on their respective weaknesses. This would also promote
convergence between the innovation performances of Member States. All new
Member States are currently below the average EU innovation performance.[132] The difficulty of this situation
has been compounded by the crisis, which has had a ‘disproportionate impact on
some less performing regions. Europe must avoid an “innovation divide” between
the strongest innovating regions and the others’.[133] More efficient use of the Structural
Funds and a more targeted approach, focused on the relative strengths of each
region (the so-called ‘smart specialisation approach’), together with cluster
initiatives, could contribute to this objective.

More generally, the crisis has imposed
tight fiscal constraints on national budgets, including those supporting
research and innovation. This problem calls for a much better aligned effort
from Member States and the Commission to pool resources and coordinate actions
in order to optimise efficiency. Such a coordination or pooling strategy would
also contribute to addressing the recent changes in global conditions and the
competition from non-EU competitors, which are following a similar innovation
path and which in many instances have already implemented a coherent research
and innovation strategy.

In this context, a fundamental challenge
for Europe is fragmentation. Research and innovation capacities in EU firms are
numerous and of a high quality, but often small in size and fragmented along
national and regional lines. This leads to duplication and overlap. Focusing on
the European dimension and going beyond mere national initiatives is necessary,
not only to overcome the scarcity of public resources, but also to acquire a
recognised weight at global level. This necessitates the pooling of EU efforts,
for example by increasing contributions to cross-European initiatives, such as
European platforms, the Lead Market Initiative, public-private partnerships,
innovation partnerships, Framework Programme support for collective projects of
firms from several Member States, or other policy measures. Such policies all
encourage cross-border convergence and synergies. They indeed serve to make
strategic European interests a priority.

Within such a framework, it is of the utmost
importance to help EU firms to become or remain innovation leaders. This
includes efforts to ensure their goods or services are low-carbon and resource-efficient.
Targeted efforts are for example needed to support the early uptake of KETs[134] (such as industrial
biotechnology, advanced materials, nanotechnology, micro- and nano-electronics,
photonics, and advanced manufacturing systems) to unleash their full beneficial
impact in other industrial sectors. New initiatives to address societal
challenges also need to be strongly encouraged, in the field of technology as
well as in the field of services.

6.4.3.
Access to markets

Access to resources and a strong innovation
performance fail to deliver optimal results if access to markets, particularly
outside the EU, is a problem. In fact, both the recovery from the crisis and
some tendencies in the context of globalisation, where newly emerging
competitors might bring forward infant industry arguments or implement other
policies that favour their native companies, result in a significant risk of
protectionism. European businesses are largely dependent on non-EU markets and
integrated global value chains. In the future, the main growth potential for
European businesses is expected to come from non-EU markets. European companies
can furthermore profit from geographical diversification to hedge against
crises that are geographically limited or affect different world regions at
different times. All of this means that the need to ensure fair access to
markets worldwide is a key ingredient for EU policy in a globalised economy,
the more so when Europe faces ever more competitive trading partners.

Access to the Single Market ‘home base’

Deepening the Single Market plays an
essential part in building and strengthening European companies’
competitiveness and giving them a ‘home base’ to compete globally.[135] In the era of globalisation,
however, deepening the Single Market goes hand in hand with opening it to the
outside world. This opening to imports and investments from trading partners is
crucial for economic growth within Europe. Competitive pressure on EU firms
from non-EU businesses provides important incentives for them to remain
innovative and rapidly adapt to global evolutions.

Access for European companies to foreign
markets

The successful removal of tariff barriers
to trade, achieved under multilateral and bilateral agreements, has significantly
increased global trade. It has benefited EU businesses, helping them to recover
from the crisis. While it is necessary to pursue these efforts, the focus has
shifted to non-tariff and other ‘behind the border’ barriers[136] (offsets, burdensome customs
procedures, discriminatory technical regulations, etc.). These obstacles are
more difficult to identify and to remove. Furthermore, the crisis has
unsurprisingly turned out to be a period of increased protectionism, precisely
in the form of hidden or ‘low intensity’ barriers. Access to the Single Market,
with its 500 million consumers, remains very attractive to foreign firms, so
reciprocity is a highly efficient instrument for reducing non-tariff trade
barriers.[137]
The economic weight of the Single Market grants the EU considerable influence
on regulatory issues in such a context. It also allows it to achieve leadership
in standardisation and other policy fields where regulatory competition will
increase.

Furthermore, European companies investing
abroad need a secure legal framework for doing so. Their capital investments
and also their technical know-how (especially in the form of IPR) need to be
protected against arbitrary interventions by the government or lack of
effective access to the courts or dispute settlement mechanisms. This is especially
so for small and medium-sized enterprises, which find it particularly
challenging to be active abroad.

Finally, distortions in international trade
and investment can result from strategic macro-economic policy choices, such as
fixed exchange rates. Exchange rates significantly influence the relative
competitiveness of industries and enterprises from different countries.
Solutions that aim to create a global level playing field must therefore address
all aspects of the existing imbalances if they are to be effective.

6.4.4.
Restructuring

The structural weaknesses of the EU economy
exposed by the crisis cannot be ignored if the objective is to achieve medium-
and long-term growth and secure jobs. Changes should aim, on the one hand, to
ensure a transition to more sustainable and innovative production and/or new
business models. On the other hand, they may be conceived to manage structural
excess capacities or to accompany changes at firm level, ranging from ‘engaging
in new business models and products to definite market exit’.[138]

Although, in order to successfully compete,
any firm and any sector must be ready to adjust, some sectors are more
concerned by the need to find new business models or markets than others. These
include, for instance, the automotive sector, the basic metals industries,
mechanical and electrical engineering, shipbuilding or the printing industry.

First, it is essential to consider that
restructuring processes constitute an inherent element of the life-cycle of
each enterprise. Companies must constantly adjust their strategies to the
changing environment and to their internal evolution. This being said, many
firms have come into difficulties almost exclusively because of the crisis and
the lingering difficult access to finance. For these firms, when facing
adjustment needs the issue of access to finance becomes existential.

Second, restructuring concerns both firms
and whole sectors. While the responsibility for restructuring is always
considered as primarily that of firms themselves, the issue becomes more
complex and sensitive when it comes to the restructuring of sectors. It might
be worth offering sectors some space to collectively rethink their role and
place in the global arena, in order to collectively contribute to their own
restructuring processes and to ensure, if needed, the orderly winding down of
businesses. This topic becomes even more complex, but certainly not less
relevant, when considering the impact of restructuring on value chains.
Decisions by single companies — or sectors — can substantially influence the
competitiveness of other, related companies or sectors.

The overall sector dimension should also be
taken into account in all public policies and decisions relating to firms. In
the field of state aid, for example, decisions taken on aid for large
investment projects on the basis of regional development considerations are already
assessed with a view to the impact on the sector, if the beneficiary has more
than a 25 % market share or, should the market be underperforming, if the
capacity increase resulting from the investment exceeds 5 % of the
consumption of the market. State aid rules also exclude certain sensitive
sectors from regional state aid (for example the steel industry). Furthermore,
aid schemes targeting specific sectors have to be notified individually. The
assessment of these schemes takes into account the impact on the sector
concerned.

For all types of company adjustment
strategies, the EU policy approach should continue to be based on identifying
and taking into account the pro-competitive effects of projects and initiatives
on the EU market. Such pro-competitive effects in turn can contribute to
increasing the competitiveness of the companies involved.

6.5.
Implications for the interface between
industrial policy and other competitiveness-related policies

Any reflections on the general principles
governing a policy approach have their litmus test in their practical
application. This reality check is all the more important — yet particularly
difficult — if the issues addressed are new and complex, necessitating a
careful balancing of objectives (such as free trade vs targeted intervention)
the implications of which are not fully clear in advance. This certainly
applies to the developments discussed in this chapter, which form a moving
target and which are only now starting to draw the attention of both policy
makers and the wider public.

What is certain in such a context is that
individual policies aiming to enhance competitiveness, such as industrial and
competition policies but also trade, internal market and other policies, need
to engage in a well coordinated exploitation of policy synergies based on sound
and joint analysis of socioeconomic developments, which by necessity starts
with fact finding. The discussion of the industrial and competition policy
interface in the 2002 Competitiveness Report pointed to the existence of such
synergies and the merits of exploiting them. Events since then have reinforced
this observation.

The subsequent discussion in this section
therefore advances and deepens this discussion in the light of recent and
expected future developments. Two principles apply:

1.           This discussion is driven
by practical examples of particular relevance at this moment in time. They
should not be seen as a complete list of issues to be addressed but rather as
typical examples. In fact, new manifestations of the challenges facing European
industry materialise by the day, and any assessment of them needs to draw on
the general tools discussed above and applied below in related fields.

2.           The development of a
consistent policy framework that addresses all challenges noted above has to be
preceded by a sound analysis, including assessment of their likely impact on
the main dimensions of European competitiveness. This will take time. In many
instances, however, there is a need for swift and timely policy action, which
in the absence of enhanced legal tools and instruments needs to build upon a
reinterpretation and extension of the current framework. The following
considerations therefore start from the legal status quo, which by no means
excludes that bolder steps are considered and prepared in parallel.

6.5.1.
Securing the strength of the European industrial
value chain

The following remarks provide examples of
how existing competition and trade policy instruments can be used and extended
to continue safeguarding industrial competitiveness in the context of the
challenges outlined above. The sub-section below starts with merger control and
antitrust enforcement, whereas state aid rules are considered in a subsequent
sub-section.

6.5.1.1.
Applying merger control and antitrust enforcement
to support industrial competitiveness

As discussed in section 6.3, the
legislative framework evolves in line with broader socioeconomic developments.
This also applies to competition rules, where European merger control and
antitrust regimes have undergone significant changes over the last decade. The
more economic approach to merger control, applied since the 2004 reforms and
supplemented by the 2008 round of guidance documents,[139] has resulted in a framework
that is increasingly focused on the economic impact of concentrations on
competition in the European Economic Area (EEA). The antitrust rulebook has
been developed with a similar objective in mind and provides increasingly
better guidance on the relevant economic considerations to companies, which since
2003 are responsible for self-assessing that their conduct is in line with
these rules.

These improvements constitute a shift
towards a more sophisticated assessment of economic reality. It also allows the
Commission to contribute to competitiveness through a more sophisticated
evaluation of notified mergers and acquisitions. Despite the fact that many of
the more than 2000 mergers notified to the Commission since 2004 have touched
upon crucial industries or transactions with far-reaching economic consequences,
the Commission has managed, with 1835 clearances, 117 conditional clearances
and only three prohibitions, to ensure that these transactions are fully in
line with the EU’s competitiveness objectives.[140] In fact, the Commission has
not prohibited any merger with any industrial policy relevance since the 2004
Merger Regulation entered into force.

In this context, it should be stressed that
European merger control policy has not prevented European companies from
becoming champions on global markets. The Commission’s practice rather shows
the contrary. Prominent cases, including EADS, Glaxo/Smithkline, GdF/Suez and
SAP/Sybase, not only demonstrate that there is no inevitable antagonism between
the idea of allowing companies to fully benefit from the enlarged Single Market
‘base camp’ and the need to protect European consumers.[141] They also show that the
European Commission, within and in accordance with existing EU competition
rules, takes into account businesses’ concerns about their competitiveness on
markets outside the EU and the need for size in this regard — concerns that
will become ever more pressing in the globalisation era — as ‘Europe needs
European champions that are able to grow on their own merits and to run with
their legs in the global race.’[142]

The economic trends identified in the
preceding sections and the dynamic character of the EU policy framework mean
that decision making has to be constantly adapted. This does not necessarily
require new rules; in fact, the current rules provide enough flexibility if
properly interpreted.[143]
It however calls for a vigilant eye for these new developments and a constant
updating of the detailed application of the tools. For this reason, the
Commission regularly assesses the effectiveness of its policy and enforcement
tools in order to ensure that they reflect market realities and the latest
economic learning and to take into account the interests and concerns voiced by
industry.

A number of features in the application of
EU merger control policy can be said to contribute to EU industrial
competitiveness. The first concerns geographic market delineation or, more
generally, the geographical scope of competitive constraints in evaluating
mergers or market positions. At least as regards investment goods and intermediary
products (less so for branded consumer goods), markets are becoming ever wider
and falling transport costs coupled with better IT inter-linkages are
increasingly facilitating global competition. In times of global integration,
markets are becoming EEA-wide or wider. In this regard, the Commission is
determined to maintain its current practice of assessing such developments as
and when they materialise taking into account the specific facts of the case,
e.g. by adequately taking rising competition from newly emerging countries into
account (such as in the decision on Arsenal/DSP).

The massive increase in the division of
labour on a global scale and the rise of globally distributed integrated value
chains also require a special focus on the vertical relationships between
companies. While this trend has proven, in essence, to be pro-competitive and
to allow European enterprises to benefit from economies of specialisation, it
has also added complexity and vulnerability to the environment that companies
face. Again, it is primarily for companies to guard themselves against these
risks (as exemplified by the recent trend to near-sourcing). The regulatory
regime — merger control ex ante and antitrust ex post — will continue to face
the task, among others, of preventing, respectively, the emergence of dominant
positions in these value chains and the abuse of dominant positions or
significant impediments to competition. The global reach of both policies (as the
effect matters, not the location of companies) plays an important role if
suppliers are concentrated outside the EU.[144]

In a more dynamic global environment, it
may be increasingly relevant to evaluate the benefits and efficiencies brought
by agreements and transactions. Where dynamic efficiencies can be expected to
play a very prominent role, even though their evaluation is more difficult and
requires more time, a pro-active approach is warranted. As regards specific
merger efficiencies, the Commission will look at such efficiencies where the
parties make such claims (it being understood that it is for the parties in
such cases to provide the necessary evidence from the outset).

As detailed in section 6.2.2 above, the governments
of some emerging economies have a much greater role in the economy than is
customary in the EU. These non-market interventions present some challenges for
applying merger and antitrust rules to cases in the extensive grey area between
the public and private sectors. The instruments developed to take into account
public sector links in the Member States or other market economies are
therefore applied to a much wider spectrum of possible government interference
(e.g. to establish the true ownership/control of enterprises in non-market
economies). In merger control for instance, the Commission’s 2008 Consolidated
Jurisdictional Notice provides a framework for assessing state influence on
undertakings. This has also been employed in practice in cases involving non-EU
state governments (recent examples are the Bluestar/Elkem, DSM/Sinochem and Petrochina/Ineos
mergers). Quite often, the problem in such cases is the difficulty of obtaining
from those countries the information necessary to perform a thorough
assessment.

The pressure to restructure and the benefits
from doing so are multiplied in an open economy with rapid technological
progress. Since restructuring, in terms of adaptation to both cyclical and
structural changes, is primarily the responsibility of firms, the regulatory
framework must allow them to act on their responsibility. Companies aiming to
restructure via mergers or acquisitions will in many instances depend on
approval under the merger control regime. Restructuring attempts that do not go
as far as a merger and which instead are implemented via coordination between
companies must be in line with the antitrust rules on cooperation between
undertakings. For both merger control and antitrust action the toolbox is in
place — in merger control for example the failing firm defence, the
counterfactual defence, or the efficiency defence can be cited, while antitrust
action has the specialisation Block Exemption Regulations and the guidelines on
horizontal cooperation agreements. Recent merger cases have included very
elaborate restructuring analysis and have clearly demonstrated that a return to
profits via the creation of a monopoly goes beyond reasonableness (e.g.
Olympic/Aegean). Companies that need to exchange information on past and
present strategic data (for example demand or capacities) that can be crucial
for the allocation of production to high-demand markets may benefit from the
more detailed guidance given in the revised Horizontal Guidelines.

Finally, the intensified competition
between economic areas also requires a continued focus on the cost of doing
business in Europe. An effective regulatory regime, maintaining the
competitiveness of European industry, by its very nature requires resources
from companies involved in proceedings. The Commission’s efforts to reduce the
length of investigations (e.g. through the recent introduction of settlement
procedures) and increase the transparency and predictability of enforcement can
contribute to keeping Europe attractive as a place to invest. This is even more
important if one considers that multiple jurisdictions all over the world often
wait with their assessment of a transaction until they know the final position
of the European Commission. The Commission, as one of the leading role models
for competition policy worldwide, has a natural role to play in aligning
substantive and procedural tools around the world and thereby tackling the
problem of the ever increasing cost of multi-jurisdictional filings and
preventing inconsistent demands on enterprises from different national
competition authorities.

6.5.1.2.
Making full use of policy toolkits in the global
context

Monitoring and assessing the risks of
disruption of production chains as well as establishing the balance between
economies of scale, security of supply and technological leadership in a
specific economic context is the primary responsibility of businesses. They are
closest to the market and thus have the best available information. Moreover,
they are the first to feel the consequences. And yet, the increasing
involvement of states, in particular non-EU non-market economies that have their
own approach to the delineation between private and public interests, creates
an asymmetry that European industry on its own cannot handle.

Traditional forms of disruptive threats to
the EU’s industrial value chains are usually directly linked to distorted price
competition. Current European trade defence instruments (anti-dumping, anti-subsidy
and safeguard measures), designed in conformity with WTO rules, enable the
European Commission to address most of these issues. However, in the context of
the internationalisation of value chains and ‘low intensity protectionism’, new
threats to the integrity of value chains have emerged. On top of the risks
outlined above, the recent economic and financial crisis has demonstrated how
exposed key suppliers, which are often SMEs, can become if access to finance
deteriorates, which is often unconnected to individual economic performance. In
fact, one lesson from the crisis is that many European manufacturing sectors
active in global value chains depend on the timely delivery of key inputs
produced by a handful of relatively small suppliers, in some instances only one
or two. In line with the concept developed in section 6.3.3, these can be
considered as ‘strategic’, as they are often indispensible not only for a sector
as a whole but for more than one single manufacturing activity. In addition,
the products manufactured with their input have significance not only for
applications in various sectors but also in specific public policy contexts.

Such strategic importance for the integrity
of the European industrial fabric increasingly turns these companies into
targets for acquisitions. From an industrial policy perspective, it is
important to closely monitor and assess the consequences, the more so when
public authorities in non-EU countries are involved in such transactions. For
example, recent scientific research suggests that mergers and acquisitions by
Chinese companies, which often are state-owned, are increasingly strategic,
building upon the underlying principle of ‘digesting rather than investing’.[145]

As a result, major EU competitors
(including recently ‘free trade’ ones, such as Canada and Australia) have
recently strengthened their policy toolkit to be able to prevent malpractices
and better preserve national interests. Although some EU Member States have
similar systems in place, the EU as a whole remains one of the most open
economic blocs in the world. A careful and balanced analysis seems warranted to
assess how to maintain this openness while taking into account the increasingly
strategic dimension in global competition. This process would usefully build on
input from and constant dialogue with European industry to flag risks. It could
also involve a broader activation of existing frameworks, whether EU country
teams abroad or information exchange mechanisms in the public realm.

As a complement, notably in the short run,
existing instruments such as the Commission’s merger control system can
continue to be applied, either directly or through meaningful exploitation of
unused opportunities, to provide a ‘safety net’ for takeovers that could
potentially restrict competition, such as by blocking downstream access to an
essential input or eliminating innovative ‘mavericks’ in a specific industry.
In fact, merger control disallows such negative competitive effects unless
sufficient clear-cut remedies are offered to offset them.

However, the EU merger control system is
neutral as regards the origin of the merging parties and applies in the same
way to EU and non-EU companies. It is firmly rooted in the idea that
competitive market structures need to be maintained to benefit consumers and
businesses. This neutrality ensures that the merger review process is
transparent, manageable and predictable to the investing community. It is also
in line with the EU’s long-established commitment to openness to the rest of
the world, and gives the EU a moral high ground in arguing for non-discriminatory
treatment at international level regarding the outgoing investments of European
companies in third countries. At the same time, though, the merger control
system ensures that global mergers and acquisitions do not have any negative
impact on prices, innovation and choice in Europe.

Addressing efficiently both traditional and
‘innovative’ forms of threats to the integrity of the EU’s industrial value
chains requires the EU to develop a stronger horizontal coordination of its
various instruments and policies. A more in-depth articulation of competition,
trade and industrial policies has to be developed, in order to ensure a
coherent and consistent approach to the protection of industrial value chains.
A particularly crucial issue for this horizontal approach is the conditions
under which such protection is allowed. An example from the current regulations
governing trade defence instruments is the ‘Community interest test’ to
determine whether the implementation of planned measures is in the interest of
European industries, users and consumers. Such a mechanism for a horizontal
approach would be based on the concept of European interest, as defined in
section 6.3.3.

6.5.2.
Enhancing the scope, impact and timing of
targeted state support

Industrial policy objectives that aim to
enhance competitiveness are complemented by state aid control, which aims to
safeguard the undistorted functioning of the Single Market, in particular in a
period when Member States’ room for manoeuvre is limited by fiscal constraints
due to the economic and financial crisis. While existing instruments could be
screened for unused potential, including procedural improvements, any
extensions to the existing framework should be considered with care and based
on the proper identification of well-demonstrated needs.

6.5.2.1.
Timely and efficient state aid assessment in a
global context

Business success first and foremost depends
on entrepreneurial vision and its translation into viable business plans. State
aid often provides an indispensible additional impetus to bridge specific
phases in the development of new products and processes not otherwise
accommodated by the market, but it remains a supplement to and not the raison
d’être for economic activity.

In order to speed up the decision-making
process and to address the time issue as such, which is a key dimension for
competitiveness, especially in R&D&I projects, it is essential to
continue improving the information flow between the Commission and
stakeholders. Despite the best efforts of the Commission to minimise the time state
aid decisions take, long delays — often caused by inefficient information flows
outside the Commission — still occur, which may in certain cases be
incompatible with the often urgent financing needs of enterprises. The recent
procedural simplifications and the adoption of the Best Practices Code help to
address such shortcomings, in particular through the generalisation of early
prenotifications. Beyond helping to save time, this also serves to clarify the
context of a project from the beginning and to establish a clear view of the
rationale and impact of any aid needed for European companies.

It is also essential to raise stakeholders’
awareness of the need for the Commission to have access to useful and updated
data on markets and sectors, in particular if they have global dimensions.
While the Commission can in most cases rely on its own resources, there are
specific situations where cross-sector information is required and where the
early supply of such data by Member States and companies can accelerate the
assessment of a project.

The time needed for assessment could also be
reduced by more dynamic cooperation between the Commission and Member States.
At the same time, sustained advocacy activities whereby the Commission seeks to
explain to stakeholders the possibilities offered by the state aid framework,
to enable them to make the best use of the rules, can also contribute to
further reducing the length of the assessment process, for instance in the
field of R&D&I. In fact, as most of the state aid rules currently in
force are the result of legislation adopted following the 2005 State Aid Action
Plan, they have so far been applied for a relatively short period of time.
Therefore, both companies and Member State authorities still need to gain
broader experience and sufficient knowledge of the practical use of these rules.

6.5.2.2.
Maintaining a strong and diversified industrial
base in Europe

To achieve the
objective of maintaining a competitive and diversified industrial base, which
could in turn contribute to the smart, sustainable and inclusive growth target
set by the Europe 2020 strategy, the EU has to ensure that firms find the
appropriate business environment they need to grow and innovate, to carry out
their activities or to change their business models and strategies. This
forward-looking strategy requires that access to finance is improved for all
types of companies in the value chain, with a view to adequately addressing
their needs and projects.

Globalisation trends put pressure on Europe
as a location for doing business, not only directly but also through a lack of
important suppliers or raw materials. From an industrial competitiveness
perspective, state aid policy contributes to addressing this challenge by
recognising that a strong competitive market structure in Europe is an
objective of common interest. In general, and as explained above, effective
access to finance must be ensured in a continuous way. State aid often
contributes to improving such access to finance, in particular when the market
does not provide sufficient alternative means of finance, for example through
venture capital funds. Moreover, access to finance can be relevant for specific
activities, such as R&D&I, where market failures exist. In this field,
there is a need to consolidate the Single Market, which forms the base camp for
European companies, in order to decrease the innovation divide between poor and
developed regions. In fact, in a context of rigid fiscal constraints in several
Member States, it is important to improve the use of the Structural Funds for
innovation priorities. The experience gained within the current programming
period should usefully guide any initiative to improve the status quo.

Moreover, difficulties in access to finance
could hamper the development of projects in technologies where Europe is leader
or intends to invest to become one, such as KETs, referred to in the Industrial
Competitiveness Communication. In addition, lack of financial resources could
prevent exploration and development of the unused innovation potential in
services, essential to address the many societal challenges faced by the EU. In
both cases, well-targeted state support can compensate for financial markets
that have turned overly risk-adverse.

6.5.2.3.
Support for early adjustment processes and
restructuring of European enterprises

While companies and sectors know best their
needs for restructuring and are in principle responsible for these processes,
wherever necessary and appropriate state aid could usefully support such
processes in various ways. As mentioned in section 6.4.4, all companies at
almost all stages of their business life constantly adjust their business
strategies: some may already find themselves in structural difficulties,
whereas others are in a stable situation but in transitional adjustment.

Independently of any difficulties, such
companies may need, at one point in time, state support in order to accompany
the transition or to address their structural problems and ensure and/or
restore long-term viability, as the biggest problem for firms undergoing
restructuring is access to finance.

One of the main challenges encountered by
European firms is the simultaneous expansion of their potential markets and the
emergence of global competitors covering increasingly larger parts of the value
chain. This double trend puts pressure on European firms, which have to
modernise, innovate and access new markets at the same time. The main challenge
for many of them is size; hence, it could be beneficial to further explore the
potential for cross-border cooperation between firms, research centres, and Member
States, for example in relation to KETs.

European state aid policy can indirectly
contribute, within its own logic, to the promotion of such cross-border
initiatives. For instance in the field of R&D&I, the current rules
already encourage cooperation beyond national frontiers through a higher aid
intensity applicable to cross-border projects. This possibility has so far not
been much used by Member States, since it is still culturally and politically
difficult for national authorities to fund the costs of a project which is not
entirely located within their territory. However, in the face of increased
global competition, trans-border cooperation between firms has to be understood
as a necessity not only for the success of a project but for pursuing the strategic
European interest as a whole, including the interests of the territories of the
Member States granting the aid. In this respect, it may also be noted that the state
aid notion of a ‘project of common European interest’, provided for by Article
107(3)(b) TFEU and the 2006 Framework on State Aids to R&D&I, has so
far rarely been used by Member States.

6.6.
Conclusions

The last decade has witnessed the emergence
of trends that will permanently transform the arena in which European industry
operates. Within the EU, enlargement has unleashed a socioeconomic dynamic that
provides firms with new opportunities and a strong base camp, but the Single
Market is as yet unfinished. Outside the EU, globalisation has greatly widened
potential markets, but also intensified competition and resulted in the
emergence of major new players on a global scale, not all of which play by the
market economy rule book. The economic and financial crisis has resulted in
fiscal constraints that reduce leverage at Member State level. As discussed in
detail above, these challenges necessitate the stepping up of efforts to enhance
the competitiveness of European industry, which in turn requires a strategic
European response that bundles resources from lower levels of decision-making.

This chapter started by enquiring how the
relationship between the EU’s set of competitiveness-related policies
(exemplified by but not confined to the EU’s industrial and competition
policies, considered to be complementary in the 2002 Competitiveness Report) could
be further improved in the light of ‘new challenges that emerge at an
accelerating rate: new markets, new ways of doing business, new drivers of
growth and of dynamic competition.’[146]
The response is clear: more than ever, the global nature of the main challenges
requires full use and, where possible and appropriate, better integration of
individual policies and a streamlining of concepts and existing instruments.
The great questions Europe faces today necessitate a horizontal approach that
applies consistent policy tools to specific questions. The preceding analysis
has provided examples for such an approach, but the list is not complete and
grows by the day.

Much of what can and should be done does
not require a radical overhaul of the rules that govern the system. Instead, it
calls for a pro-active approach that uses unexploited potential within the
existing framework and only extends it where demonstrably necessary.
Implementing a European strategy is a question of will, not ability. The tools
are in place, as are the drivers, which beyond the political players consist of
the most important facet of competitiveness: European firms, which in many
fields are global leaders and benchmarks for excellence. A closer alignment
between the real needs of enterprises at global level and the practical will to
offer solutions at short notice is the main deliverable all competitiveness
policies have to provide. This is precisely what a symbiosis of industrial
dynamism, competition policy rigour and the global reach of trade policy can
deliver.

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7.
Sectoral Competitiveness indicators

Explanatory notes

Geographical coverage: all indicators in
tables 7.1 to 7.8 refer to EU-27. The indicators in tables 7.9 and 7.10 refer
to the individual Member States, EU-27, the US, Japan, Brazil, China, India and
Russia.

Production index[147]: The production index is an
index of final production in volume terms.

Labour productivity: this indicator is
calculated by combining the indexes of production and number of persons
employed or number of hours worked[148].
Therefore, this indicator measures final production per person of final
production per hour worked.

Unit Labour Cost: it is calculated from the
production index and the index of wages and salaries and measures labour cost
per unit of production. “Wages and salaries” is defined (Eurostat) as “the
total remuneration, in cash or in kind, payable to all persons counted on the
payroll (including homeworkers), in return for work done during the accounting
period, regardless of whether it is paid on the basis of working time, output
or piecework and whether it is paid regularly wages and salaries do not include
social contributions payable by the employer”.

Relative Trade Balance: it is calculated,
for sector “i”, as (Xi-Mi)/(Xi+Mi), where Xi and Mi are EU-27 exports and
imports of products of sector “i” to and from the rest of the World.

Revealed Comparative Advantage (RCA):

The RCA indicator for product “i” is
defined as follows:

where: X=value of exports; the reference
group (‘W’) is the EU-25 plus 38 other countries (see list below); the source
used is the UN COMTRADE database. In the calculation of RCA, XEU stands for exports to the
rest of the world (excluding intra-EU trade) and XW measures exports to the rest of the world by the countries in the
reference group. The latter consists of the EU-25 plus the following countries:
Afghanistan, Albania, Algeria, Angola, Argentina, Armenia, Australia, Azerbaijan,
Bahamas, Bahrain, Bangladesh, Belarus, Belize, Benin, Bhutan, Bolivia, Bosnia
Herzegovina, Botswana, Brazil, Brunei, Burkina Faso, Burundi, Cambodia, Cameroon,
Canada, Cape Verde, Central African Rep., Chad, Chile, China, China, Hong Kong
SAR, China, Macao SAR, Colombia, Comoros, Congo, Costa Rica, Côte d'Ivoire, Croatia,
Cuba, Dem. People's Rep. of Korea, Dem. Rep. of the Congo, Djibouti, Dominican
Rep., Ecuador, Egypt, El Salvador, Equatorial Guinea, Eritrea, Ethiopia, Gabon,
Gambia, Georgia, Ghana, Guatemala, Guinea, Guinea-Bissau, Haiti, Honduras, Iceland,
India, Indonesia, Iran, Iraq, Israel, Jamaica, Japan, Jordan, Kazakhstan, Kenya,
Kuwait, Kyrgyzstan, Lao People's Dem. Rep., Lebanon, Lesotho, Liberia, Libya, Madagascar,
Malawi, Malaysia, Maldives, Mali, Mauritania, Mauritius, Mexico, Mongolia, Montenegro,
Morocco, Mozambique, Myanmar, Namibia, Nepal, Neth. Antilles, New Zealand, Nicaragua,
Niger, Nigeria, Norway, Occ. Palestinian Terr., Oman, Pakistan, Panama, Paraguay,
Peru, Philippines, Qatar, Rep. of Korea, Rep. of Moldova, Russian Federation, Rwanda,
Saudi Arabia, Senegal, Serbia, Sierra Leone, Singapore, Somalia,, South Africa,
Sri Lanka, Sudan, Suriname, Swaziland, Switzerland, Syria, Tajikistan, TFYR of
Macedonia, Thailand, Timor-Leste, Togo, Trinidad and Tobago, Tunisia, Turkey, Uganda,
Ukraine, United Arab Emirates, United Rep. of Tanzania, Uruguay, USA, Uzbekistan,
Venezuela, Viet Nam, Yemen, Zambia, Zimbabwe.

For services, countries consist of EU-25
plus the following 75 countries: Albania, Algeria, Argentina, Armenia, Aruba, Australia,
Azerbaijan, Bangladesh, Belarus, Bermuda, Bolivia, Bosnia & Herzegovina, Botswana,
Brazil, Cambodia, Canada, Cape Verde, Chile, China,P.R.: Mainland, China,P.R.:Hong
Kong, China,P.R.:Macao, Costa Rica, Croatia, Egypt, El Salvador, Ethiopia, The
Gambia, Georgia, Guatemala, Guinea, Honduras, Iceland, India, Indonesia, Israel,
Japan, Kazakhstan, Kenya, Republic of Korea, Kuwait, Kyrgyz Republic, Macedonia,
Malaysia, Mauritius, Mexico, Moldova, Montenegro, Morocco, Mozambique, Namibia,
New Caledonia, New Zealand, Norway, Pakistan, Panama, Paraguay, Peru, Philippines,
Russian Federation, Saudi Arabia, Republic of Serbia,  Seychelles, Singapore, South
Africa, Sri Lanka Switzerland, Tanzania, Thailand, Tunisia, Turkey, Uganda, Ukraine,
United States, Uruguay, Zambia.

Data sources: Tables 7.1 to 7.6 are based
on Eurostat’s indicators. Tables 7.7 to 7.9 are based on United Nations’
COMTRADE. Table 7.10 is based on IMF, OECD and Eurostat data.

Table 7.9:  RCA in manufacturing
industries in 2009: EU countries, US, Japan and Brazil, China, India and
Russia.

ANNEX

List of background studies

to the European Competitiveness
Report 2011

Some parts of the European Competitiveness
Report 2011 are based on, or use, material prepared by a consortium led by
WIFO, the Austrian institute for economic Research:

Chapter 1 – “Crisis, recovery and the role of
innovation" was written by Jorge Durán and benefitted from research
assistance by Giorgos Alaveras and from contributions by Mats Marcusson.
Comments and suggestions are acknowledged to João Libório, Maya Jollès and Ágnes
Magai. Statistical assistance is acknowledged to Luigi Cipriani.

Chapter 2 – “Convergence
of knowledge intensive sectors and the EU’s external competitiveness” was
coordinated by Mats Marcusson and is based on the background study “Convergence
of knowledge intensive sectors and the EU’s external competitiveness” by Sabine Biege (2), Martin Borowiecki (1), Bernhard Dachs (1), Joseph
Francois (4), Doris Hanzl (4), Johan Hauknes (3), Angela Jäger (2), Mark Knell (3), Gunther Lay (2), Olga Pindyuk (4), Doris Schartinger (1) and Robert Stehrer (4).

(1) AIT, Austrian Institute of Technology.

(2) ISI, Fraunhofer Institute for Systems and Innovation Research.

(3)NIFU STEP, Norwegian Institute for Studies in Innovation, Research
and Education.

(4) wiiw, Vienna Institute for International Economic Studies.

Chapter 3 – “European Competitiveness in Space Manufacturing and Operations”
is based on the background study "Competitiveness of the European Space
sector" by Robert Piers,
Dick Mans, Konstantina Laparidou, Koen Berden, Afke Mulder, Jurgen Vermeulen
and Sophie Willems (Ecorys Rotterdam).

Chapter 4 – “Access to non-energy raw
materials and the competitiveness of EU industry” was coordinated by Ágnes
Magai and is based on the background study “Access to non-energy industrial raw
materials and the competitiveness of EU industry" by Valentijn Bilsen,
Sjouke Beemsterboer, Ruslan Lukach, Elissavet Lykogianni, Pieter Staelens,
Miriam Van Hoed, Jan Wynen (all from IDEA Consult) and Andreas
Unterstaller (Ecorys Brussels)

Chapter 5 – “EU Industry in a Sustainable Growth Context” was coordinated by
João Libório and is based on the background study "EU Industry in a
Sustainable Growth Context” by Koen Rademaekers, Koen Berden, Jan Maarten de
Vet, Matthew Smith, Jeron Van de Laan, Afke Mulder (all from ECORYS) and
Elissavet Lykogianni and Miriam Van Hoed (both from IDEA Consult).

Chapter 6 – “EU Industrial Policy and Global Competition: Recent Lessons and Way
Forward” was coordinated by Joachim Schwerin and co-drafted by Adriana Czechowska,
Torsten Frey, Joachim Schwerin, Edouard Simon, Kamila Skowyra and Marie-Laure
Wyss (all from DG ENTR, Unit B2). The chapter has substantially
benefited from comments and suggestions from Chris Allen, Petar Angelov,
Manfred Bergmann, Maya Jollès, João Libório and Konstantin Pashev.

[1]               In the Report, the term of "raw materials"
is understood as non-energy, non-agricultural raw materials used for industrial
and manufacturing purposes and that are not primarily used to generate energy.
For a more detailed definition of raw materials discussed in this chapter, see
section 4.1.3.

[2]               See European Commission
(2008a), e.g. Angerer G. et al. (2009), and Öko-Institut e.V., (2009).

[3]               For example, trade in base metals increased by 21.6 %
yearly on the global market over the period 2004-2008.

[4]               However this should not be taken too far since in
2005 for instance China had import dependency rates ranging from 70-100 % for 
cobalt, copper, manganese, nickel, and titanium, see Hveem (2010). The European
Commission (2009) also pointed out that countries generally considered
resource-rich (like China, Canada, Russia, India, or Australia) can be
dependent on imports of some raw materials.

[5]               See for example Fraunhofer ISI, IZT (2009).

[6]               European Commission (2008a).

[7]               European Commission (2010a and 2010b). These
materials are antimony, beryllium, cobalt, fluorspar, gallium, germanium,
graphite, indium, magnesium, niobium, platinum, rare earths, tantalum, and
tungsten.

[8]               European Commission (2011a).

[9]               European Commission (2011b).

[10]             Council of the European Union (2011).

[11]             European Commission (2010c).

[12]       Although raw
materials are commonly associated with minerals and metals, in particular the
list of 14 critical raw materials identified by the Commission, the concept
used in this chapter is wider. Although the latter two are typically used for energy
production, they are the main raw materials in the chemical industry. Wood is
considered as ‘forestry materials’.

[13]          See European Commission (2010a).

[14]          OECD (2010b).

[15]          See Goldman Sachs (2008).

[16]          See for example OECD (2010b), European Commission (2011a).

[17]          J.P. Morgan (2010).

[18]          OECD (2010a).

[19]          UNCTAD (2007), p. 83.

[20]          J.P. Morgan (2010).

[21]          A good example is platinum: global recovery from car
catalysts has risen by more than 10 % every year since 2006, with 39 % of this
secondary platinum produced in Europe in 2009.

[22]          The significant increase in copper imports during this
period can be partly explained by the boom in the construction sector, which is
the largest user of copper in Europe. The substantial decrease in iron ore
imports can be linked to the falling demand for raw materials in the
manufacturing industry, especially in the automotive sector, during the crisis.

[23]          Rare earth elements are a collection of 17 chemically
similar metallic elements. The term ‘rare earth’ is a misnomer arising from the
rarity of the minerals from which they were originally isolated.

[24]          However, it should be noted that these intra-EU-27 imports
may be re-exports from EU countries. The recorded exports of Germany and the UK
of these materials are also re-exports.

[25]          For example: the setting of targets for recycling,
landfill taxes and restrictions etc.

[26]          For recycling rates for metals, various recycling metrics
and current estimates on global end-of-life recycling rates, recycled content,
and old scrap ratios, see UNEP (2011).

[27]          For the list of interviewed persons see References.

[28]          Since no input-output table is available for the whole of
the EU-27 (or even part of it) the results for the largest industrialised
economy are presented.

[29]         According to WTO, export
restrictions are "a border measure that takes the form of a government law
or regulation which expressly limits the quantity of exports or places explicit
conditions on the circumstances under which exports are permitted, or that
takes the form of a government-imposed fee or tax on exports of the products
calculated to limit the quantity of exports."

[30]          OECD (2010a).

[31]             Iron ore is the main input for steel industry. Other
important raw materials used in steel production are coal, coke.

[32]             Rio Tinto, BHP and Vale.

[33]             Oxford Analytica (2011).

[34]             Russia has benefited from material cost advantages from
all fronts, due to abundance of iron ore, coal/coke, scrap and energy.
(SteelConsult International (2005)).

[35]             European
Confederation of Iron and Steel Industries http://www.eurofer.org/index.php/eng/Issues-Positions/Transport,
accessed on 14.07.2011.

[36]          AT Kearney (2010).

[37]          Non-ferrous metals cover common metals (mainly aluminium,
copper, zinc, lead, nickel and tin) and precious metals (gold, silver,
platinum, and palladium) and minor metals (e.g. tungsten, tantalum, cobalt, and
germanium).

[38]          Ecorys (2011a).

[39]          European Commission (2008a).

[40]          OECD (2010d).

[41]          European Commission (2007a).

[42]          KPMG (2011).

[43]          Cefic (The European Chemical Industry Council) http://www.cefic.org/Policy-Centre/Industry-Policy/Access-to-Raw-Materials/,
accessed on 05.07.2011.

[44]          Mantau U. et al. (2008).

[45]             European Commission (2010a) p.52.

[46]             European Commission (2010a).

[47]             Ecorys (2011b).

[48]             UNCTAD (2007).

[49]             Ecorys (2008).

[50]             According to the National Bureau of Statistics of
China, at the end of 2008 Chinese outward FDI in the mining sector (including
other than iron ore mining as well) accounted for 12% of its total overseas FDI
stock.

[51]             ZEW (2011a).

[52]             ELV Directive 2000/53/EC, for an assessment of the ELV
Directive see Chapter 5, Box 4.4.

[53]             Directive
2005/64/EC on the type-approval of motor vehicles with regard to
their reusability, recyclability and recoverability and amending Council
Directive 70/156/EEC.

[54]             The automotive industry is a prime sector in driving
new technological developments. Because of its high R&D expenses, this
industry is determining the directions of research in several area’s’, see
Fraunhofer ISI (2003).

[55]             Ecorys (2011b).

[56]             McKinsey&Company (2004).

[57]             In Germany, for example, raw material intensity in the
chemical industry decreased by 26% between 1994 and 2007, and a target was set
to reduce it by a further 32% by 2020.

[58]             Plant, animal and microbial biomass which are based on
the photosynthetic primary production and are used by man outside the food and
feed area for material or energy consumption. These include materials such as
plant oils, animal fats, sugar, cellulose fibres, wood etc. (ETC/SCP 2010).

[59]             ETC/SCP (2010).

[60]             For instance, the FP7 NMP Work programme 2012 provides
sources for research on production of fine chemicals from CO2
directly or indirectly.

[61]             For instance, due to current high import duties on
bio-ethanol, the chemical industry finds it less expensive to produce
bio-ethanol based chemical products outside Europe (e.g. Brazil) and export
them to Europe with lower import duties due to the tariff harmonization
agreement concluded in the Uruguay Round, even though bio-ethanol is the most
important production cost factor.

[62]             Recovered Paper Council (2011).

[63]          See e.g.: http://ec.europa.eu/enterprise/sectors/metals-minerals/non-energy-extractive-industries/index\_en.htm.

[64]          IDEA Consult (2011): Background report on the "Access
to non-energy raw materials and the competitiveness of EU industry".

[65]             European Commission (2010a).

[66]             European Commission (2007b).

[67]             GMES: Global Monitoring for Environment and Security,
the EU’s earth observation programme.

[68]             European Commission (2011).

[69]             University of Leoben (2004).

[70]             IDEA Consult (2011).

[71]             However, not all upstream industries have a high
recycling potential. The mining and extraction industry is situated at the very
top of the value chain, which is precisely why the concept of recycling does
not really apply in these industries. Recycling requires the presence of
certain processing capabilities, which the extraction industry does not have.

[72]             EU-27 less Bulgaria and Romania, as EU KLEMS data were
unfortunately unavailable for these countries – the use of EU-25 from this
point forward refers to this definition.

[73]          GVA has been indexed to 1995 constant prices using
industry and member state specific price deflators, also contained in the EU
KLEMS dataset – this process has been used for all GVA and intensity
calculations to present the real economic changes as far as possible.

[74]             This figure should be interpreted
as follows: a high GVA growth in combination with low
or negative growth  in energy use can be considered efficient. Hence, further
to the left along the horizontal axis and further up  along the vertical axis
is better in various terms. The 45 degree line marks the no change in energy
intensity locus. The vertical distance from a given point to the 45 degree line
gives an approximation to the percentage  change in energy intensity (the exact
percentage change is equal to this distance/ (1 + % change in GVA)).

[75]             EU-27 – minus BG, RO, CY and
MT, due to incomplete datasets.

[76]             EU-12 – minus BG, RO, CY and MT, due to incomplete
datasets.

[77]             See references for the list of interviews conducted.

[78]             The NACE rev 1.1. sector scope of both GHG emissions
and FEC is not clearly defined, particularly in respect of FEC-related construction
emissions.

[79]             The data are compiled on a NACE rev. 2 sectoral basis,
which is not directly comparable with other data, such as GVA data from EU
KLEMS, compiled on a NACE rev. 1.1 basis.

[80]             This is for NACE rev.2
categories A to F. While the category headers are
similar to NACE rev.1.1, there are differences in their composition. Focusing
solely on industrial sectors A to F covers 93 to 94% of waste generated across
all NACE categories and 83.8% to 86.3% of all NACE category and household waste
generated in this period across the whole EU27.

[81]             GVA data are not yet available for 2008.

[82]             These years were selected as they were the years when
most Member States reported EPE data. They were chosen to maximise coverage and
relevance.

[83]             For a more detailed account of
these policy instruments see the background report to this study (ECORYS, 2011a).

[84]          The EU ETS is the prime example of
this type of instrument in the EU. The performance of the ETS has been mixed
and has illustrated both the pros and cons of a trading permit scheme. It has
been successful in bringing the largest emitters of GHG into a compliance and
reduction scheme, creating a viable market for permits and contributing to
overall emission reductions. Yet the costs to firms of participating, i.e. the
transaction costs, have been high, as they have learned to adapt to the market.
This is a big barrier to introducing permit trading schemes that will have an
impact on SMEs and large numbers of operators. There has also been contention
about the over-allocation and free allocation of permits, creating both a weak
cap and a weak market price and handing free income to polluters, a perverse
incentive. To reap the full efficiency benefits of a permit trading system, it
is essential to move towards a larger share of permits auctioned. With the ETS
phase 2 and plans for phase 3 moving in this direction, this should become less
of an issue.

[85]             European Commission (2002), 2002 European
Competitiveness Report, Commission Staff Working Paper, SEC(2002) 528, p.
93.

[86]             Cf. European Commission (2002), 2002 European
Competitiveness Report, Commission Staff Working Paper, SEC(2002) 528.

[87]             European Commission (2009), Five years of an
enlarged EU – Economic achievements and challenges, Communication from the
Commission, COM(2009) 79, p. 2.

[88]             European Commission (2010), An Integrated Industrial
Policy for the Globalisation Era Putting Competitiveness and Sustainability at
Centre Stage, Communication from the Commission, COM(2010) 614.

[89]             European Commission (2010), Towards a Single Market
Act, For a highly competitive social market economy, 50 proposals for improving
our work, business and exchanges with one another, Communication from the
Commission, COM(2010) 608.

[90]             Brazil, Russia, India and China.

[91]             All data are from UNCTADstat. The period is 2000 to
2009; the GDP share in constant prices/exchange rates (2000). The term ‘world
trade’ combines imports and exports.

[92]             The BRIC countries are expected to account for 60 %
of world GDP by 2030 (EIM study on internationalisation of SMEs).

[93]             European Commission (2011), Review of the ‘Small Business
Act’ for Europe, Communication from the Commission, COM(2011) 78.

[94]             Notably China has recently moved into the manufacturing
of high-tech goods as well. India is particular strong in services such as IT
or customer care.

[95]             UNCTADstat.

[96]             European Commission (2011), Tackling the Challenges
in Commodity Markets and on Raw Materials, Communication from the
Commission, COM(2011) 25.

[97]             Cf. European Commission (2010), An Integrated
Industrial Policy for the Globalisation Era Putting Competitiveness and Sustainability
at Centre Stage, Communication from the Commission, COM(2010) 614; and
European Commission (2010), European Competitiveness Report 2010, Commission
Staff Working Document SEC(2010) 1276, Accompanying Document to the
Communication from the Commission, An Integrated Industrial Policy for the
Globalisation Era Putting Competitiveness and Sustainability at Centre Stage,
COM(2010) 614.

[98]             European Commission (2010), European Competitiveness
Report 2010, Commission Staff Working Document SEC(2010) 1276, Accompanying
Document to the Communication from the Commission, An Integrated
Industrial Policy for the Globalisation Era Putting Competitiveness and
Sustainability at Centre Stage, COM(2010) 614, p. 81; data are
available for the period 1999 to 2008.

[99]             Figure for 2008; source: WTO International Trade
Statistics 2009.

[100]            European Commission (2010), An Integrated Industrial
Policy for the Globalisation Era Putting Competitiveness and Sustainability at
Centre Stage, Communication from the Commission, COM(2010) 614.

[101]            European Commission (2010), EUROPE 2020, A strategy
for smart, sustainable and inclusive growth, Communication from the
Commission, COM(2010) 2020 p. 21; European Commission (2011), Review of
the ‘Small Business Act’ for Europe, Communication from the Commission,
COM(2011) 78, p. 14.

[102]            European Commission (2011), Trade and Investment
Barriers Report 2011, Engaging our strategic economic partners on improved
market access: Priorities for action on breaking down barriers to trade, Communication
from the Commission, COM(2011) 114.

[103]            The EU maintains for example 30 ‘Market Access Teams’ in
its key export markets and also provides help for European companies that face
IPR problems in China.

[104]            Posen, A., Véron, N., (2009), A Solution for Europe’s
Banking Problem, Bruegel Policy Brief 2009/03. It also had an indirect
impact on the valuation of the European corporate landscape, with banks
representing 24 % of the aggregate market value of European listed
companies among the world’s 500 largest in mid-2007 and only 12 % in March
2009.

[105]            European Commission (2009), Economic Crisis in
Europe: Causes, Consequences and Responses, European Economy 2009-7, DG
Economic and Financial Affairs.

[106]            European Commission (2010) Monthly Note on Economic
Recovery in Manufacturing, Construction and Services Industries, March 2010, DG
Enterprise & Industry.

[107]            European Commission (2010), An Integrated Industrial
Policy for the Globalisation Era Putting Competitiveness and Sustainability at
Centre Stage, Communication from the Commission, COM(2010) 614, point 3.2.

[108]            European Commission (2010), Towards a Single Market
Act, For a highly competitive social market economy, 50 proposals for improving
our work, business and exchanges with one another, Communication from the
Commission, COM(2010) 608, point 1.4.

[109]            Treaty of Lisbon amending the Treaty on European Union
and the Treaty establishing the European Community, signed at Lisbon, 13
December 2007, Official Journal C 306 of 17 December 2007.

[110]            Article 151 TFEU on social policy, Article 189 TFEU on
space policy and Article 195 TFEU on tourism, cf. the consolidated versions of
the Treaty on European Union and the Treaty on the Functioning of the European
Union, Official Journal C 83 of 30.03.2010.

[111]            Cf. also European Commission (2002), 2002 European
Competitiveness Report, Commission Staff Working Paper, SEC(2002) 528, p.
82.

[112]         European Commission (2010), Member States
competitiveness performance and policies, Commission Staff Working Document
SEC(2010) 1272, Accompanying Document to the Communication from
the Commission, An Integrated Industrial Policy for the Globalisation Era
Putting Competitiveness and Sustainability at Centre Stage, COM(2010) 614.

[113]         Priollaud,
F-X., Siritzky, D., (2010) Le Traité de Lisbonne: commentaire, article par article,
des nouveaux traits européens (TUE-TFUE), Paris, Documentation française,
p. 284.

[114]         Council of the European Union (2010), Council
conclusions on the need for a new industrial policy, 2999th Competitiveness
Council meeting, Brussels, 1 March 2010, point 9.

[115]         De Gucht, K., The implications of the Lisbon Treaty for
EU Trade policy, S&D seminar on EU Trade Policy, Oporto, 8 October
2010.

[116]         As opposed to vertical policies that target specific
sectors.

[117]            European Commission (2002), Industrial Policy in an
Enlarged Europe, Communication from the Commission, COM(2002) 714.

[118]            European Commission (2003), Some Key Issues in
Europe’s Competitiveness — Towards an Integrated Approach, Communication
from the Commission, COM(2003) 704.

[119]            European Commission (2004), Fostering structural
change: an industrial policy for an enlarged Europe, Communication from the
Commission, COM(2004) 274.

[120]            European Commission (2005), Common Actions for Growth
and Employment: The Community Lisbon Programme, Communication from the Commission,
COM(2005) 330.

[121]            European Commission (2010), An Integrated Industrial
Policy for the Globalisation Era Putting Competitiveness and Sustainability at
Centre Stage, Communication from the Commission, COM(2010) 614.

[122]            European Commission (2010), Member States
competitiveness performance and policies — 2010 edition, Commission Staff
Working Document, SEC(2010) 1272.

[123]            European Commission (2011), Trade and Investment
Barriers Report 2011, Report from the Commission to the European Council,
COM(2011) 114.

[124]            European Commission (2011), Tackling the challenges
in commodities markets and on raw materials, Communication from the
Commission, COM(2011) 25.

[125]            Council Regulation (EC) No 597/2009, of 11 June 2009 on
protection against subsidised imports from countries not members of the
European Community.

[126]            European Commission (2010), An Integrated Industrial
Policy for the Globalisation Era Putting Competitiveness and Sustainability at
Centre Stage, Communication from the Commission, COM(2010) 614.

[127]            Cf. Bertoncini and de Beaufort (2009).

[128]            As such, the concept obviously includes not only
existing and fully active firms but new entrants.

[129]            See Box 1 in Chapter 1 of this report.

[130]            European Commission (2011), Tackling the Challenges
in Commodity Markets and on Raw Materials, Communication from the
Commission, COM(2011) 25.

[131]         European Commission (2010), An Integrated Industrial
Policy for the Globalisation Era Putting Competitiveness and Sustainability at
Centre Stage, Communication from the Commission, COM(2010) 614.

[132]         Innovation Union Scoreboard 2010: The Innovation Union’s
performance scoreboard for Research and Innovation (2011), ProInno Europe
Report.

[133]         European Commission (2010), Europe 2020 Flagship
Initiative Innovation Union, Communication from the Commission, COM(2010)
546.

[134]         Reference to 2009 COM.

[135]         European Commission (2010), Towards a Single Market Act,
For a highly competitive social market economy, 50 proposals for improving our
work, business and exchanges with one another, Communication from the
Commission, COM(2010) 608.

[136]         European Commission (2007), Global Europe, A stronger
Partnership to Deliver Market Access for European Exporters, Communication
from the Commission, COM(2007) 183.

[137]         Accordingly, the Agreement on Government Procurement (GPA),
for instance, contains specific reciprocity clauses.
http://www.wto.org/english/docs\_e/legal\_e/gpr-94\_e.pdf.

[138]         ‘An integrated Industrial Policy for the globalisation era
putting competitiveness and sustainability at Centre Stage’.

[139]         The most important are the revised Merger Regulation No
139/2004 of 20 January 2004, the Horizontal Merger Guidelines (OJ 2004/C 31/03)
of 05 February 2004, and the Non-Horizontal Merger Guidelines (OJ 2008/C
265/07) of 18 October 2008.

[140]         Figures are for the period between January 2005 to March
2011 (referrals to the Commission or to the Member States explain the
difference in figures).

[141]         Speech by Vice-President Almunia on 28 September 2010 on
‘The past and the future of merger control in the EU’:         
http://europa.eu/rapid/pressReleasesAction.do?reference=SPEECH/10/486&format=HTML&aged=1&language=EN&guiLanguage=en;               
further examples include Lufthansa/SN Brussels Airlines, Lufthansa/Austrian
Airlines, Air France/KLM, EDF/British Energy and Carrefour/Promodès.

[142]         Mario Monti, A New Strategy for the Single Market,
Report to the President of the European Commission, 09 May 2010.

[143]         The core of substantive EU merger secondary law/guidance
dates from 2004 and 2008. An (albeit important) exception is the Market
Definition Notice (OJ 97/C 372/03), which has not been revised since 1997.

[144]         Global sourcing also presents the problem of how to take
into account indirect sales in cartel cases.

[145]         E.g. Ping Deng (2009): ‘Why do Chinese firms tend to
acquire strategic assets in international expansion?’, Journal of World
Business 44 (2009) 74–84.

[146]         European Commission (2002), p. 93.

[147]         The data are working-day adjusted for production.

[148]         The data are working-day adjusted for hours worked.

TABLE OF CONTENTS

Foreword. 9

EXECUTIVE SUMMARY.. 11

1........... Crisis,
recovery and the role of innovation. 26

1.1........ Recovery
of output 26

1.2........ The
boom period in the labour market 31

1.3........ Borrowing,
lending and the exit from the recession. 35

1.4........ Restructuring
versus conjunctural downturn. 37

1.5........ The
role of innovation in the recovery. 41

1.6........ Overview
of R&D in Europe. 43

1.7........ Sectoral
dimension of innovation. 46

1.8........ The
returns to R&D and policy considerations. 49

2........... Convergence
of knowledge intensive sectors and the EU’s external competitiveness. 56

2.1........ Introduction. 56

2.2........ The
rising importance of service sectors in the economy. A comparison of the EU
with the US and Japan  57

2.2.1..... Introduction. 57

2.2.2..... KIBS
services and classification. 57

2.2.3..... KIBS
contributions to growth. 59

2.2.4..... The
role of KIBS as an intermediate input in the EU, US and Japan. 61

2.3........ Embodied
and sectoral linkages between Manufacturing and the Knowledge-intensive
services  64

2.3.1..... Introduction. 64

2.3.2..... Inter-industry
technology flows. 64

2.3.3..... Backward
and forward linkages between manufacturing and KIBS. 67

2.4........ Services
as output of manufacturing. 72

2.4.1..... Introduction. 72

2.4.2..... Why
do manufacturing firms offer services?. 72

2.4.3..... Macroeconomic
evidence. 73

2.4.4..... Which
manufacturing firms offer services?. 76

2.5........ European's
position in trade in goods and services and EU’s external competitiveness. 82

2.5.1..... Introduction. 82

2.5.2..... Trends
in KIBS trade. 82

2.5.3..... Patterns
of specialisation. 86

2.5.4..... KIBS
intensity of production and trade. 88

2.5.5..... Conclusions. 90

3........... European
Competitiveness in Space Manufacturing and Operation. 101

3.1........ Introduction. 101

3.1.1..... Recent
developments reflecting the new Treaty provisions. 101

3.1.2..... Interaction
with other EU policies. 102

3.1.3..... Defining
the EU space sector: space manufacturing and operations. 102

3.2........ Characteristics
of the EU space sector 103

3.2.1..... Turnover 103

3.2.2..... Profitability. 104

3.2.3..... Employment 105

3.2.4..... Turnover
per employee as proxy for labour productivity. 106

3.3........ Policy
and regulatory environment of the EU space sector and framework conditions. 107

3.3.1..... Policies. 107

3.3.2..... Regulatory
conditions. 108

3.3.3..... Framework
conditions. 109

3.4........ Results
of the analysis. 109

3.4.1..... Largely
institutional customer base. 109

3.4.2..... High
degree of concentration. 111

3.4.3..... Strong
EU research effort but modest by international standards. 111

3.4.3.1.. Research, development and innovation. 111

3.4.3.2.. Technology development and non-dependence. 113

3.4.3.3.. Patents. 114

3.4.4..... Trade
balance of the EU space sector 115

3.4.5..... The
EU space sector benchmarked against its US competitor 117

3.4.6..... The
EU space sector benchmarked against the aeronautics and defence sectors. 120

3.4.7..... Strengths
and weaknesses of the EU space sector 121

3.5........ Conclusions
and policy implications. 123

3.5.1..... Conclusions. 123

3.5.2..... Framework
conditions and regulatory environment 124

3.5.3..... Policy
implications. 125

LIST
OF FIGURES

Figure 1.1: The
recession as a correction: The housing boom and the contraction in employment 27

Figure 1.2: Real GDP in 2010Q3 with peak and trough value
(2000 = 100) 28

Figure 1.3: Unemployment rate in 2010Q3 with minimum and
maximum value before and during the recession  33

Figure 1.4: Germany and Spain compared: Employment in the
construction sector in persons and in percentage of total employment 35

Figure 1.5: Net lending (+) / net borrowing (-) for
selected EU Member States. 36

Figure 1.6: Real GDP in EU-27 and selected economies
(2007 = 100) 37

Figure 1.7: Cyclical intensity and the drop during the
downturn in the EU-27. 39

Figure 1.8: Real growth rates for R&D and GDP, OECD
area, 1982-2007. 43

Figure 1.9: R&D intensity (R&D expenditures over
value added) of the manufacturing sector, year 2005  44

Figure 1.10: R&D intensity in US states and EU Member
States. 45

Figure 1.11: Economic sectors: R&D intensity and the
weight in total value added 2006. 48

Figure 1.12: The role of sector intensities and sectoral
structure in differences in business R&D intensity (with respect to the EU) 49

Figure 1.13: R&D intensity and specialization. 50

Figure 1.14: RDI, productivity growth and catch-up. 51

Figure 2.1: KIBS shares in total economy (in %), 1995 and
2005. 59

Figure 2.2 - Contributions to growth by country,
1995-2007. 60

Figure 2.3.a: Share of KIBS in total intermediate
consumption. 62

Figure 2.3.b: Share of KIBS in manufacturing intermediate
consumption. 63

Figure 2.3.c: Share of KIBS in high-tech manufacturing
(NACE 30-33)  intermediate consumption. 63

Figure 2.4: Technology intensity relative to total value
added by source, 2005. 65

Figure 2.5: Backward linkage of manufacturing embodied
inputs into KIBS sectors, domestic and imported supply. Ranked by total
linkage, 2005. 68

Figure 2.6: Backward linkage of KIBS embodied inputs into
manufacturing sectors, domestic and total supply. Ranked by total linkage, 2005. 69

Figure 2.7: Forward linkage of manufacturing embodied
inputs into KIBS sectors, domestic and imported supply. Ranked by total
linkage, 2005. 70

Figure 2.8: Forward linkages of KIBS embodied inputs into
manufacturing sectors, domestic and total supply. Ranked by total linkage,
2005. 71

Figure 2.9: Service share of manufacturing output in
various countries, 2005. 74

Figure 2.10: Service share of manufacturing output broken
down according to innovation intensity, 2005  75

Figure 2.11: KIBS and technology-intensive merchandise
exports in 2007, USD bn. 83

Figure 2.12: Average annual growth of exports and imports
of KIBS and technology-intensive manufacturing, 1996-2007, %.. 84

Figure 2.13: Shares of global exports and import in 1997
(%) 86

Figure 2.14: RCAs in KIBS. 87

Figure 2.15: RCAs in technology-intensive goods. 88

Figure 2.16 — KIBS shares of direct costs in
manufacturing, 2007. 89

Figure 3.1: Final sales 2009, EU space sector by segment 104

Figure 3.2: Consolidated final sales of the EU space
manufacturing segments, 2003–2009. 104

Figure 3.3: Direct employment in the EU space sector,
2009. 105

Figure 3.4: Direct employment in EU space manufacturing,
2000–2009. 105

Figure 3.5: Turnover per employee (thousand €) in EU
space manufacturing, 2003–2009. 107

Figure 3.6: EU space manufacturing, final sales by
customer category, 2003–2009. 110

Figure 3.7: ESA budget, 2003–2010 (million €) 112

Figure 3.8: Space patent applications filed at EPO by
country of applicant, 1999–2009. 114

Figure 3.9: Total European exports and imports in value
(million €), 2001–2008. 116

Figure 3.10: Main origins of EU space product imports,
2008 (million €) 117

Figure 3.11: Main destinations for EU space
product exports, 2008 (million €) 117

Figure 3.12: Breakdown of total OECD R&D for space,
2004. 118

Figure 3.13: Space R&D as a share of government
R&D budget in selected OECD countries, 2004. 119

Figure 3.14: Space product exports from selected OECD
countries in 2004 (export value and share of total) 120

LIST
OF TABLES

Table 1.1: An
overview of the recession, real GDP during 2007-10; index, 2000=100. 29

Table 1.2: An overview of the recession, employment
during 2007-10; index, 2000Q2=100(a) 30

An extreme case is Spain, where employment increased by
32 percent from 2000 to its peak in 2007. (This compares with 10 percent in the
EU-27 as a whole). Thus, despite a considerable contraction, Spain ends the
decade 20 percent above its initial level (see Table 1.2). This expansion is
partly explained by large flows of migrants: in the boom period, the proportion
of foreign workers grew from 2 to 14 percent of Spain’s total active workforce. 31

Table 1.3: Decomposing changes in real GDP per head,
2000-08 and 2000-10. 32

Table 1.4:  Recent developments in EU-27 sectors.
Percentage changes in value added. 40

Table 1.5: Trends in productivity and hours worked.
Percentage changes in 1995-2007. 41

Table 1.6: An overview of differences EU-US in R&D.. 47

Table 2.1: Share of KIBS (incl. 71) in total economy (in
%), 1975-2007. 58

Table 2.2: Growth contributions of KIBS, 1975-2007. 59

Table 2.3:
Determinants of the share of services on turnover of manufacturing firms,
results from a Generalized Linear Model 80

Table 2.4: KIBS export and import structure, %.. 85

Table A – 2.3.1 Population of the data set. Distribution
across countries. 99

Table A – 2.3.2. Distribution of population over
industries. 99

Table A – 2.3.3. Distribution of population across
sectoral innovation intensity. 100

Table A – 2.3.4. Distribution of population across firm
sizes. 100

Table A – 2.3.5. Distribution of population across firm
age. 100

Table 3.1: Sales of civilian and military systems to
civilian and military customers 2009. 111

List
of country abbreviations

AT || Austria

BE || Belgium

BG || Bulgaria

CY || Cyprus

CZ || Czech Republic

DE || Germany

DK || Denmark

EE || Estonia

EL || Greece

ES || Spain

FI || Finland

FR || France

HU || Hungary

IE || Ireland

IS || Iceland

IT || Italy

LI || Liechtenstein

LT || Lithuania

LU || Luxembourg

LV || Latvia

MT || Malta

NL || Netherlands

NO || Norway

PL || Poland

PT || Portugal

RO || Romania

SE || Sweden

SI || Slovenia

SK || Slovakia

UK || United Kingdom

Acknowledgements

This report was prepared in the
Directorate-General for Enterprise and Industry under the overall supervision
of Heinz Zourek, Director-General, and Viola Groebner, Director of the
Directorate for Industrial Policy and Economic Analysis.

The publication was developed in the unit ‘Economic
Analysis and Impact Assessment’, under the management of Konstantin Pashev,
Head of Unit, and João Libório, Project Manager.

Specific contributions and coordination of
work on individual chapters were provided by Tomas Brännström, Jorge
Durán-Laguna, Maya Jollès, João Libório, Ágnes Magai and Mats Marcusson. See
page 301 for a list the background studies on which individual chapters are
built.

Comments and suggestions by many colleagues
from the Directorate-General for Enterprise and Industry as well as from other
services of the Commission are gratefully acknowledged.

Statistical support was provided by Luigi
Cipriani and Claudio Schioppa. Dominique Delbar-Lambourg and Patricia
Carbajosa-Dubourdieu provided administrative and organisational support.

Comments on the report would be gratefully
received and should be sent to:

Directorate-General for Enterprise and
Industry

Unit B4 - Economic Analysis and Impact
Assessment

European Commission

B-1049 Brussels (Belgium)

or by e-mail to konstantin.pashev@ec.europa.eu
or joao.liborio@ec.europa.eu

Foreword

This is the 14th edition of the
Commission’s European Competitiveness Report (ECR). The first ECR was published
in 1997, on the basis of the 1994 Industry Council resolution, which called on
the Commission to report annually on the competitiveness of European industry.

As in previous editions, the ECR 2011
analyses a number of topics that are important for the competitiveness of the
EU industry and economy. The analysis is based on economic theory and empirical
research. The aim of the report is to contribute to policymaking by drawing
attention to recent economic trends and developments and by discussing policy implications.

The first chapter presents an overview of the recovery from the recent recession,
changes in GDP in the EU and the Member States, labour productivity and
employment. The analysis shows that the experience of the recession varies
according to how the countries were involved in the build-up of imbalances in
the period 2000-07. It also argues that the competitive sectors that grew in a
balanced way before the crisis will continue to be the leaders during the
recovery. The specific role of R&D and innovation in the process of economic
recovery is analysed, arguing that a strong and sustained recovery growth will
depend on the capacity to create the environment in which firms can thrive, and
where innovations are created and taken to the market.

Chapter 2
analyses knowledge intensive business services (KIBS) and their role as sources
of innovation, technologies and as inputs for manufacturing and the whole
economy. KIBS are defined as computer and related activities, R&D and other
business services. Their importance for the rest of the economy has become
visible as firms increasingly tend to develop new services as part of a product
package that includes physical, tangible goods. This is a prominent feature of
what has been called the "convergence process". The convergence of
manufacturing and services is an opportunity for the European manufacturing
sector to increase its competitiveness and market base. The shares of direct
and indirect KIBS in total exports have increased over time for both the EU-12
and EU-15. Measured directly, KIBS activities account for 4% of EU-12 and 11%
of EU-15 exports and, if measured indirectly, KIBS account for 9% of EU-12 and
18% of EU-15 exports.

Chapter 3
shows that the EU space sector is a world technology
leader in certain segments and enjoys a strong competitive position inter­nationally,
especially in heavy launchers and associated launching services as well as in
satellite communication services. Together with the United States, it is a
major net exporter of space products, and less hampered than its US competitor
by export control rules. The EU space sector is heavily influenced by public
policies, funding and procurement, but the share of commercial customers is
growing. In order to remain competitive the sector needs to secure its supply
of skills and sustain innovation efforts and R&D funding. It should also be
vigilant in the face of competition from emerging space nations eager to build
up their own space industries and become less dependent on the EU and US space
sectors.

Chapter 4
analyses the EU's import dependence on non-energy raw materials and how this
affects the competitiveness of certain EU manufacturing industries. In terms of
raw materials, two main competitiveness areas can be distinguished for the
sectors analysed. The first one refers to the cost competitiveness effects on
essential raw material inputs, stemming from different sources such as
increasing global demand, trade restrictions, transport costs etc. The second
competitiveness issue concerns company strategies, including recycling and use
of substitute materials etc., applied to tackle scarcity of raw materials.
Access to raw materials can be facilitated by different policy tools, such as
ensuring a better operational and regulatory environment for industries
affected by the scarcity of raw materials, fostering a global level playing
field in trade and investment, ensuring intelligent exploration and
exploitation of the resources available in Europe, and encouraging R&D and
innovation into substitutes, better recycling techniques and sustainable
production.

Chapter 5
reviews the progress made in moving EU industry towards a more sustainable
growth path over the last 10-20 years. The analysis reveals that EU industry
overall has improved its resource efficiency, carbon and energy intensity
during the period and that these trends are continuing in most sectors and
Member States. The overview of public policy instruments currently in use
showed that, at the EU level, attention has recently been strongly focused on
energy and controlling carbon emissions. However, the number of policy
initiatives is increasing, with the emphasis of policy attention shifting
towards sustainable consumption and production, green public procurement and,
more recently, resource-efficiency. Choosing and designing a coherent and
effective mix of policies is crucial to improving eco-performance and
facilitating industry’s simultaneous transformation towards more sustainable
ways of production and improved competitiveness. Aspects such as the whole life
cycle of products and different stages of the supply chains, complementarities
between the existing national and regional regulatory frameworks, enforcement
and monitoring costs, effects on competitiveness and compliance burdens on EU
industry need to be taken into account in the selection and design of these
policies.

Chapter 6
examines the interplay between industrial policy, competition policy and trade
policy in promoting the strengths of European companies and enhancing their
competitiveness. In the light of the EU enlargement, the expansion of global
value chains and the recent economic and financial crisis, it argues that there
is great potential and underexploited synergies in the existing
competitiveness-related policies. As underlined in the 2010 Industrial Policy
Communication, the key challenge is to create a framework that accompanies
firms through all phases of their life cycle and provides the right incentives
for them to increase their competitiveness in a globalised environment. The
remaining challenges involve refocusing on the needs of the real economy, and
in particular on improving access to finance and creating a global level playing
field (as also highlighted in Chapter 4).

EXECUTIVE SUMMARY

1. Introduction

The European Union and the world economy are
recovering from a deep global economic crisis, but this process has been
relatively slow. In view of the difficult economic situation, global
competition has become much tougher while the need to remain competitive on the
world market has become more important.

The 2011
European Competitiveness Report is prepared in the context of the 'Europe 2020 strategy for smart, sustainable
and inclusive growth' and in consideration of its major
flagships, in particular 'An integrated Industrial Policy for the Globalisation
Era. Putting Competitiveness and Sustainability at Centre Stage' which was
adopted by the Commission in October 2010.

The Report
looks first at the overall economic performance and its impact on productivity
- the key factor for competitiveness in the long run - as well as the role of
R&D and innovation in this process. Developments in a number of sectors and
topics that are key for the competitiveness of European industry and its
economy in general are then analysed. These topics include convergence in
knowledge intensive services, the competitiveness of the European space sector,
access to non-energy raw materials and EU industry in a context of sustainable
growth. Finally, the Report analyses the relationship between the EU industrial
and competition policies as well as the changes in this respect that have taken
place over the last decade.

2. Crisis,
recovery and the role of innovation

The European Union is recovering from the
effect of the major global crisis in 2008-2010. The recession originated from
the accumulation of considerable imbalances in the pre-crisis period 2000-07,
notably the inflation of house and stock prices in the US and some EU Member
States, and the subsequent unbalanced capital flows.

The crisis has affected all EU Member States
and, with the exception of Poland and Slovakia, no country experienced less
than a full year of recession. Even if by mid-2009 most countries had started
to recover, some Member States like Greece, Ireland or Romania were still in
recession by the beginning of 2011: after almost three consecutive years of
decreasing income. The experience is also mixed when it comes to the depth of
the recession, ranging from a tiny one-quarter point drop in Poland to a 25
percent loss during the more than two years of recession in Latvia. The reason
is that not all countries played the same role during the accumulation of these
imbalances and, consequently, not all countries are affected in the same way.
On the one hand, countries like Latvia, Ireland or Spain, which were severely
affected by a housing bubble, are now going through a major readjustment. On
the other hand, there are countries like Austria, Belgium or Germany that can
be seen mostly as suffering the collateral effects from the readjustments in
the US and in the first group of Member States; these countries have been
affected chiefly through international trade, but also through the exposure of
their financial systems to loans made to countries with large imbalances.

As expected, employment reacted later and
is recovering more slowly. In countries not directly affected by internal
imbalances, the contraction of employment (and the increase in unemployment)
has been moderate. Belgium, Germany or the Netherlands experienced slight
changes, while countries like Estonia or Spain have seen their unemployment
rates soar by 15 percentage points. This distinctive reaction of employment can
be explained by the different exposure to mispriced assets and, to a lesser
extent, to other factors such as the degree of openness or the introduction of
certain structural reforms before the crisis. In countries affected by these
distortions, households had the incentive to borrow in order to purchase these
assets. Once the bubble burst, the price of these assets drops mechanically and
caused and exposed the vulnerability of highly indebted households. Hence, in
these countries there are two reasons why their unemployment is rising by more
than the average and also more persistently. First, they are undergoing a major
structural readjustment, namely the downsizing of the construction sector which
is having permanent effects. Second, households and firms are trying to
deleverage, i.e. reduce the level of liabilities relative to assets by cutting
down consumption and increasing savings, thus slowing down the recovery and
worsening the business conditions for firms which, in turn, are then reluctant
to hire new workers. In contrast, the countries not affected by the bubble
faced better prospects of a swift recovery, with the result that employers were
able to resort to labour sharing schemes which kept employment at a relatively
stable level.

Despite the severity of the recession, it
has not come close to wiping out a decade of relatively strong growth. All in
all, most EU countries display reasonable records of real growth during the
decade 2000-10. This is particularly true for EU-12 countries, immersed in a
catch-up process following their accession to the EU. Two exceptions stand out
among EU-15: namely Portugal and Italy, which literally stagnated during these
years and have ended up at roughly the same point as they started.

A glance at the sectoral reactions to the
recession reflects the aggregate picture described above. Manufacturing output
initially fell steeply by some 20%, before recovering strongly over the last
two years. However, manufacturing output is still some 9% below its peak and
manufacturing jobs have fallen by around 11%. Construction of buildings
(excluding civil engineering) has dropped by more than the average and has not
yet begun to recover. Other sectors not directly related to the construction
boom will recover relatively quickly. The way countries are performing along
this recession, at the aggregate level, will depend on the relative importance
of each of these sectors. However; performing sectors will do well wherever
they are established in terms of sustained growth of productivity.

While acknowledging that the downturn
requires an understanding of the contraction in construction and real estate,
the key to the future competitiveness of the EU lies in performing sectors that
already did well in the past years and will now lead the recovery together with
new and emerging fast-growing sectors.

This line of
reasoning also explains the apparent paradox of countries which have been hit
hard by the recession, and yet have shown an overall reasonable performance
over the decade. This is in principle a good sign for the medium-term recovery
outlook and raises the issue of how to support innovation and productivity growth
in the EU.

The focus here
is on R&D and innovation, because it is regarded as an important source of
sustained growth. The EU is characterized by a lower intensity than the US and
a remarkable heterogeneity in R&D intensity across Member States. However,
a closer look at the individual US states shows that the internal variability
there is no different from that within the EU. This variability reflects
patterns of regional specialization which may be optimal from the social point
of view. In that sense, it is worth recalling that the new Europe 2020 strategy
maintains the Lisbon strategy target of a 3 percent for R&D intensity for
the EU as a whole (rather than for each individual Member State).

One possible
explanation for these differences is that EU Member States tend to specialize
in sectors characterized by a lower R&D intensity. However, a closer look
at the figures shows that, even if the sectoral composition plays a role, most
of the differences with the US can be associated with lower EU intensities in
individual sectors rather than an over-representation of low-intensive sectors
in the EU. Furthermore, when comparing similar firms from across the Atlantic,
they turn out to be remarkably similar in that they are making similar efforts
in terms of R&D. These two pieces of evidence together show the frequency
with which we find innovative firms in the US being compared with the EU.
Hence, the key area is the relatively poor commercialisation of R&D and
non-technological innovation in the EU, rather than R&D per se. The EU must
therefore do more than just foster basic research in order to create ideas, and
it needs to create the right business conditions for new technologies and
innovations to be developed and commercialised on the market. The whole process
has to be complemented by an adequate level of intellectual property rights
protection: enough to give incentives to innovators but not so much that it
hampers the creation of new ideas or withdraws research too soon from academia
by offering excessive incentives to privatise basic lines of research. The EU
is currently working with a High Level Group of experts to examine how to
improve the commercialisation of key enabling technologies.

3. Knowledge
intensive services

The importance of services for the economy
has steadily increased over time in most OECD countries. This process known as
"tertiarization" means not only that services are taking up
increasing shares of GDP, but also that they are playing an increasingly
important role in intermediate inputs for manufacturing, and high-tech
manufacturing in particular. Knowledge intensive business services (KIBS) are
especially important in this development. KIBS are defined according to the
NACE classification, NACE REV 1.1. as including the categories computer and
related activities (NACE 72), research and development (NACE 73) and other
business activities (NACE 74). Their importance as sources of innovation,
technologies and inputs has increased steadily over time. As a consequence,
linkages between KIBS and manufacturing industries in different countries have
strengthened over time.

The tendency of KIBS firms to develop new
services as part of a product package that includes physical, tangible goods is
a prominent feature of what has been referred to as a "convergence
process". This process encompasses manufacturing firms which have also
begun to offer services as part of a package including both the physical
product and services. High-tech products, for example, are often sold in
combination with maintenance services.

The "convergence process" and the
increasing role of KIBS for manufacturing have consequences for the external
competitiveness of EU manufacturing firms as implied by the increasing share of
KIBS in value added exports, especially for high-tech manufacturing goods. But
KIBS are important for external competitiveness per se, since the share of the
services trade in the overall trade has grown over time.

Growing importance of knowledge
intensive sectors in the economy

Services industries have grown in
importance over the last decades in terms of both output and employment. Within
services, KIBS play an important role and have been the main source of job
creation in Europe in the past decade and have also contributed substantially
to value added growth. The share of services in GDP has grown over time and now
amounts to some 70% in the EU and Japan and almost 80% in the US. While total
services as a share of GDP have grown by 5 to 10% since1995, shares of KIBS
have grown by around 30 to 40% in the EU, Japan and the US, although it should
be pointed out that the shares were initially quite low. The share of KIBS in
GDP now amounts to some 11% in the EU, 13% in the US and 8% in Japan.

The importance of KIBS can also be seen by
their contribution to the growth of GDP. The total contribution of KIBS to GDP
growth since 1996 has amounted to approximately 17% in the EU, 28% in Japan and
22% in the US. The largest contributions to GDP growth, within the EU, were
recorded in the UK and Belgium where the KIBS contribution to growth has
exceeded 25% since 1996.

Integration of KIBS in the value chains of
other industries has become more important over time, as illustrated by the
growing share of KIBS products in intermediate consumption. The KIBS share of intermediate
consumption in high-technology manufacturing amounted to some 14% in EU-15 and
16% in Japan and the US.

Important technology flows between KIBS
and manufacturing

The integration of KIBS
in the value chains of other industries is not limited to intermediate
consumption of KIBS products. Knowledge produced within KIBS is also used in
other sectors. Knowledge also flows in the other direction, from other sectors
to KIBS. In manufacturing, imported knowledge flows from other manufacturing
and KIBS constitute the largest knowledge flows in every country, except for
the USA and Japan. Foreign manufacturing sectors are the main sources of
imported knowledge inputs for manufacturing in most countries. The exception is
Ireland, where imports of KIBS for intermediate use in manufacturing are more important
sources of knowledge.

Imported knowledge
inputs to KIBS are larger than other technology flows from domestic sectors in
almost every country. Estonia, Slovakia, Romania and Ireland are almost
completely dominated by imported knowledge inputs. The EU-12 is heavily
dependent on manufacturing knowledge imported from abroad in this sector.

Analyses show that the backward linkage
from KIBS to manufacturing is not very strong. The backward linkage from
manufacturing to KIBS appears to be substantially stronger. Conversely, the
strength of the forward linkage from manufacturing to KIBS is substantially
weaker than the forward linkage from KIBS to manufacturing. The reason is that
the size of the KIBS sector is substantially smaller than the manufacturing
sector as a whole. The measures of linkage strengths reflect this size
difference.

Convergence
of manufacturing and services

Manufacturing
firms are increasingly offering services along with their traditional physical
products. This trend is often called "convergence of manufacturing and
services". The convergence of manufacturing and services is an opportunity
for the European manufacturing sector to open up new markets, find new sources
of revenue around their products, and increase competitiveness.

The output of manufacturing still consists
of manufactured products to a very large extent. Service output of
manufacturing, however, is growing quite fast, reaching annual growth rates of
5 to 10 % for the period 1995-2005. Between 2000 and 2005, which is the latest
available year for data[1],
service output of manufacturing grew in all Member States except the Czech
Republic. Taking into account that the latest recession hit manufacturing
industries relatively harder than services, the shares of service output of
manufacturing are likely to have increased further.

The service output of manufacturing firms
is related in various ways to research, development and innovation. Both
R&D and complementary service offers are strategies of firms to
differentiate their products from the products of their competitors. Services are produced predominantly by manufacturing industries with
high and medium-high innovation intensity. KIBS account for more than two
thirds of the service output of manufacturing in half of the Member States.
Hence, not only is the manufacturing sector a main client of KIBS, it also
produces KIBS to a considerable degree.

Trade in KIBS and the importance of KIBS
for EU external competitiveness

EU-15 has on average stronger revealed
comparative advantages in KIBS exports than in technology-intensive merchandise
exports. The strongest comparative advantage for the EU-15 is found in R&D
services. Also, EU-15 has also increasingly specialized in computer and information
services exports, in contrast to the US, which has lost this specialization.

The importance
of KIBS for the EU's external competitiveness can be measured both directly and
indirectly. For both the EU-12 and EU-15, the shares of direct KIBS exports have
increased over time. Measured directly, KIBS activities account for between 4%
of EU exports for EU-12 and 11% for EU-15. Measured indirectly, KIBS exports
account for between 9% for EU-12 and 18% for EU-15 exports.

4. European
competitiveness in space manufacturing and operations

Europe has a rich heritage in space, going
back a quarter of a century for the EU and even longer for several Member
States as well as for the European Space Agency (ESA). The space sector
contributes directly to the objectives of smart, sustainable and inclusive
growth laid down in the Europe 2020 Strategy, which refers to the development
of an ‘effective space policy to provide the tools to address some of the key
global challenges and in particular to deliver Galileo and GMES’. This reflects
the shared competence of the EU and its Member States stemming from the
introduction of Article 189 of the Treaty on the Functioning of the European
Union, mandating the EU to draw up a European space policy with a view to
promoting, among other things, EU competitiveness.

The most striking characteristics of the
space sector worldwide as well as in the EU are the extent to which it is
driven by public institutions; the small number of actors and Member States
involved; the high financial and technological risks; and the limited
production runs.

Bearing in mind these peculiarities of the
space sector, the evolution of three manufacturing segments and four segments
of operation or exploitation is analysed. The three manufacturing segments are satellite
manufacturing, launcher manufacturing, and ground segment. The four
operation/exploitation segments are launching services, satellite
communication, earth observation, and satellite navigation. No downstream
services or applications are included in the sector analysis as they are
considered to be customers of the space sector, notwithstanding the fact that
they represent the part of the value chain with potentially the greatest impact
on the EU economy.

Strong European position globally,
driven by public institutions

The space sector in the EU is a driving
force for growth and innovation, generating employment and market opportunities
for innovative products and services. Together with the US space sector it
dominates the world market for satellites, launchers, ground segments and
related operations and exploitation. It depends less on the requirements and
funds of public institutions than in the United States, but even so the EU
space sector is strongly driven by public policy, public procurement and public
funding (BIS 2010). The relative importance of public institutions as customers
has however decreased slightly in recent years.

Excluding downstream services and
applications, the EU space sector generates direct sales in excess of EUR 10
billion per year and employs around 36.000 persons. Its direct contribution to
EU GDP is relatively small but due to its high technology content and high
value added, productivity is higher than in most other EU sectors. Most of the
sales and employment are generated in satellite manufacturing and the operation
of communication satellites. It is however important to note that the greatest
impact on the EU economy is generated downstream by services and applications
not covered by this report.

Most of the EU space sector is concentrated
in a small number of locations in a handful of Member States such as France,
Italy, Germany and the United Kingdom, while a number of Member States are
hardly participating at all. The sector is also highly concentrated in terms of
the number of manufacturers and operators, notably due to the small size of its
market as well as high entry barriers: costs, infrastructure, know-how, risks.
Another consequence of the high barriers to entry is that there are few SMEs in
the sector.

The EU and the United States are the
largest exporters on the world market, running sizeable trade surpluses against
the rest of the world in the space sector (in spite of strict export control
rules in the USA). The EU surplus of between half a billion and one billion
euro a year is generated by exports mainly to the United States, Russia,
Kazakhstan, Brazil, China and Turkey, and imports almost exclusively from the
United States. There is also considerable intra-EU trade.

Importance
of skills, R&D and innovation

Some of the
expected benefits of space investment stem from its impact on innovation, not
least indirectly in the form of spillover effects, spin-offs and technology
transfer, including spin-ins. Setting ambitious objectives for the EU space
sector will stimulate innovation and can make a real contribution to the
Innovation Union. Those objectives can only be attained from a strong
technological base, therefore basic space research needs to continue to be
carried out in Europe and be properly funded by the EU, ESA and their members,
which in the case of the EU includes the Framework Programme for research,
technological development and demonstration activities. It is particularly
vital to support research into critical and breakthrough technologies (European
Commission 2011). On the other hand, it is crucial to maintain R&D funding
for the development of satellite communication, given its importance for the
space sector as a whole.

A major challenge facing the global space
industry and the European space sector in particular is the supply of skills in
the years ahead. In Europe a generation of space engineers and technicians is
nearing retirement and it is not clear whether the EU education system will be
able to deliver the skills needed in sufficient numbers and on time to replace
them. If it is not, an underlying problem might be the relatively low
attractiveness of space careers in comparison with other high-technology
professions. EU policymakers may need to consider how to raise the profile of
space in education and how to address any structural deficit in the supply of
skills to the EU space sector.

Regulation

Standardisation improves industrial
competitiveness and efficiency; together with inter­operability it is essential
for the competitiveness of the EU space sector.

International Traffic in Arms Regulations
(ITAR) are believed to hamper US exports of space products on the world market
and even if the EU space sector is not directly targeted by ITAR, it may prove
an obstacle also to the EU industry in cases of re-export. On the other hand it
represents an opportunity for the EU space sector to offer ‘ITAR-free’ systems.

Natural resources

Space
manufacturing requires specific and scarce raw materials due to the extreme
environment in which the components will operate. As discussed elsewhere in the
Report, the EU possesses some but not all of these raw materials of limited
availability. The most important natural resource for satellite communication
is radio frequency spectrum which is already becoming scarce due to the growth
in space applications combined with increasing bandwidth. In the global
allocation of frequencies, the interests of the EU space sector, and in
particular of satellite communication, must be defended.

5. Access to non-energy raw materials and the
competitiveness of EU industry

Non-energy raw
materials can be seen as raw materials that are mainly used in industrial and
manufacturing processes, semi-products, products and applications and that are
not primarily used to generate energy. As such industrial minerals and purified
elements (e.g. feldspar, silica), ores and their metals and metallic
by-products (e.g. copper, iron but also germanium, rhenium, rare earth
elements) and construction materials are within the scope as well as wood.

Global demand for these raw materials
started to increase significantly in the last decade, driven by the strong
growth of emerging economies in particular. Additionally, recent trends
indicate that also the rapid dissemination of emerging technologies is expected
to boost demand for raw materials. Accordingly, the growing need for consumer
and investment goods in emerging countries and the spread of new technological
applications will result in a high long-term demand for most of the non-energy raw
materials. These developments are likely to have significant impacts on the
European manufacturing sector.

Europe is highly dependent on raw materials
imported from the rest of the world. While the EU has many raw material
deposits, their exploration and extraction is hindered mainly by a highly
regulated environment, high investment costs and increasingly competing land
uses.

Non-energy raw materials inputs and
competitiveness aspects

Access to and affordability of non-energy raw
materials is crucial for the competitiveness of the EU industry. For sectors such
as steel, pulp and paper, chemicals, aerospace, electronics, automotive or
construction it can be hampered, directly or indirectly, by a limited or more
costly supply of these raw materials.

As far as raw materials are concerned, two
main competitiveness areas can be distinguished: the effects on costs for raw
material inputs and the effects on the company strategies.

Cost
effects

Rising
prices for raw material inputs in manufacturing production, due to distortion
of conditions of access and growing global demand, may lead to a deterioration
of the competitiveness of European industries.

There are several reasons for rising raw
materials costs. A large share of many raw materials is concentrated in a small
number of countries, which often apply export restrictions, leading to higher
prices and an insufficient supply of inputs for international producers. At the
same time, countries imposing export barriers can benefit from lower input
prices, creating an artificial support for domestic industry. Also the
oligopolistic nature of several non-energy raw materials production has
contributed to significant price increases. The time lags in the supply
response to changes in demand, which often lead to price increases in the
global market for metals and minerals, are yet another reason. When an increase
in production costs is not matched in other regions of the world Europe faces a
deterioration of its competitiveness position.

Solutions, strategies

The negative effects stemming from the
scarcity of raw materials are in the form of pressures on the competitiveness of
European industries. Companies active in the affected sectors have chosen a
range of solutions to reduce the risks and costs of non-energy raw materials.
In this regard, R&D and innovation play an important role in alleviating
the vulnerability of material intensive EU industries.

Increasing use
of recycled and recovered materials, more efficient use of materials and
substitute/alternative materials are of key importance in improving the competitiveness
of European manufacturing industries. Recycling rates vary widely, depending on
the materials used in the production process. In certain sectors, recycling
rates are very high (e.g. pulp and paper industry), while in others there is
still some potential for further improvement (e.g. waste electronics). Some
sectors make widespread use of resource efficient technologies (e.g. automotive
industry) and substitute materials (e.g. chemical industry) in order to reduce their
dependency on primary raw materials. From the competitiveness point of view, development
of specific skills, R&D and innovation play a central role throughout the
entire value chain, including extraction, sustainable processing, recycling and
developing new materials, in addressing the challenges posed by the lack of
non-energy raw materials.

Companies can use a range of different
strategies to tackle import dependency even though not all of these are
beneficial from the point of view of European growth and jobs. Vertical
integration helps to circumvent the risks in the market thereby securing access
to raw materials (for example in the steel industry). Relocation of the
production processes to countries where the materials are produced makes it possible
to secure access under more favourable economic conditions, because trade
restrictions are avoided (e.g. the chemical industry). However, it is clear
that this puts the EU and unfairly at a disadvantage in relation to those
producing countries which impose such restrictions. Outsourcing of manufacturing
can also be seen as one option to secure access to certain materials (e.g. the
automotive industry).

The role of EU policies to reduce raw
material dependency

Access to raw
materials can be facilitated by different policy tools, such as ensuring a
better operational and regulatory environment for industries affected by the
scarcity of raw materials and fostering a global level playing field in trade
and investment. Encouraging and supporting R&D and innovation for substitutes,
better recycling techniques and sustainable production is of key importance in
tackling the shortage of non-energy raw materials for EU manufacturing in the
longer term. Furthermore, there is potential to reduce import dependency in the
case of some of the non-energy raw materials of which Europe still has several
large deposits. However, the non-energy extractive industry has to confront a
number of challenges, such as competing land use. At the same time, innovation
in resource efficient and sustainable production technologies can be important
drivers for future competitiveness of the non-extractive industries.

6. EU industry in the sustainable growth context

In order to
foster economic growth in a sustainable way, European industry and policymakers
are facing strong pressures to reduce the negative impacts of economic
activities on the environment (e.g. climate change, environmental degradation,
etc.) and to address concerns about resource scarcity, security of supply and
the EU’s reliance on external supplies of energy, raw and critical materials.
The Europe 2020 strategy recognises this - in particular with the Flagship initiatives
on Industrial Policy and Resource Efficiency - by setting out a new framework
to promote the modernization of the industrial base and the transition to a low
carbon, resource efficient economy. At the same time, European industry is
already moving over to more sustainable methods of production, with
particularly strong growth being achieved in what are known as "eco-industries".
However, sustainable growth is not exclusive to certain sectors. Rather it represents
a re-orientation of the entire economic landscape, where resource and
eco-efficiency and innovation become the key for delivering environmental and
other societal goals, whilst simultaneously reinforcing competitiveness and providing
growth and jobs.

Relative decoupling of economic growth
and environmental impact has been achieved

Significant progress has already been made
on the road to a resource efficient and low carbon economy. Overall there has
been relative decoupling of economic growth and
environmental impact in the EU over the past two decades in terms of energy and
resource use, emissions and waste generation. However, absolute decoupling
remains a challenge in some areas and sectors, e.g. for households. EU industry overall has improved its resource efficiency, carbon and
energy intensity during the period, being in many instances ahead of the US and
having closed the gap on Japan – the world leader in
many aspects of industrial efficiency.  However, it is
difficult to make a clear-cut analysis as to the extent in which the overall
improvements achieved are the result of enhanced industry efficiency. Many of
the most positive aspects of industry's eco-performance are based on
improvements in emissions in the energy sector, but the evidence points to them
being based on broader developments or policy interventions in the energy
generation sector, rather than on industry action alone. Notwithstanding this
qualification, the evidence does support the view that industry has increased
its energy and resource efficiency over the period and that these trends are
continuing in most sectors and Member States.

Overall there is broad evidence pointing
to relative decoupling in industry

By and large, there is strong evidence of
at least relative decoupling across industry, particularly as regards energy,
greenhouse gas (GHG) and other emissions and water use. Relative decoupling is
also apparent in material consumption, but not to the same extent as other
areas.

Although total energy use has risen in the
EU-27, it has increased more slowly than in the US. In fact, the EU has
improved its energy intensity in recent times and has now closed the gap on Japan.
However, the US has also narrowed its energy intensity gap. Meanwhile, China
has overtaken the EU in terms of energy use. Although total EU energy use has
risen, industrial energy use has remained broadly stable in the last 15 years.
In parallel, there has been a decline in energy use in many of the EU-15
countries, while EU-12 Member States and others that experienced rapid
industrial economic growth have seen their energy use increase. The EU-12
countries achieved a significant reduction in their industrial energy
consumption intensity and also in the gap vis-à-vis the average industrial energy
intensity of the EU-15.

From a sectoral perspective, the iron and
steel and chemical sectors - the two biggest industrial energy users - have
seen their energy use and intensity fall significantly. Industrial energy
intensity has improved by 18% since 1995, and although the most significant
improvements were achieved prior to 2000, the downward trends are continuing.

In the case of GHG emissions there
is also strong evidence of decoupling, as overall GHG emissions are falling
while the economy grows. Similar evidence exists for industrial emissions. GHG
emissions are linked very closely to overall energy use and the emissions
intensity of the energy mix, and these trends are broadly similar. The best
available calculation of industrial emissions intensity reported a 30% decrease
in emissions intensity for industry, which is slightly better than overall
energy trends. This illustrates the emissions benefits resulting from changes
to the energy mix, such as increased renewable energy, fuel switching from coal
to gas and the impacts of policy such as the Large Combustion Plant Directive
(LCPD).

The fact that EU-27 GHG emissions declined
by 5.1% in the period where energy consumption rose again points to the
de-carbonization of energy supply and decoupling of impacts. However, emissions
reductions are generally concentrated in the EU-15, with most EU-12 Member
States seeing overall emissions rise as their economies grow. At the sectoral
level, the industrial (manufacturing and construction) GHG reduction - at 13% -
is higher than the overall emissions reduction. This points to non-industrial
GHG emissions growing faster than industrial emissions.

In the case of materials there is
also some evidence for relative decoupling as materials usage has been
increasing, but at a slower rate than the economy. Direct materials consumption
(DMC) and direct materials inputs (DMI) increased over the period, but by less
than overall or industrial gross value added (GVA) growth.
Some countries (e.g. Germany, UK, and Italy) achieved reductions in materials
use while industrial GVA was increasing, whereas the trends in EU-12 are
pointing towards increased materials use.

Materials productivity has increased in the
EU-27, albeit gradually and unevenly. The indications are that materials
productivity is closely related to structural economic factors, which control
the extent to which improvements can be achieved. This supports the view that
decoupling is still relative in terms of resource use. The generation of waste
by industry has declined significantly. Evidence also indicates that industry
has better eco-performance than the wider economy in respect to waste.

In the case of water there is some
evidence of at least a relative decoupling, but is hard to draw any hard and
fast conclusions as data is sparse. Overall water abstraction (i.e. the volume of water that is taken from surface and
ground water sources) is down in
the countries for which data are available, with a particular improvement
recorded in Germany. Abstraction by the manufacturing industry is also down and
typically the decline in manufacturing abstraction tends to be greater than the
decline in overall abstraction.

As far as other emissions are
concerned, there is evidence of absolute decoupling – emissions have been
falling while industry has been growing. Measures of acidification and
particulate emissions (PM10) were very closely related to energy supply. It is
therefore likely that a large proportion of emissions reductions are a result
of policy actions to clean up large combustion plants.

Effects of the recent crisis are not yet
clear

Many of the fastest and most significant
improvements in eco-performance occurred in the 1990s, partly in response to a
number of one-off events and historical developments. These events included the
transition from a 'planned' to a market based economy in central and eastern
Europe, the closure of significant parts of heavy industry, a major  switch
from coal to gas and the implementation of the LCPD and associated air-quality
legislation.

Achieving levels of progress similar to
those seen in the 1990s, and speeding up the improvements in eco-performance
will require effective policies and actions. Certainly the policy framework in
the EU has been strengthened significantly over the past decade and it is
possible that similar large scale changes may come about - for example – as
result of the widespread deployment of renewable energy or the tightening and
expansion of the EU ETS (Emissions Trading System) emissions caps. At the same
time there is the possibility that the one-off benefit of the transition from a
'planned' to a market based industry may start to erode, as the new Member
States grow faster while their eco-performance, even though rapidly improving,
remains weaker than in the rest of the EU. This could act as a drag on the
eco-performance of EU industry in the future.

The majority of the datasets available to analyse the eco-performance of industry are
only fully updated to 2007. The recent economic and financial crisis is likely
to have had a significant impact on both industry and its eco-performance. So
far, however, it is unclear whether these effects are positive or negative.

7. EU
industrial policy and global competition: recent lessons and the way forward

In 2002, the European Competitiveness
report analysed the relationships between enterprise and competition policies.
The complementarity of these policies and the potential for further synergies
were well established at that time. However, the last decade has seen several
developments which point towards a need to shift from a predominantly
intra-European focus of the two policies towards a global perspective. This
calls for a renewed assessment of the overlap between industrial policy,
competition policy and including also trade policy.

Four major developments played a key role
in triggering this shift. The first is the enlargement and the emergence of the
EU as the biggest trading bloc, with an imperfectly developed single market.
The second important change is the recent financial and economic crisis which
had a profound impact on the European economy. The third aspect is
globalisation, which defines the agenda for the next decade. Lastly, there is
the new EU industrial policy.

These changes create real challenges for
European enterprises. As far as the internal market is concerned, there is much
unused potential for developing the strength of European companies and of
enhancing their competitiveness. This thinking also underpinned the 2010
Industrial Policy Communication. The report further makes it clear that the key
challenge is to create a framework that accompanies firms through all phases of
their life cycle and provides the right incentives for them to increase their
competitiveness in a globalised environment. The remaining challenges involve
refocusing on the needs of the real economy, in particular on its access to
finance - which has been the key lesson learnt during the recent crisis - and
creating a global level playing field.

After defining
the notions of “European company” and “European Common Interest”, the analysis
focuses on situations where such an approach could usefully be applied. It
concerns companies' access to resources, be they raw materials or finance, and
the improvement of competitiveness through increased innovation. In this
context, while the approach of the EU and national administrations is to
provide complementary solutions, more targeted involvement by the EU can be
beneficial. The new approach concerns the ways in which European companies can
optimise their access to foreign markets on the basis of permanent reciprocity.
It also applies to restructuring processes, which reflect the constant need of
all enterprises and sectors to adjust to the changing economic circumstances.
There is a need to support prompt and adequate reactions in order to help
companies avoid getting deeper into difficulties. At the same time, their exit
- where necessary - should not be prevented, as this would lead to adverse
effects on the economy.

8. Conclusions

The analysis
in this report shows that the experience of the recession varies according
to the way in which countries were involved in the building up of imbalances in
the pre-crisis period 2000-2007. It also argues that competitive sectors that
grew in a balanced manner before the crisis will also lead the recovery. In
any case, a strong and sustained recovery will depend on their capacity to
create the environment in which firms can thrive and innovation is created and
taken to the market. Achieving this aim will require the careful design of
public policies: from basic research in universities to generate ideas to the making
it easer to do business, so as to have start-ups bringing innovations to the
market.

The importance of services for the economy
has increased steadily over time in most OECD countries. Especially important
in this development are knowledge intensive business services (KIBS) which have
become increasingly important over time as sources of innovation, technologies
and as inputs for the whole economy. The importance of KIBS for the rest of the
economy has become visible through the tendency of firms to develop new
services as part of a product package that includes physical, tangible goods.
This is a prominent feature of what has been referred to as a "convergence
process". The process encompasses manufacturing firms which have also
begun to offer services as part of a package including both the physical
product and services. The convergence of manufacturing and services is an
opportunity for the European manufacturing sector to increase its
competitiveness. The importance of KIBS for the EU's external competitiveness
can be measured both directly and indirectly. The shares of direct KIBS exports
have increased over time for both the EU-12 and the EU-15. Measured directly,
KIBS for EU-12 account for 4% and for EU-15 11% in terms of exports. Measured
indirectly, KIBS activities account for 9% of EU-12 exports and 18% of EU-15
exports.

The EU space sector enjoys a strong
competitive position internationally and is the world technology leader in certain
segments. Together with the United States the EU is a major net exporter of
space products, but is less hampered than its US competitor by export control
rules. The EU space sector is heavily influenced by public policies, funding
and procurement, but the share of commercial customers is increasing. In order
to remain competitive the sector needs to secure its supply of skills and keep
a watchful eye on competition from emerging space nations that are eager to
build up their own space industries and become less dependent on the EU and US
space sectors.

The accessibility and affordability of non-energy raw materials is crucial for ensuring the competitiveness
of EU industry. Several European industries are affected by a limited or more
costly supply of certain raw materials. Access to raw materials can be
facilitated by a range of policy tools. Firstly, existing regulations and
directives at the EU level should be made internally consistent, which would
promote a better operational and regulatory environment for industries affected
by the scarcity of raw materials. Internal consistency should be in line with
sustainability objectives and policies. Secondly, promoting a global level
playing field in trade and investment is essential in order to ensure a fair
and sustainable supply of non-energy raw materials from international markets.
Thirdly, intelligent development of the further exploration and exploitation of
the European non-energy raw materials resources can play an important role in
providing certain materials for production. Finally, encouraging and supporting
R&D and innovation for substitutes, better recycling techniques and
sustainable production (material efficiency) are all of key importance in tackling
the relative shortage of raw materials in the EU manufacturing sector.

The transition
to a more sustainable, resource efficient, low carbon industry is key for the
competitiveness of the European economy in the future. The overview of public
policy instruments currently in use has shown that, at the EU level, policy
attention has recently been strongly focused on energy and the control of
carbon emissions. However, the number of policy initiatives is rising, and the
emphasis of policy attention is shifting to sustainable consumption and
production, green public procurement and - more recently – resource efficiency.
Choosing and designing a coherent and effective mix of policies (including
market based instruments, such as taxes, subsidies or trading schemes,
environmental regulations and standards, voluntary agreements, co-regulation,
communication and information, etc) is crucial as a means of improving eco-performance
and facilitating the simultaneous transformation of industry towards more
sustainable ways of production and improved competitiveness. Aspects such as
the whole life cycle of the products, interactions between the different stages
of the supply chains, complementarity with the existing national and regional
regulatory frameworks, enforcement and monitoring costs, compliance burdens for
firms and SMEs, market structure and effects on competitiveness of EU industry
need to be taken into account in the selection and design of these policies.

The analysis confirms that the main findings on the
relationship between enterprise and competition policies in the 2002
Competitiveness Report remain valid. This applies to the complementarity
between these policies and the scope that still exists for improved use of
unexploited synergies. At the same time, the existing approach needs to be
extended and supplemented. In particular, as the global focus and global consequences
of policy action have become more important, trade policy considerations need
to be systematically included. Indeed, key developments over the last decade,
such as enlargement, the financial and economic crisis, the rise of new non-EU
competitors and the formulation of a new EU industrial policy, need to be taken
into account in policy formulation. Policy should continue to focus on the general
EU interest, including by facilitating the functioning of EU companies in the
global economy.

1.
Crisis, recovery and the role of innovation

The
period 2008-10 has foreseen a large global recession. While individual
countries had of course experienced similar recessions in the past, this time
was unprecedented because of the depth (overall magnitude of the downturn) and
scope (the number of countries severely affected).

Box 1.1: Competitiveness A competitive economy is one that raises living standards sustainably and provides access to jobs for people who want to work. At the roots of competitiveness are the institutional and microeconomic policy arrangements that create conditions under which businesses can emerge and thrive, and individual creativity and effort are rewarded. Other factors that support competitiveness are macroeconomic policies promoting a safe and stable business environment and the transition to a low-carbon and resource-efficient economy. Ultimately, competitiveness is about stepping up productivity, as this is the only way to achieve sustained growth in per capita income — which, in turn, raises living standards. The notion of living standards encompasses many social aspects, so this broad definition of competitiveness comprises elements of all three pillars of the Lisbon Strategy — prosperity, social welfare and environmental protection. In the context of international trade, the (external) competitiveness of a country or sector is an elusive concept. Indeed, some indexes aiming to reflect this notion of competitiveness, such as the real effective exchange rate, have to be interpreted with care, because ‘loss of competitiveness’ in an individual industry may well reflect the outstanding export performance of other domestic industries. For example, a rise in the value of the euro may worsen the competitive position of a given industry, but this may simply reflect strong productivity growth in other industries, and hence strong exports and an increasing demand for the euro.

1.1.
Recovery of output

By the beginning of 2011, fears of a double
dip recession vanished but recovery proved slow. This is particularly true for
employment and for the countries most affected by speculative bubbles during
the 2000-07 period. The origins of the recession are imbalances accumulated
during the boom period, notably the inflation of house prices in some Member
States and the subsequent external imbalance.[2]
Consequently, not all EU Member States have been affected in the same way or
with the same intensity. On the one hand, countries like Estonia, Ireland and
Spain were severely affected by a housing bubble and are now going through a
major correction, with considerable downsizing of the construction sector. It
is therefore not surprising that these are also the countries with the largest
rises in unemployment during the recession (see Figure 1.1). On the other hand,
the economies of countries like Austria, Belgium and Germany are largely
victims of the readjustment in the US and the other Member States — whether
because their financial system was exposed to loans from bubble countries or
because of a drop in international trade. The prospects of recovery also vary according
to the way each country has been involved in this crisis. While countries not
directly affected by internal imbalances can expect a prompt recovery,
countries affected by the bubble find themselves in a process of deleveraging
that will slow down the recovery as long as households and firms are immersed
in their balance sheet correction (OECD (2011)).

Figure 1.1: The recession as a correction: The housing boom and the contraction in employment

Note: The rise in investment in dwellings is the increase in % points of GDP of investment in dwellings from 2000 to 2006. The rise of unemployment is the difference between the minimum rate of unemployment before the crisis and the maximum (for some countries the current, by 2010Q3) during the crisis.

Source: Unemployment rate: Eurostat, Quarterly LFS statistics for employment, Unemployment - LFS adjusted series (une\_rt\_q). Investment in dwellings: AMECO database, European Commission, investment in dwellings (UIGDW) as a percentage of GDP (UVGD).

Table 1.1 gives an idea of magnitude and
scope of the downturn but also of the differences across EU Member States. With
the exception of Poland and Slovakia, no Member State experienced less than a
full year recession. Even if by mid-2009 most countries started to recover,
some Member States like Greece or Romania were still in recession by the
beginning of 2011: almost three consecutive years of decreasing income. The
experience is also mixed when it comes to the depth of the recession. From a
tiny one-quarter drop in Poland to a 25 percent loss along a more than two
years recession in Latvia, there are many and diverse experiences. In general
EU-15 countries can be divided among those more affected by a real estate
bubble ―Spain, Denmark, United Kingdom or Ireland― with drops in
real activity up to 14 percent, and the rest of countries displaying
considerable but more moderate contractions. EU-12 Member States, with the
exception of Poland, have all suffered a sharp contraction of GDP, on average
larger than that observed in the EU-15: most EU-12 countries are close or well
above the double-digit contraction, with the Baltic Republics suffering the
deepest cuts.

Figure 1.2: Real GDP in 2010Q3 with peak and trough value (2000 = 100)

Source: Eurostat, Quarterly National Accounts.

Table 1.1: An overview of the recession, real GDP during 2007-10; index, 2000=100

                2007                                         2008                                         2009                                         2010                                                           Q1        Q2        Q3        Q4        Q1        Q2        Q3        Q4        Q1        Q2        Q3        Q4        Q1        Q2                Q3        Drop\*    Relative drop EU-27       115.4    115.9    116.6    117.2    117.9    117.6    116.9    114.7    111.9    111.6    111.9    112.2    112.6    113.8                114.3    6.3        5.3 BE            113.7    114       114.4    114.6    115.5    116.1    115.6    113.1    111.2    111.4    112.5    113       113.1    114.3                114.8    4.9        4.2 BG            145.4    147.9    149.9    153       155.4    157.4    159.6    160.4    150.3    150.2    150       149.7    149       149.7                150.8    11.4      7.1 CZ            134.4    135.2    136.9    138.3    138.8    139.8    140       138.8    133.8    133.1    133.8    134.3    135.2    136.2                137.5    6.9        4.9 DK            111.5    110.6    112.2    112.9    111.2    112       110.9    108.1    106.4    103.8    104.2    104.7    105.4    106.7                107.8    9.1        8.1 DE            108.7    109.1    109.9    110.1    111.6    110.9    110.4    108       104.3    104.8    105.5    105.8    106.4    108.9                109.6    7.3        6.5 EE            172.1    172.8    173.5    174.2    170.3    168.5    164       154.7    146.1    140.6    138.8    140.7    142.2    144.8                145.8    35.4      20.3 IE             145.8    144.1    142.7    147.6    143.9    141.2    140.4    134.1    130.7    130.3    129.6    126.6    129.3    128                128.7    21         14.2 EL            131.6    132.2    133.2    134.1    134.4    134.8    134.5    134       132.5    132.1    131.2    129.7    128.9    126.7                125.1    9.7        7.2 ES            125.1    126.1    127.1    127.9    128.5    128.4    127.4    126       124       122.7    122.4    122.2    122.3    122.7                122.7    6.3        4.9 FR            112.8    113.3    114       114.3    114.8    114.1    113.8    112       110.4    110.6    110.8    111.4    111.7    112.3                112.7    4.4        3.8 IT              108.1    108.2    108.4    107.9    108.4    107.7    106.5    104.3    101.3    101.1    101.5    101.4    101.8    102.3                102.6    7.3        6.7 CY            126       127.7    129.2    130.5    131.7    133.2    133.5    133.5    132.2    131       130       130       130.6    131.4                132.2    3.5        2.6 LV            176.7    181.6    185       186.7    181.2    177.9    174.8    167.8    148.8    146.8    140.7    139.8    141.3    143                144.2    46.9      25.1 LT             164.4    170.2    175.9    176.5    178.2    179       175.7    173.5    153.5    150.3    150.2    148.6    150.6    152.1                152.6    30.4      17.0 LU            130.9    132.9    134.1    136.1    138.6    137.8    135.3    130.1    130.9    127       131.2    132.9    132.8    134                135.9    11.6      8.4 HU            126.5    126.4    126.8    127.5    129       128.7    127.5    124.7    120.8    119.3    118.3    118.3    119.5    119.9                120.9    10.7      8.3 MT            113.1    113.7    114.5    115.1    116.8    117.9    117.8    116       114       114       115       116.8    118.5    118.6                119.2    3.9        3.3 NL            113.2    113.8    115.1    116.7    117.6    117.3    117       115.6    112.9    111.4    112.2    112.8    113.4    114.4                114.3    6.2        5.3 AT            115.8    116.1    116       117.5    119.7    120       118.8    116.9    114.5    113.5    114.1    114.6    114.6    115.9                117       6.5        5.4 PL            128.8    131       132.7    135.6    137.5    138.5    139.6    139       139.6    140.3    140.9    142.9    143.9    145.7                147.6    0.6        0.4 PT            107.9    107.9    107.8    108.8    108.9    108.8    108.1    106.7    104.9    105.5    105.8    105.6    106.7    107                107.3    4          3.7 RO            147.1    148.9    150.1    155       160.9    163.3    162.6    159       152.4    150.2    150.3    148       147.5    148                147       16.3      10.0 SI             132.5    134.7    137.4    138.5    140.8    141.8    142.1    137.4    129.1    128.3    128.8    128.9    128.8    130.1                130.5    13.8      9.7 SK            145.7    149.4    153.2    161.2    158.9    160.4    162.4    163.3    150.8    152.5    154.3    156.4    157.7    159.3                160.8    12.5      7.7 FI              122.9    124.6    125.8    127       127.4    127.6    127.1    123.1    116.2    114.9    116.4    116.8    116.9    119.9                120.5    12.7      10.0 SE            121.9    122.6    123.4    124.8    123.5    123.5    123.5    118.4    115.3    115.7    115.6    116.5    118.5    120.9                123.4    9.5        7.6 UK            118.5    119.2    119.8    120.1    120.7    120.4    119.3    116.8    114.2    113.3    113       113.5    113.9    115.2                116       7.7        6.4

Note: Shaded cells denote period from peak to trough. \* The drop is in percentage of 2000 income while the relative drop expresses the drop at the trough in percentage of the peak.

Source: Eurostat, Quarterly National Accounts.

Table 1.2: An overview of the recession, employment during 2007-10; index, 2000Q2=100(a)

                2007                                         2008                                         2009                                         2010                                                           Q1        Q2        Q3        Q4        Q1        Q2        Q3        Q4        Q1        Q2        Q3        Q4        Q1        Q2                Q3        Drop     Rel. Drop (b) EU-27       106.5    108.2    109.4    109.0    108.6    109.6    110.5    109.5    107.5    107.9    107.9    107.3    105.9    107.2                107.7    4.5        4.1 BE            105.5    105.4    106.3    107.9    107.9    107.0    108.4    108.2    107.3    106.8    107.1    108.0    108.3    107.8                108.8    1.6        1.5 BG            109.3    113.3    115.5    115.2    114.5    117.3    119.0    117.1    113.7    115.0    114.3    110.5    105.0    107.1                108.2    14.0      11.8 CZ            104.0    105.1    105.6    106.2    106.0    107.0    107.2    107.6    105.8    105.6    105.2    105.3    103.2    104.3                105.0    4.5        4.1 DK            102.7    103.7    103.3    103.2    103.4    105.5    105.5    105.1    103.1    102.6    102.9    100.1    99.5      100.9                100.4    6.0        5.7 DE            103.1    104.8    106.3    106.5    105.5    105.9    108.3    108.3    106.0    106.3    106.5    108.2    105.5    106.2                107.0    2.8        2.6 EE            113.8    115.9    116.5    115.0    115.5    115.5    116.2    114.8    107.7    104.3    105.2    102.1    97.4      98.3                101.7    19.1      16.4 IE             124.5    125.8    128.5    128.0    127.8    126.2    126.6    122.4    116.8    115.4    114.5    112.2    110.2    111.3                110.8    18.4      14.3 EL            108.8    110.2    110.7    110.2    110.0    111.7    111.9    111.0    109.4    110.5    110.7    109.2    107.9    107.9                107.3    4.6        4.1 ES            129.9    131.9    132.8    132.6    132.1    132.3    131.8    128.6    123.6    122.7    122.2    120.7    119.1    119.6                120.1    13.7      10.3 FR            108.9    110.5    111.6    111.2    111.3    112.3    112.8    111.8    110.8    111.7    111.6    110.5    110.5    111.6                112.1    2.3        2.1 IT              109.2    111.4    111.9    111.5    110.7    112.7    112.4    111.6    109.8    110.9    110.0    109.6    108.8    109.9                108.9    3.9        3.5 CY            125.9    128.7    129.3    130.9    129.0    130.6    129.9    131.2    128.3    130.3    130.1    130.4    129.1    131.8                131.1    2.9        2.2 LV            115.4    117.9    120.3    122.3    121.1    121.5    120.5    115.5    111.4    106.3    101.5    99.2      97.6      99.6                102.2    24.7      20.2 LT             106.6    109.2    110.4    107.7    106.8    107.9    108.8    106.6    101.3    100.5    100.8    97.9      94.0      94.0                95.6      16.4      14.9 LU            112.0    111.0    113.3    112.6    109.8    115.3    112.5    110.0    118.6    120.8    120.5    119.7    121.1    121.1                122.6    3.4        3.0 HU            102.6    103.6    103.7    102.7    101.0    101.6    103.1    101.9    98.9      99.8      99.4      99.4      97.7      99.3                100.4    6.0        5.8 MT            107.1    110.2    110.2    109.7    110.3    111.9    113.9    112.2    112.8    112.7    113.6    113.8    114.7    115.6                115.2    1.7        1.5 NL            106.3    107.6    108.3    108.1    108.1    109.0    109.7    110.1    109.9    109.4    108.9    108.8    107.5    108.6                106.7    3.4        3.1 AT            106.2    108.5    110.1    108.4    108.0    110.4    111.2    110.2    108.1    109.7    110.7    109.9    108.1    109.7                111.5    3.1        2.8 PL            102.3    104.5    106.4    107.1    107.0    108.2    110.2    110.3    108.3    109.2    110.4    109.6    107.4    110.2                111.7    3.0        2.8 PT            102.3    102.6    103.5    103.4    103.4    104.1    103.4    103.0    101.6    101.2    99.8      99.9      99.6      99.3                98.7      5.4        5.2 RO            85.8      89.0      91.3      86.4      85.9      89.5      90.7      87.0      85.2      88.4      89.8      85.1      84.2      89.4                89.4      7.1        7.8 SI             107.0    110.8    112.3    109.8    108.7    110.9    114.3    112.0    107.6    109.4    111.1    109.7    108.0    108.3                108.2    6.7        5.9 SK            111.7    112.2    113.6    115.1    114.8    115.4    118.7    118.3    114.7    114.1    113.6    111.8    109.5    111.0                112.0    9.1        7.7 FI              102.0    106.6    107.4    105.0    104.5    108.7    108.4    106.0    103.4    105.5    104.6    101.7    100.9    105.0                105.2    7.8        7.2 SE            107.4    110.1    112.4    110.3    109.6    112.1    113.3    110.4    108.3    109.7    110.2    108.1    107.5    110.4                112.3    5.8        5.1 UK            105.9    106.3    107.2    107.7    107.5    107.7    107.8    107.6    106.5    105.6    106.1    106.1    105.1    105.7                106.9    2.7        2.5

Note: shaded cells denote period from peak to trough. (a) France is 2000Q1. (b) Drop in percentage of 2000Q2 employment; relative drop compares the trough with the peak.

Source: Eurostat, Labor Force Survey (LFS) quarterly data.

Despite the severity of the recession,
however, the regression in GDP has not come close to wiping out a decade of
relatively strong growth. Tables 1.1 and 1.2 show how all countries grew over
the decade despite the sharp downturn in 2008-10. Some countries (such as
Germany or Denmark) have a poor track record over the decade, with an annual
average growth rate below one percent. Most EU countries, however, end the
decade with significant improvements in real income: Spain, Ireland and Sweden
grew annually by an average of more than 2 percent, while some EU-12 countries
show an average annual growth rate of more than 4 percent, despite the large
contraction experienced during the recession.[3]
Two exceptions stand out: Italy and, to a lesser extent, Portugal. In Italy,
the meagre outcome of a decade of weak growth was wiped out by the recession,
so that by the end of the decade real GDP is virtually at the same level as in
2000.

1.2.
The boom period in the labour market

Some of these growing countries, however,
saw large increases in their workforce, either through migration or because of
an increase in the activity rate. In other words, increases in output do not
necessarily reflect increases in productivity.

An extreme
case is Spain, where employment increased by 32 percent from 2000 to its peak
in 2007. (This compares with 10 percent in the EU-27 as a whole). Thus, despite
a considerable contraction, Spain ends the decade 20 percent above its initial
level (see Table 1.2). This expansion is partly explained by large flows of
migrants: in the boom period, the proportion of foreign workers grew from 2 to
14 percent of Spain’s total active workforce.[4]

Table 1.3: Decomposing changes in real GDP per head, 2000-08 and 2000-10

|| 2000-10 || 2000-08 || 2000-08

|| Real GDP per head || Real GDP || Population || Real GDP per head || Real GDP || Population || Real GDP per hour || Average hours || Employment rate || Activity rate

European Union || 9.8 || 14.0 || 3.9 || 13.2 || 16.9 || 3.3 || : || : || : || :

Belgium || 8.0 || 14.5 || 6.0 || 10.4 || 15.4 || 4.5 || 4.9 || 1.3 || -0.1 || 4.0

Bulgaria || 62.0 || 49.3 || -7.8 || 68.8 || 57.2 || -6.9 || 31.8 || 1.0 || 11.5 || 13.8

Czech Republic || 33.5 || 36.9 || 2.6 || 37.4 || 39.6 || 1.5 || 36.6 || -5.0 || 4.6 || 1.2

Denmark || 3.3 || 7.2 || 3.7 || 7.4 || 10.5 || 2.9 || 4.1 || 0.7 || 1.0 || 1.4

Germany || 9.8 || 9.0 || -0.7 || 10.5 || 10.4 || -0.1 || 10.8 || -3.3 || 0.2 || 2.9

Estonia || 48.4 || 44.9 || -2.3 || 68.2 || 64.4 || -2.3 || 47.6 || -2.8 || 9.3 || 7.2

Ireland || 9.7 || 29.0 || 17.6 || 19.8 || 39.9 || 16.8 || 20.3 || -6.0 || -2.2 || 8.3

Greece || 20.7 || 25.9 || 4.3 || 30.6 || 34.4 || 3.0 || 19.7 || -0.3 || 4.0 || 5.3

Spain || 7.1 || 22.6 || 14.5 || 12.7 || 27.6 || 13.2 || 7.1 || -4.9 || -0.5 || 11.1

France || 5.6 || 12.7 || 6.7 || 7.8 || 13.9 || 5.6 || 9.2 || -2.0 || 1.1 || -0.4

Italy || -3.6 || 2.5 || 6.3 || 1.6 || 6.8 || 5.1 || -0.3 || -3.8 || 3.6 || 2.2

Cyprus || 13.4 || 31.3 || 15.8 || 16.4 || 33.0 || 14.3 || 10.2 || -4.0 || 1.2 || 8.7

Latvia || 51.4 || 43.1 || -5.5 || 83.5 || 75.2 || -4.5 || 61.0 || -9.1 || 7.3 || 16.8

Lithuania || 61.4 || 51.9 || -5.9 || 84.9 || 77.4 || -4.0 || 58.3 || 3.3 || 12.8 || 0.3

Luxembourg || 16.3 || 34.6 || 15.7 || 21.0 || 35.4 || 11.9 || 6.9 || 9.4 || -2.5 || 6.1

Hungary || 22.7 || 20.3 || -1.9 || 29.8 || 27.6 || -1.7 || 35.4 || -2.7 || -1.7 || 0.2

Malta || 10.8 || 17.5 || 6.0 || 10.1 || 16.4 || 5.7 || 7.9 || -3.5 || 0.9 || 4.8

Netherlands || 9.5 || 14.2 || 4.3 || 13.2 || 16.9 || 3.3 || 13.1 || -3.9 || 0.0 || 4.1

Austria || 11.3 || 16.5 || 4.7 || 14.2 || 18.8 || 4.1 || 12.4 || -2.8 || -0.3 || 4.7

Poland || 46.3 || 46.0 || -0.2 || 39.3 || 38.8 || -0.4 || 28.7 || -0.8 || 10.7 || -1.4

Portugal || 2.4 || 6.7 || 4.1 || 4.1 || 8.1 || 3.9 || 8.2 || -2.3 || -3.9 || 2.5

Romania || 55.1 || 48.1 || -4.5 || 69.6 || 62.6 || -4.1 || 84.4 || 1.4 || 1.4 || -10.5

Slovenia || 27.8 || 30.7 || 2.2 || 38.1 || 40.6 || 1.8 || .. || .. || 2.4 || 4.4

Slovakia || 59.4 || 59.9 || 0.3 || 61.1 || 61.2 || 0.1 || 49.7 || -7.0 || 11.4 || 3.9

Finland || 15.3 || 19.5 || 3.7 || 23.1 || 26.3 || 2.7 || 17.9 || -2.5 || 3.9 || 3.0

Sweden || 15.5 || 21.8 || 5.5 || 17.5 || 22.5 || 4.3 || 16.4 || -1.0 || -0.7 || 2.7

United Kingdom || 9.2 || 15.4 || 5.7 || 14.4 || 19.3 || 4.3 || 15.4 || -3.5 || -0.3 || 3.0

Note, however,
that employment (except in Romania and Portugal) increased over the decade,
despite the recent downturn. Other than in Estonia, Luxembourg and Spain, the
share of foreign workers remained fairly stable during this strong cycle —
which is quite surprising. More strikingly, the recession has not changed that
share. In some cases it has not even reversed the increasing trend. This
suggests that foreigners do not constitute a disposable work force but are
well-integrated into the economic tissue of their host countries. The same goes
for the share of part-time workers in total employment, which remained roughly
constant, ranging from low values like 4 percent in Hungary to 46 percent in
the Netherlands, with an average of 18 percent for the EU-27.

The behaviour of temporary contracts depends
on how (and why) such contracts are used. In Germany the share is a constant 14
percent but in Spain it reaches a peak in 34.6 percent in 2006 and then drops
to 24 percent.[5]

Figure 1.3: Unemployment rate in 2010Q3 with minimum and maximum value before and during the recession

Source: Eurostat, Quarterly LFS statistics for employment, Unemployment - LFS adjusted series,une\_rt\_q.

Box 1.2: Employment: Conjunctural versus structural readjustment Countries affected by housing bubbles or other imbalances have seen their unemployment rates soar in comparison to other Member States. The reason is to be found in the different prospects faced by firms in these countries. In bubble countries there are two reasons why unemployment has risen more than the average. First, they are undergoing a major structural readjustment, namely the downsizing of their construction sector. Second, as mentioned above, households and firms are trying to deleverage, cutting down consumption and increasing savings. This slows down the recovery and worsens the situation for businesses, which are then reluctant to hire new workers. In contrast, in countries not directly affected by these imbalances, the better prospects of a swift recovery made possible for employers to hoard labour rather than firing workers. Indeed, if resizing the labour force entails adjustment costs, firms will react by hoarding labour to preserve good matches as well as firm-specific human capital. In turn, workers kept in employment help maintain internal demand, making these countries’ prospects even better by comparison with bubble countries. It thus appears that labour hoarding is a natural response to a good business outlook in the short-term. The government should not force firms to respond in the same way if major structural readjustments are taking place because it would just delay an inevitable adjustment. Figure 1.4 takes two of the most obvious cases at both extremes of the spectrum and is self-explanatory.

Figure 1.4: Germany and Spain compared: Employment in the construction sector in persons and in percentage of total employment

Note: Until 2008Q4 NACE rev.1, thereon NACE rev.2. In both cases construction is epigraph F. Until 2004 German data only available one quarter per year: the missing observations are linearly interpolated to build the graph.

Source: Eurostat, Labour Force Survey, LFS series - Detailed quarterly survey results (lfsq\_egana).

1.3.
Borrowing, lending and the exit from the
recession

While there is still some debate on the
origin of these imbalances, there is already a degree of consensus on the role
of the euro in their development (see European Commission (2010c). The boom
years saw a notable increase in capital flows in all European countries. The
way net lending and borrowing (Figure 1.5) behaved gives an idea of how
countries were affected throughout this period, and may indicate how they will
get out of the recession.

There are four types of countries. In the
first group one finds countries like Belgium or the Netherlands. They have
traditionally been net lenders and the boom period, if anything, intensified
this trend. In the second group are countries like Germany or Sweden that
started being borrowers and became major lenders. In the case of Sweden this
change occurred after the financial crisis in the 1990s: in the case of Germany
it happened approximately when the euro was introduced. A third group comprises
those countries that have seen their levels of borrowing increase to
unsustainable levels. They include Greece, which in 2008 borrowed an amount
equivalent to 15 percent of its GDP, and Spain which went from being a net
lender in the late 1990s to borrowing almost 10 percent of its GDP for three
consecutive years between 2006 and 2008. These countries will find it harder to
recover since they will face substantial sectoral readjustments in addition to
the deleveraging of households and firms. Greece, Spain and Ireland are showing
signs of this readjustment in that their net borrowing is decreasing very fast,
mirroring the decrease in lending by Germany and Belgium.

Finally, the fourth group comprises
Portugal and Italy, neither of which had a bubble but both of which show weak
growth. More intriguingly, neither of them has really managed to reduce its
dependence on foreign capital after the crisis. They differ only in that Italy
does not have a significant external imbalance while Portugal does, and it
started twenty years ago.

Figure 1.5: Net lending (+) / net borrowing (-) for selected EU Member States

Source: AMECO database, European Commission; Net lending (+) - net borrowing (-), total economy (UBLA).

In short, countries like Germany and Sweden
will recover very fast, France and the UK more slowly. Greece and Spain will
follow a path of modest growth while deleveraging is ongoing; Italy and
Portugal are likely to face persistent stagnation unless they undertake
structural reforms.

If Europe is set on a path of recovery, it
is a slow one compared to the US and even more so when compared with emerging
economies. Estimates of real growth rates for the last three years tend to
indicate that the EU’s income has not yet returned to its 2007 level while its
main Asian competitors have seen their income rise well above pre-crisis levels
(Figure 1.6): South Korea 10 percent higher, India 23 percent and China 32
percent.[6]
Note that East Asian economies can be seen as victims of the imbalances in the
US and the EU: they were not affected by internal imbalances; it was a
conjunctural downturn, hence the strength of their recovery is not surprising
and it will in turn help the European recovery.

Figure 1.6: Real GDP in EU-27 and selected economies (2007 = 100)

Source: OECD Quarterly National Accounts.

1.4.
Restructuring versus conjunctural downturn

From Table 1.3 it is clear that there is no
obvious connection between the severity of the recession and recent
productivity developments. To understand this, and in connection with all of
the above, we need to note that different sectors have been affected in very
different ways.

As is usual in recessions, consumer durable
goods and investment are the most sensitive items. Consumers postpone purchases
of items like cars and household appliances while continuing to consume energy
and non-durable items like food (see Table 1.4). This would explain the marked
difference in the drop in 2009, which for the EU was around 15 percent for
durables and barely 2.7 percent for non-durables.

More interesting, however, is the large
contraction of building (not civil engineering). It has dropped more than the
average and by March 2011 it had not yet started to recover; see the Monthly
Note March 2011 (European Commission (2011c). This is a sign of the correction
taking place after a decade of overinvestment in the housing sector. Indeed,
the recession can be seen as a correction or readjustment once the prices of
certain assets are deemed unsustainable. Other sectors not directly related to
the construction boom will recover relatively faster. Those more cyclical like
Basic metal, Motor vehicles, etc., display in table 1.4 double digit positive
growth since the trough. The way countries perform, overall, during this
recession will depend on the relative importance of each of these sectors. But
high performing sectors, those who performed well before the crisis, will in
all likelihood do well in the future in every Member State. This line of
reasoning explains the apparent paradox of countries hit hard by the recession,
and yet with an overall reasonable performance over the decade (see again Table
1.3). In other words, that the construction sector was oversized in 2007 does
not mean that it was at the expense of other productive sectors that may be
driving growth of productivity, maintaining international market shares, and
leading now the recovery.[7]

Indeed, the recovery of other sectors,
notably manufacturing, is already under way, and it is benefiting from the
steady growth of economic activity in emerging countries. As noted in the
previous section, GDP outside the EU and the US was not much affected and is
now growing fast, attracting European exports. By January 2011 the value of EU
exports was 33 percent above its level a year earlier.

On the finance side, according to the
Monthly Note March 2011, recovery from the credit squeeze is lagging behind the
recovery of manufacturing activity but is not worsening.[8] Less encouraging are the grim
prospects for European venture capital. According to Coller Capital (2011), a
recent survey of the private equity industry, large investors will be moving
away from venture capital in Europe in the coming years. In the US, 50 percent
of investors consider venture capital a promising investment. The corresponding
figure in Europe is less than 10 percent. Hardly anyone who answered the survey
believes that venture capital will generate consistently strong results over
the next decade, given its poor performance in the last ten years. As discussed
below, this may handicap the EU’s ability to bring innovations to the market
through start-ups.

Figure 1.7: Cyclical intensity and the drop during the downturn in the EU-27

Note: Cyclical intensity is defined as the standard deviation of output from trend for each sector relative to that of total manufacturing. The trend is extracted with the Christiano-Fitzgerald band-pass filter and the period is 1990-2010. The drop is measured as the percentage difference between the peak and the trough.

Source: European Union Industrial Structure 2011.

Table 1.4:  Recent developments in EU-27 sectors. Percentage changes in value added

NACE Rev.2                                                         Growth 2008              Growth 2009    Last six months                                            Post trough growth     Spread last six months            Capital                                      0              -19.4         9.4            13.8          1.1            Consumer                                 -2             -4.3           3.7            4.7            -4            Durable consumer                     -5             -15.1         6.3            7.7            -0.7            Nondurable consumer                -1.5           -2.7           3.1            4.4            -4.6            Intermediate                              -3.6           -17.8         11             15.1          3.1 B          Mining & quarrying                     -3.6           -11.1         1.2            0.5            -4.9 C          Manufacturing                           -1.9           -14.5         8.1            9              - C10      Food                                        -0.6           -0.9           1.7            3.8            -6.5 C11      Beverages                                 -1.9           -2.7           -1.6           0.1            -9.5 C12      Tobacco                                   -16.2         -1.9           -5.9           0              -9.6 C13      Textiles                                    -10.1         -16.4         8.9            14.4          4.8 C14      Clothing                                    -3.4           -11            2.4            6              -0.2 C15      Leather and footwear                  -7.9           -12.4         5.4            8.4            2.4 C16      Wood                                       -8.8           -14            4.2            5              -3 C17      Paper                                       -3.4           -8.9           7.3            9              -0.9 C18      Printing & publishing                  -2.3           -7.4           0.4            2.5            -6.9 C19      Refined petroleum                      3.2            -7.9           1.1            7.9            -6.1 C20      Chemicals                                -3.3           -10.7         11.3          19.7          2.6 C21      Pharmaceuticals                       1.6            3.1            6.9            13.6          -5.3 C22      Rubber & plastics                      -4.8           -12.9         8              11             -0.3 C23      Non metallic mineral products     -6.7           -18.4         4.7            6.3            -2.1 C24      Basic metals                             -2.8           -25.6         21             42.4          13.7 C25      Metal products                          -2.4           -21.8         8.9            11.1          1.3 C26      Computers, electronic & optical  2.7            -16.7         10.6          11.5          0.7 C27      Electrical equipment                  -0.1           -20.2         13.8          14.6          5.7 C28      Machinery n.e.c.                       1.4            -25.9         12.2          18             4.7 C29      Motor vehicles                           -6.1           -21.8         19             48.3          9.6 C30      Other transport eq.                    4.3            -5.9           -3.2           2.2            -10.7 C31      Furniture                                   -1.1           -5.9           8.6            1.2            1 C32      Other manufacturing                  -4.9           -16.5         0              9              -6.2 C33      Repair of machinery                   5.5            -8.5           2.3            6.5            -3.4 D          Electricity, gas & water              0.3            -4.9           3.7            7.7            -4.8 F          Construction                             -3.7           -9             -2.8           4.8            -10.4 F41       Buildings                                  -4.4           -11.4         -3.4           4.1            -11.2 F42       Civil engineering                        -1.2           1.8            2.2            7.3            -4.9

Source: European Union Industrial Structure 2011.

Table 1.5: Trends in productivity and hours worked. Percentage changes in 1995-2007

                                                                                per person in employment           per hour worked                                                                 hours per person in employment TOT          Total                                                           14.11        18.59        -3.77 AtB           Agriculture                                                   34.67        38.40        -2.69 C              Mining and quarrying                                    14.54        13.53        0.89 D              Total manufacturing                                      34.83        40.10        -3.76 15t16        Food, beverages and tobacco                        6.02          12.23        -5.53 17t19        Textiles                                                       23.63        26.00        -1.87 20             Wood                                                          33.29        39.99        -4.79 21t22        Pulp, paper and printing                                32.27        32.29        -0.02 23             Coke, refined petroleum                                -11.14       -4.11         -7.33 24             Chemicals                                                   51.39        58.71        -4.62 25             Rubber and plastics                                     43.27        48.91        -3.79 26             Other non-metallic mineral                            26.66        32.03        -4.07 27t28        Basic metals                                               18.57        20.98        -1.99 29             Machinery, nec                                            23.56        28.43        -3.79 30t33        Electrical and optical equipment                    97.19        106.34      -4.43 34t35        Transport equipment                                     35.11        46.10        -7.52 36t37        manufacturing nec; recycling                         15.23        18.52        -2.78 E              Electricity, gas and water supply                   42.90        50.46        -5.02 F              Construction                                                -0.48         -0.80         0.33 G              Wholesale and retail trade                            17.69        23.95        -5.05 50             Retail trade of motor vehicles                        13.31        19.64        -5.29 51             Wholesale trade; no motor                            26.28        31.47        -3.94 52             Retail trade; no motor vehicles                      9.98          16.67        -5.73 H              Hotels and restaurants                                 -8.31         -1.01         -7.38 I               Transport, storage, communication                49.18        53.57        -2.86 60t63        Transport and storage                                   21.74        26.44        -3.72 64             Post and telecommunications                       129.81      135.95      -2.60 JtK           Finance, real estate and business services    -3.18         -0.80         -2.40 J               Financial intermediation                                45.02        48.97        -2.65 70             Real estate activities                                    -9.83         -5.94         -4.14 71t74        Renting of m&eq and other business activities                -1.60         0.75          -2.34 LtQ           Community and social services                     -0.13         2.85          -2.90 L              Public admin and defence                             12.20        15.83        -3.14 M             Education                                                    -7.95         -8.27         0.35 N              Health and social work                                 6.09          9.01          -2.68 O              Other community                                         -7.00         -3.42         -3.70 P              Private households                                       -9.85         -4.94         -5.16

Note: Numbers are percentages.

Source: European Union Industrial Structure 2011.

1.5.
The role of innovation in the recovery

If the recession is about restructuring
some sectors, but does not affect the capacity of competitive sectors to
thrive, the outlook for the medium-term recovery is good, and leads to the
issue of how to support innovation and productivity growth in the EU. The focus
here is on R&D, for it is considered an important source of innovation and
therefore sustained growth.

Despite the emphasis on R&D intensity of
the Lisbon strategy, progress in the past decade has been modest. The Innovation
Union Competitiveness Report 2011 (European Commission (2011b)) reports that
some countries (Estonia, Portugal, Ireland, Spain and Cyprus) have doubled or
more their R&D intensity since 2000 while most countries have increased it
by 50% or less and a last group (Greece, Belgium and Slovakia) has shown no
change or a small decrease. Of course, the departure point was very different
across countries: the larger Member States are among the slowest progressing
countries, which explains the limited progress of the EU aggregate R&D
intensity. Hence, albeit good progress has been made in several countries, the
EU as a whole is still far from the target set in the Lisbon strategy.

The crisis will not help either although it
is expected that R&D expenditures financed by the business sector will
rebound for they are known to be strongly procyclical. In times of crisis firms
cut down spending in R&D and there is evidence that financial constraints
play an important role. Indeed, during a recession, most efforts are directed
to cost-saving innovations. Even without financial constraints, it may be
optimal from the individually point of view for R&D expenditures to be
procyclical. However, because of positive externalities of R&D it may be
too procyclical (see the discussion in section 1.4, European Competitiveness
Report 2009). This would be a case for counter-cyclical public funding of
R&D, and indeed, actual R&D financed by the government appears to go
counter the cycle in Figure 1.8.

Box 1.3: Technical change In the economic jargon technical change refers to any new process or commodity that allows increasing the value of production per unit value of inputs (including factors of production, like capital and labour, and intermediates). Examples include the refinement of a process that allows reducing the consumption of energy, given the level of production, or the introduction of a new good, like mobile phones, that fulfils a consumer demand so far unsatisfied. Robert M. Solow (1956) noted how physical capital (machines) could not reproduce itself indefinitely.[9] He then concluded that observed sustained growth of income had to be explained by technical change: by the ability to add more value sustainably with the same amount of labor. In other words, the importance of innovation stems from the fact that, ultimately, it is the only source of long-run growth or productivity, in turn the only source of raising living standards. Indeed, innovation and technical change are two faces of the same phenomenon. Innovations stem from experience (learning-by-doing), the accumulation of human capital through formal education (learning-or-doing) and from research and development (R&D) activities. R&D can be seen as the purposeful allocation of resources (labor, capital) to the generation or adaption of innovations: new goods, new processes and new knowledge. From the moment in which firms devote resources to R&D, these have to be innovations with (at least) a (potential) commercial value. In turn, if it has a market value one can conclude that R&D induces technical change: the ability to produce more value given the inputs. It should be noted, however, that private R&D does not include all forms of “purposeful” innovation: it also includes basic research, public R&D, or even other steps in the innovation process such as marketing, a key step in taking effectively an innovation to the market and therefore give it in effect a commercial value.[10]

Figure 1.8: Real growth rates for R&D and GDP, OECD area, 1982-2007

Source: Figure I.2.1 in Innovation Union Competitiveness Report 2011 (European Commission (2011b)).

1.6.
Overview of R&D in Europe

The extent to which a society is committed
to innovation can be captured by R&D intensity: the share of R&D
expenditures in value added. R&D intensity is for innovation what the
saving rate represents for physical capital, a measure of foregone resources
today for a promise of a return tomorrow, in this case in the form of new
technologies or goods or services.

If one feature characterizes business
R&D intensities across countries, it is the large variability observed.
Figure 1.9 illustrates this variability for the manufacturing sector; from 0.5
percent in Slovakia to 12.4 in Sweden. Furthermore, it is also clear that the
US invests significantly more in R&D than the EU-14. It should be noted,
however, that the differences between the US and the EU lie in the business
enterprise activities: R&D funded by the government, typically performed in
universities and other research organizations as well as by the government
itself, is already similar across the Atlantic.

Figure 1.9: R&D intensity (R&D expenditures over value added) of the manufacturing sector, year 2005

Note: 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; EU-14 is the EU-15 minus Luxembourg.

Source: OECD, STAN indicators 2009.

A second remark concerns regional or within-country
variability. Figure 1.10 shows how US states display a similar range of
variability to that of EU Member States: from the extremely low investment of
Wyoming, a scarcely populated rural state, to the extreme case of Maryland with
close to a 6 percent of GDP of expenditures in R&D.[11] This variability, of course,
reflects patterns of regional specialization that may be optimal from the
social point of view. If spillovers and other positive externalities typical of
knowledge-intensive activities apply to R&D, it may pay off to invest more
in Silicon Valley rather than in Wyoming.[12]
These numbers also illustrate the reason why the EU ―the Lisbon strategy
first and the EU 2020 strategy now― has always set the 3 percent R&D
intensity target for the EU as a whole and not for individual Member States.

Figure 1.10: R&D intensity in US states and EU Member States

Source: OECD Main Science and Technology Indicators Database.

In any case, a glance at this figure shows
that the EU and the US are reasonably similar as for geographic patterns: it
does not seem that the aggregate differences observed correspond to a
consistently lower investment in EU Member States. It does not seem either to
be related to some environmental factor directly affecting RDI: empirical
evidence shows that similar firms across the Atlantic behave similarly (in the
sense of having similar RDI, profits, etc.).[13]

1.7.
Sectoral dimension of innovation

Observed differences in R&D intensities
across Member States and between the EU and the US may have different
explanations. One possibility is that EU Member States tend to specialize in
sectors characterized by a lower R&D intensity. Indeed, different sectors
will be characterized by different intensities because of intrinsic and
extrinsic characteristics. For example, different sectors of economic activity
are characterized by different technologies. To the extent that these
technologies have different degrees of codability,[14] one should observe different
degrees of R&D intensity to the extent that R&D is directed towards
patentable discoveries. This would explain differences in levels across
sectors. A clear examples of an extrinsic trait would be the degree of
competition: Laing et al. (1995) suggest that the level of market integration
(increased competition) affects both the incentives to engage in R&D and
the returns to this investment, but the degree of competition may well be
different per sector given the nature of the commodities produced and traded.
Along the same lines, Baily and Laurence (2001) link competitive markets to the
adoption of information technologies (IT) in the US.

What about the differences between the EU
and the US? When examining the distribution of R&D expenditures across
sectors, the EU Industrial R&D Investment Scoreboard (European Commission
(2010d)) shows that medium-tech sectors are overrepresented in R&D
expenditures by EU firms compared to US firms. This would be consistent with
the observation that EU economies show some sectoral structure sluggishness
compared to the US, a rigidity that would explain why in the US investment in
high-tech sectors has soared in the past 20 years while the distribution of
expenditures in the EU looks today similar to that of the 1980’s.

Table 1.6: An overview of differences EU-US in R&D

                                                                                                     Distribution of R&D across sectors, % total  R&D intensity (over value added)                                                                                                      EU-14   US        EU-14   US   C15T37 MANUFACTURING                                                             81.53    70.30    6.26      9.79     C15T16 Food products, beverages and tobacco                              1.76      1.44      1.14      2.04     C17T19 Textiles, textile products, leather and footwear                    0.59      0.36      1.04      2.02     C23T25 Chemical, rubber, plastics and fuel products                       21.72    20.43    9.75      13.61     C26 Other non-metallic mineral products                                        0.78      0.40      1.31      1.69       C27 Basic metals                                                                       1.08      0.28      1.98      1.12       C28 Fabricated metal products, except machinery and equipment  1.12      0.61      0.89      1.11     C29T33 Machinery and equipment                                                 28.78    28.79    9.69      22.33         C30 Office, accounting and computing machinery                       1.92      2.19      18.47    24.66         C31 Electrical machinery and apparatus, n.e.c.                          2.96      1.07      5.00      5.24         C32 Radio, television and communication equipment                   10.74    13.10    29.67    43.06         C33 Medical, precision and optical instruments                           5.08      8.66      11.62    43.68       C34 Motor vehicles, trailers and semi-trailers                                16.03    7.12      15.44    16.38       C35 Other transport equipment                                                    8.47      8.82      23.33    24.75     C36T37 Manufacturing n.e.c. and recycling                                     0.56      0.52      1.09      1.13   C40T41 ELECTRICITY GAS AND, WATER SUPPLY                         0.58      0.09      0.39      0.09   C45 CONSTRUCTION                                                                     0.41      0.56      0.09      0.21   C60T64 TRANSPORT, STORAGE AND COMMUNICATIONS             3.02      1.26      0.58      0.39         C72 Computer and related activities                                           5.94      13.49    3.99      15.52         C74 Other business activities                                                    2.20      ..          0.35      ..   C75T99 COMMUNITY, SOCIAL AND PERSONAL SERVICES           0.37      ..          0.02      .. C50T99 TOTAL SERVICES                                                               16.42    29.04    0.30      0.68

Notes: 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; EU-14 is the EU-15 minus Luxembourg.

Source: OECD, STAN indicators 2009.

A problem with the scoreboard, however, is
that it is a sample constituted of the largest R&D investors.[15] Looking at OECD aggregate data
(Table 1.6), focusing on R&D performed in a given region by all firms
regardless their nationality, there is no extraordinary difference between the
EU and the US as for the distribution of R&D across sectors within
manufacturing.[16]
Furthermore, these sectors account for similar shares of total value added in
the economy (Figure 1.11). In short, differences are to be found rather in the
amount invested, particularly in high-tech sectors like Radio, television and
communication equipment or medium-high-tech sectors like Machinery and
equipment.

Figure 1.11: Economic sectors: R&D intensity and the weight in total value added 2006

Note: 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. The EU is AT, BE, CZ, DK, FI, FR, DE, EL, HU, IE, IT, NL, PL, PT, ES, SE, UK. Data corresponds to 2006 except EL, IE and PT that use 2005.

Source: OECD, STAN database for structural analysis and STAN indicators 2009.

A more systematic and synthetic look at the
differences in R&D intensities confirms the intrinsic smaller intensity of
European sectors (and allows to have a good glance at all Member States).

Box 1.4 Sectoral structure versus individual intensities Differences in R&D intensities across countries can be attributed to differences in the industrial structure or to differences in sectoral intensities. Indeed, on one hand, it could be that one of the countries specializes in sectors that are relative more (or less) R&D intensive (the sectoral factor). On the other hand, it may also be that the same sectors of economic activity display a different intensity (the intensity factor). The literature uses a common additive decomposition (e.g., Moncada et al. (2010)) that has the inconvenient of assuming that the country of reference has, in a sense, the “right” sectoral intensities. In this section an alternative way to decompose aggregate differences into sectoral and intensity differences is applied. This decomposition uses the Fisher ideal index. Being defined as the geometric average of the Laspeyres and Paasche index, the sectoral intensities of any given two countries or regions are treated symmetrically: no region is assumed to have the “right” intensities, and hence the choice of the reference country is unimportant (for the details see Durán (2011)). The factorial decomposition is then linearized to obtain the aggregate differences in intensities additively decomposed in a sectoral and an intensities component as in Figure 1.12.

Figure 1.12: The role of sector intensities and sectoral structure in differences in business R&D intensity (with respect to the EU)

Note: The total difference is the difference in business R&D intensity in percentage points of value added. The sectoral structure and individual intensities factors add up to the total difference. Hence, for example, AT and BE are shown to be close to the EU average. The EU here is the current selection of Member States; countries are chosen as a function of data availability.

Source: OECD STAN database for structural analysis.

In general, aggregate intensity in R&D
is determined by both the sectoral structure, the weight of more intensive
sectors in total value added, and the intensities of individual sectors, how
intensive a given sector is across countries. Hence, observed aggregate
differences can be decomposed into a sectoral structure and an individual
intensities factor (see Box 1.4). Figure 1.12 shows how the bulk of the differences
with the US are associated to higher intensities in given sectors in accordance
to the preliminary evidence of the previous section.

It also provides in a simple glance a
picture of the different ways in which EU Member States depart from the EU
average. From the intensities perspective, the case of Hungary stands out for
its extreme decomposition. The combination of the “right” sectoral structure
(R&D intensive sectors weight a lot in the economy) and the very low
intensity denotes an assembly economy that indeed exports high-tech commodities
produced for foreign corporations (so that the associated R&D is performed
somewhere else).

1.8.
The returns to R&D and policy considerations

Examining these differences in R&D
intensity across countries and regions leads to the question of whether there
is anything to do about it. This is particularly true in times of distress with
budgetary pressures exacerbating the tension between the need to support growth
strategies and the balance of public finances.

As discussed above, R&D is an important
source of innovation and therefore sustained growth. Investment in R&D is
associated with important private returns but also with significant spillovers
that would justify public intervention; McMorrow and Röger (2009) includes a
comprehensive review of the vast literature on the returns to R&D. Indeed,
public support to R&D, typically in the form of tax relief or direct
subsidies, has been traditionally justified in terms of spillovers: if the
social returns are larger than the private ones, there remains the possibility
that the market underinvests in R&D compared to the social optimum.
Furthermore, as noted above, private R&D may tend to be excessively
volatile, again from the social optimal point of view, which motivates increasing
public support to R&D in bad times to smooth investment over the cycle.

Figure 1.13: R&D intensity and specialization

Note: The indicator of sectoral specialisation compares the share of a given sector in one country with the share of the same sector in the EU as a whole. The country index of specialization is the Euclidean distance to the EU average. Hence, more diversified economies have smaller indexes of specialization.

Source: Specialization index: EU Industrial Structure 2011. RDI: OECD, STAN database for structural analysis and STAN indicators 2009, own calculations.

Finally, the variability across Member
States can be seen either as room for improvement in those regions with less
R&D intensity or as reflecting a natural process of regional
specialization. The second interpretation seems reinforced in regard of the
similar variability observed across US states. This means that the traditional
support to R&D may help cover the gap between private and social returns to
R&D but may not help close the gap across regions. Indeed, regions with
lower intensity are not necessarily regions where individual firms invest less
in R&D because similar firms (in terms of size, sector, turnover, etc.)
tend to be similar as well as regards R&D intensity (see again Moncada
(2010)). Hence, aggregate differences seem to respond to the less frequent
observation of R&D intensive firms. More intriguing is the fact that
differences in R&D intensity are not translated into differences in trend
growth rates. Indeed, despite large differences in R&D intensities, in the
longer term countries tend to grow on average at similar rates. The role of
technology adoption and trade in technical change diffusion may be the key
explanation for this apparent paradox (see, e.g., Guellec and van Pottelsberghe
(2001)). To illustrate this, consider the last decade in Europe: in Figure 1.14(a)
we can see that there is a connection between R&D expenditures and
productivity growth; however, the catch-up process of the EU-12 Member States
is a far stronger driver of technical change.

Figure 1.14: RDI, productivity growth and catch-up

                                       (a)                                                                          (b) (c)

Note: Variables are average RDI (over value added) in 2000-05, percentage growth of GDP per hour worked in 2000-10, and GDP per capital in Euros in 2000. A simple regression of productivity against RDI and the level of income at the beginning of the period (and its square) yields the estimates 0.80 (0.79), -2.53 (-3.34) and 0.03 (2.48) where the number in parenthesis is the t-statistic (and the adjusted R-square is 0.53).

Source: AMECO database, European Commission, for productivity; OECD, STAN indicators 2009, for RDI.

These pieces of evidence together indicate
that besides the importance of traditional R&D activities, there are other
important sources of innovation. The EU Industrial R&D Scoreboard points
out that the EU has fewer young innovative firms than the US; and that these young
firms, on average, invest less in R&D than their US counterparts. This
suggests that part of the observed differences in R&D intensity may lie in
differences in the creation of firms, the intensity of start-ups, the growth
and the survival of these firms.[17]
Hence, besides the traditional support to R&D in incumbent firms, other
policy instruments could focus in supporting the creation and survival of
innovative firms, be it entirely new establishments or spin-offs from
universities or corporations.

All these facts together suggest that an
important fraction of innovations are vague ideas difficult to transmit or
codify, and hence posing two problems: they make it difficult to finance by
nature[18]
and difficult to protect by patents or other means of intellectual protection.
Indeed, their ambiguity is connected with its incodificability, difficult to
turn into a patent. The only alternative is “do it yourself” and be the first
mover creating the firm. In such case, entrepreneurs turn out to be key
innovators bringing new ideas to the market in the form of start-ups. But then
the key issue when it comes to these innovators turns out to be framework
conditions and, in particular, the easy to do business. Add the evidence
mentioned above about the lower R&D intensity of young innovators, and the
support to start-ups appears as a potentially effective policy target.

The protection of these innovators requires
as well the fine-tuning of intellectual property rights (IPR). The importance
of the protection and promotion of IPR is obvious. IPR is necessary to protect
creators of new industrial ideas (patents), artists and media (copyrights) or
the reputation of a company (trademarks). Nevertheless, in this field more in
not necessarily better: an excessive protection can hamper the creation,
development and commercialization of new ideas. For instance, the European
Commission advocates the monitoring of competition services to prevent “the
abuse of IPR which can hamper innovation or exclude new entrants, and specially
SMEs, from markets.”[19]
For example, an excessive protection may seriously distort incentives and use
patents as an offensive device. In a world in which physical capital and other
inalienable assets are less important, patents seem to be one of the main assets
behind a company’s value (Kaplan et al. (2005)). This has the potential to
distort the market in two ways. On one hand, firm managers have an incentive to
patent in excess to reduce competition[20]
and increase the value of the firm in the short-term. On the other hand, and
for the same reasons, managers have incentives to buy out other firms just to
take control of their patent portfolio to hamper the development of outside new
ideas that may harm their business model and to increase the price of shares in
the stock exchange.[21]
Finally, another possibility, at least in theory, pointed out in Aghion et al.
(2008) is that we “privatize” research lines sooner than it would be optimal
from the social point of view in two senses: too expensive and preventing potential
ideas to arise because the kind speculative research that gives origin to many
breakthroughs is typically not pursued in private sector, much more focus on
the development of commercial applications.

Public support to R&D is a key element
of any broad innovation policy. If anything, the evidence reviewed above calls
for a careful choice of the targets. For instance, there is evidence that
public support to private R&D is more effective in small firms, probably
because they are more likely to be credit-constraint.[22] Support to small enterprises
is even more important in times of crisis because small liquidity-constraint
firms tend to cut expenditures in activities like R&D that have
non-immediate returns (see section 1.4 in the ECR 2009 and references therein).
Furthermore, in light of the discussion above, focusing on start-ups and young
innovative firms may prove to be a more effective way of fostering innovation.
Recent examples following this logic is the new focus of the Canadian NSERC on
small firms partnering with scientists or the focus of the Western Sweden
region on a “systemic vision of innovation” that favours “initiatives targeting
public bodies and research institutions” where private firms are not the main
target. [23] Finally, an
important aspect of innovation is education: if R&D represents the demand
for high-skilled labor, support to higher education should guarantee that the
supply-side meets the demand from businesses. Conte et al. (2009) present
evidence that the efficiency of policies supporting R&D relies in related
education policies.[24]
In that respect it may be worth noting that the EU spends significantly less
than the US in higher education: 1.1% of GDP versus 2.9% respectively;
increasing support to R&D without education may risk distorting the market
for scientists and engineers.[25]

References

Aghion, P., Dewatripont, M. and Stein, J.
(2008), ‘Academic freedom, private-sector focus, and the process of innovation’,
RAND Journal of Economics, 39(3), 617-635.

Baily, M.N. and Lawrence, R.Z. (2001), ‘Do
We Have a New E-Conomy?’, American Economic Review, 91(2), 308-312.

Bronzini, R. and Iachini, E. (2011), ‘Are
incentives for R&D effective? Evidence from a regression discontinuity
approach’, Banca d’Italia Working Paper 791, February 2011.

Caselli, F. and Wilbur, J.C. II (2001),
‘Cross-Country Technology Diffusion: The Case of Computers’, American
Economic Review, 91(2), 328-335.

Claessens, S., Kose, M.A. and Terrones,
M.E. (2009), ‘A recovery without credit: Possible, but…’, VoxEU column no.
3600.

Coller Capital (2011), Global Private
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Dijkstra, L. (2010), ‘The Regional Lisbon
Index’, Regional Focus 03/2010, Directorate-General Regional Policy, European
Commission.

Durán, J. (2011), ‘Decomposing aggregate differences
into differences in sectoral structure and sectoral intensities’, Mimeo, Directorate-General
Enterprise and Industry, European Commission.

EEAG (2011), The EEAG Report on the
European Economy, CESifo, Munich 2011.

European Commission (2009a), European
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European Commission.

European Commission (2009b), ‘Economic
Crisis in Europe: Causes, Consequences and Responses’, European Economy 2009-7,
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European Commission (2010a), European
Competitiveness Report 2010, Directorate-General Enterprise and Industry,
European Commission.

European Commission (2010b), Employment
in Europe 2010, Directorate-General Employment and Social Affairs, European
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European Commission (2010c), Product
Market Review 2010, Directorate-General Economic and Financial Affairs,
European Commission.

European Commission (2010d), The 2010 EU
Industrial R&D Investment Scoreboard, Joint Research Centre,
Directorate-General Research and Innovation, European Commission (online at
iri.jrc.ec.europa.eu).

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in Europe 2010, Directorate-General Employment and Social Affairs, European
Commission.

European Commission (2011a), European
Union Industrial Structure 2011, Directorate-General Enterprise and
Industry, European Commission).

European Commission (2011b), European
Research and Innovation Competitiveness Report 2011. Directorate-General
Research and Innovation, European Commission.

European Commission (2011c), ‘The Economic
Recovery in Industry’, monthly note, March 2011, Directorate-General Enterprise
and Industry, European Commission.

Goolsbee, A. (1998), ‘Does Government
R&D Policy Mainly Benefit Scientists and Engineers’?, American Economic
Review, 88(2), 298-302.

Guellec, D. and Van Pottelsberghe de la
Potterie B. (2010), ‘R&D and productivity growth: Panel data analysis of 16
OECD countries’, OECD Economic Studies No. 33, 2001/II.

Hayashi, F. and Prescott E.C. (2002), ‘The
1990s in Japan: A Lost Decad’e’, Review of Economic Dynamics, 5(1),
206-235.

Kaplan, S.N., Sensoy B.A. and Strömberg P.
(2005), ‘What Are Firms? Evolution from Birth to Public Companies’, NBER
Working Paper 11581.

Klette, T.J. and Kortum S. (2004),
‘Innovating firms and aggregate innovation’, Journal of Political Economy,
112(5), 986-1018.

Laing, D., Palivos T. and Wang P. (1995),
‘R&D in a Model of Search and Growth’, American Economic Review,
85(2), 291-295.

Mc Morrow, K. and Werner, R. (2009),
‘R&D capital and economic growth: The empirical evidence’, EIB Papers
4/2009, European Investment Bank, Economic and Financial Studies.

Moncada-Paternò-Castello, P. (2010),
‘Introduction to a special issue: New insights on EU-US comparison of corporate
R&D’, Science and Public Policy, 37(6), 391-400.

Moncada-Paternò-Castello, P., Ciupagea, C.,
Smith, K., Tübke, A. and Tubbs, M. (2010), ‘Does Europe perform too little
corporate R&D?, A comparison of EU and non-EU corporate R&D performance’,
Research Policy, 39(4), 523-536.

Nelson, R. (1980), ‘Production Sets,
Technological Knowledge, and R&D: Fragile and Overworked Constructs for
Analysis of Productivity Growth?, American Economic Review, 70(2),
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Phelps, E.S. (2006), ‘Further steps to a
theory of innovation and growth - On the path begun by Knight, Hayek and
Polanyí’, Notes for a presentation at the ASSA 2006 conference.

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jobless recoveries’, Mimeograph.

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the theory of economic growth’, Quarterly Journal of Economics, 70(1),
65-94.

2.
Convergence of knowledge intensive sectors and the
EU’s external competitiveness
2.1.
Introduction

 The share of knowledge-intensive services
and products in the total demand and production of both advanced and also less
advanced or emerging economies has steadily increased over time. This is
documented in a large number of publications studying ‘tertiarisation’ (e.g.
Peneder et al. 2003, Montresor and Marzetti, 2010), especially emphasising the
role of knowledge-intensive services. Though the rising share of services along
with a declining share of manufacturing is undisputed, some studies raise
questions about future developments. Pender et al. (2003), for example, use the
term ‘quaternisation’ stressing the role of knowledge-intensive services and
their steadily rising importance as sources of innovation and technology and as
inputs. As there are still large cross-country differences in this process,
however, it is still too early to conclude that ‘quaternisation’ has yet
manifested itself in the majority of advanced countries.

The study presented here analyses the roles
of knowledge-intensive business services (KIBS) over the more recent period and
covers a larger set of countries compared to the studies mentioned above. It
stresses the role of the service output of manufacturing firms, a phenomenon,
also termed a ‘convergence process’, which so far has not received so much
attention in the literature. Knowledge-intensive service firms are increasingly
developing new services as a part of a product package that includes physical,
tangible goods. Firms developing new products also offer additional services as
part of a package including both the physical product and the services (see
Monti, 2010). For example, high-tech products are often sold in combination
with maintenance services.

These developments give rise to technology and
product flows between the services and manufacturing sectors, which deepen
inter-industry linkages. The study also analyses the role of knowledge-intensive
business services (KIBS) in generating embodied knowledge flows and linkages
between KIBS and manufacturing sectors. This underpins the further growing
evidence in the literature that services have been playing an increasing role
in boosting the productivity of manufacturing sectors (e.g. Arnold, Javorcik
and Mattoo, 2006, and Javorcik, 2004).

Finally, the analyses in this chapter
document that the share of such products in total world trade has been steadily
increasing over time as well. Simultaneously, technology flows within and
between different firms and industries seem to have become more important. Due
to more intensive international economic integration, these technology flows
have also increased between different parts of the world as firms outsource and
choose to locate parts of their production in locations according to
comparative advantages. These trends have led to changes in industrial
structure worldwide.

As the definition of KIBS is still
not standard across the literature, one can find various attempts to describe
the term (e.g. den Hertog, 2000; Bettencourt et al., 2002). On the other hand, the
classification often follows the NACE classification system, covering the
sectors ‘computer and related activities’ (NACE 72), ‘research and development’
(73), and ‘other business services’ (NACE 74). However, whether the sub-sectors
of ‘other business services’ are included or not is again not uniform across
studies (compare e.g. Muller and Doloreux, 2007; European Commission, 2009).

Based on this background the study
addresses the following issues:

·
To which extent have services become more
important over time and how does Europe differ from other major economies like
the US and Japan in this respect? Therein is the specific role of knowledge
intensive business services (KIBS) addressed.

·
How important are the direct and indirect flows
of knowledge between KIBS and manufacturing industries? How have these
developed over time and are there important differences across countries and in
relation to the US and Japan in particular?

·
To which extent is there a tendency towards an
increase in the share of services in the output of manufacturing industries and
firms? How does this relate to firms performance and innovation?

·
Finally, the study focuses on the importance of
trade in knowledge intensive manufacturing and services (overall and KIBS in
particular) regarding the competitiveness of the EU with respect to trade in
services in general and trade in knowledge intensive business services in
particular.

2.2.
The rising importance of service sectors in the
economy. A comparison of the EU with the US and Japan
2.2.1.
Introduction

Services industries have grown in
importance over the last decades both in terms of output and employment. Within
services, KIBS play an important role and have been the main source of job
creation in Europe in the last decade and also contributed substantially to
value added growth as pointed out in the literature (see e.g. European
Commission, 2009).

This section provides a comparative overview
of the relevance and trends in these service activities across countries and
over time. Major advanced non-EU countries (in particular the US and Japan) are
also included in the cross-country comparison. The analysis is mainly based on
the EU KLEMS dataset. This section will in particular address the following points:

·
What is the role of service activities and
output in Europe, the US and Japan and what are the trends over time?
Specifically, the question whether there has been some kind of convergence
process in structures across countries is addressed.

·
Additional information on the role of services
can be derived from the EU KLEMS data set. In particular, the importance of
services in value added growth across countries is discussed.

·
 The use of input-output tables further allows
for analysis of the importance of KIBS industries as inputs in the production
process of manufacturing industries. This will be addressed in this section as
well in a descriptive manner providing also information on linkage indicators
between industries.

2.2.2.
KIBS services and classification

Stehrer et al. (2011) show in the
background study that the share of services in general increased in all
countries considered over a long period of time. The aim of this section is to
look more closely at a particular part of services, the knowledge intensive
business services as defined above. Specifically the focus is on the NACE rev.
1.1 categories computer and related activities (72), research and development (73)
and other business activities (74). In this overview which is based on the EU
KLEMS data, also the industry renting of machinery and equipment (NACE rev. 1.1
71) is included since it is not separable from the other industries for all
countries in the database. For the comparison across countries the limited data
therefore only allows for the use of the category 71t74. Table 2.1 provides the
respective shares of value added and employment in the total economy.

Table 2.1: Share of KIBS (incl. 71) in total economy (in %),
1975-2007

|| || 1975 || 1985 || 1995 || 2005 || 2006 || 2007

Value added || EU-25 || || || 8.3 || 11.0 || 11.1 || 11.4

|| EU-15 || 4.7 || 6.7 || 8.7 || 11.5 || 11.7 || 12.0

|| EU-10 || || || 4.4 || 5.9 || 6.1 ||

|| USA || || 7.2 || 9.4 || 12.9 || 13.0 || 13.3

|| JPN || 2.3 || 4.3 || 6.1 || 7.7 || 7.8 ||

Employment || EU-25 || || || 7.8 || 11.1 || 11.4 || 11.7

|| EU-15 || 4.0 || 5.6 || 8.6 || 11.9 || 12.2 || 12.6

|| EU-10 || || || 3.7 || 6.3 || 6.6 ||

|| USA || || 8.2 || 11.0 || 13.2 || 13.4 || 13.5

|| JPN || 2.9 || 4.9 || 7.1 || 10.6 || 10.9 ||

Source: EU KLEMS, Release
2009, own calculations.

The value added share of KIBS increased by
about 7 percentage points in the EU-15 from 4.7 to 12 % between 1995 and
2007. In relative terms the increase was even larger in Japan, from 2.3 to 8 %.
The value added share of KIBS in the US was slightly larger in 1985 compared to
the EU-15 (7.2 compared to 6.7 %). However the share increased faster in
the US to 13.3 % in 2007, thus 2 percentage points above the share in the
EU-15. The value added share of KIBS in the EU-10 was only 6 % in 2006,
starting from a share of 4.4 % in 1995. The figures are similar for
employment patterns as well, with Japan showing a stronger increase, reaching
about 11 % in 2006. Employment shares in the US are about 2 percentage
points above those found for the EU-15. Again the share for the EU-10 is well
below that for the EU-15.[26]

Figure 2.1: KIBS shares in total economy (in %), 1995 and 2005

Source: EU KLEMS, Release 2009, own calculations.

The divergence, w.r.t. to the size of KIBS
shares, was driven by some countries at the upper end of the distribution like
UK, France, Germany and the Netherlands whereas for the other countries the
shares increased less, cf. Figure 2.1, which shows the share of KIBS in the
total economy. This is even more evident when for employment shares in which
case also productivity developments play a particular role especially for the
countries at the lower end which are mostly EU-10 countries. A possible
explanation behind this pattern is the relatively lower labour productivity
growth rates in KIBS which imply increasing employment shares for this sector.
This is slightly different from the pattern emerging from the shares of KIBS in
business services. Disregarding Cyprus and Estonia, employment shares increased
more in those countries with lower shares in 1995 which again are the EU-10
countries. There is some divergence of value added with the countries at the
upper part gaining shares in relative terms though the picture looks more
diverse when considering some outlying countries like Lithuania, Slovak
Republic and Estonia.

2.2.3.
KIBS contributions to growth

This section discusses the contribution of
the KIBS industries to overall value added growth. The contribution of a sector
can be calculated by multiplying the respective growth rates of value added in
constant prices (1995 prices were used) with the share of the sector's in the
economy (the average shares for the time period considered were used). The
results for the groups of countries considered are provided in Table 2.2.

Table 2.2: Growth contributions of KIBS, 1975-2007

|| 1975-1985 || 1986-1995 || 1996-2007

|| Share || Contribution to growth || Share || Contribution to growth || Share || Contribution to growth

EU-25 || || || || || 9.5 || 16.8

EU-15 || 6.4 || 12.8 || 8.1 || 14.9 || 10.0 || 18.2

EU-10 || || || || || 5.0 || 7.6

USA || 6.8 || 14.5 || 8.9 || 16.0 || 11.1 || 21.9

JPN || 4.1 || 7.1 || 5.2 || 8.5 || 7.7 || 27.6

Source: EU KLEMS, Release
2009, own calculations.

First, the contribution to growth of the
KIBS in all periods was much larger than its share in value added at constant
prices. In the EU-15 the average share over 1975-1985 was 6.4% whereas the
contribution to growth was 12.8%. Over the period 1995-2007 the share of KIBS sectors
in value added at constant prices was 10% whereas the contribution to growth
was 18.2%. Thus, though the KIBS industries account for about a tenth of value
added the contribution to growth accounts for about one fifth. This can be
contrasted with the USA where the contribution to growth was almost 22% with an
average share of 11%, not much larger than the one in the EU-15. Over time, the
contribution to growth was relatively larger in the USA compared to the EU-15.
The opposite is true for Japan where the contribution to growth was relatively
low with 7.1 and 8.5% in the first two periods, respectively. Only in the last
period 1995-2007 the contribution peaked to 27.6%. The EU-10 countries are
again exceptional in the way that on top of the relatively low share of KIBS
the contribution to growth was also relatively low with 7.6% only. The
relatively low shares of KIBS and their contribution to growth in the EU-10,
can at least partly be explained by restructuring of the economies that have
taken place in many of these countries following the transformation to market
economies and later integration into the EU. The industrial structure in the
EU-10 had and has in comparison a relatively lower share of market services,
including KIBS, and a relatively larger share of manufacturing industries. With
a relatively lower share of high-tech in manufacturing and a lower share of
skilled labour, the potential for using KIBS is lower.

The end of the time period is studied in
more detail across countries below. Figure 2.2 presents the average share of
KIBS and the contribution to growth for the EU-25 countries plus USA and Japan.

First, the overall shares of KIBS vary from
about 13% in the UK, Netherlands and France to less than 5% in Greece,
Portugal, and Poland. However, the contribution to value added growth in all
countries with the exception of Estonia, Czech Republic and Portugal are larger
than this share would suggest. The contribution of KIBS to growth was much
larger than the shares of KIBS in the UK, Belgium, Japan, Italy, and Austria.
The ratios of the contributions to growth and the shares of KIBS were much
lower for Hungary, Ireland, Slovenia, Cyprus, Finland, Estonia, Czech Republic,
Poland, Portugal and Greece. This could be explained by the fact that manufacturing,
and other sectors, which occupy larger shares in most of the latter countries
than KIBS, have displayed stronger growth. The catching-up effects of
manufacturing have been larger thus limiting the role of KIBS in overall growth.

Figure 2.2 - Contributions to growth by country, 1995-2007

 Source: EU KLEMS,
Release 2009, own calculations.

2.2.4.
The role of KIBS as an intermediate input in the
EU, US and Japan

Services and KIBS in particular play an
important and growing role as inputs into manufacturing processes. The focus in
this section is on this important aspect of KIBS. For this purpose, the role of
KIBS as intermediate inputs in the EU is examined compared to that in the US and
Japan. ‘Knowledge-intensive services’ can be described by their knowledge-intensity,
relative capital intensity and high degree of specialisation (European
Commission, 2009, p.19). Business services again cover a wide range of
services, which serve as intermediate inputs in value chains of companies. They
often complement or substitute in-house service functions of their clients. In
this function, they contribute to the competitiveness of companies, stemming
from quality and innovation gains coming from the interaction between suppliers
and clients (European Commission, 2009, p.15). The questions to be addressed
are whether the EU-countries use more or less KIBS in their economy compared to
the US and Japan as inputs in other sectors? It is further interesting to study
how do KIBS shares vary for the total economy, for manufacturing and for
high-tech sectors.

Input-output tables are used to analyse the
importance of KIBS sectors as inputs in the total economy and the manufacturing
sector in particular. Input-output data are an appropriate tool for
investigating inter-industrial relationships and the composition of supply and
use of goods and services. The OECD Stan Input-Output database-2009 edition
covering 21 EU countries, the US and Japan is used.[27] The database supplies
symmetric industry-by-industry input output tables for the whole economy, for
the domestic economy and for imports. The shares of KIBS in total intermediate
inputs, in manufacturing and in certain high-tech manufacturing sectors for the
years 1995, 2000 and 2005 are calculated. Data are provided only at the 2-digit
ISIC rev. 3 (which is compatible to NACE rev.1) level. The following activities
are subsumed under the term ‘knowledge-intensive business services: computer
and related activities (72), research and development (73) and other business
services (74).

KIBS are important intermediate inputs for
the total economy (see Figure 2.4.1a): In 2005, KIBS accounted for almost 15%
of total intermediate consumption in the EU-15, but only 9% in the EU-6.[28] In Japan, this share was about
12%, while in the US it reached 14% in that year – slightly below the EU-15
share. Development trends differed between Japan and the other countries over
the last 10-years: While in Japan the share increased substantially between
1995 and 2000 (though this might be due to a methodological change) and fell
again until 2005 according to the data, in the EU and US shares increased
continuously. However, the share expanded slightly more in the US than in the
EU-15. There is however a substantial differentiation across EU economies which
is documented in detail in the background study (Stehrer et al., 2011).

Figure 2.3.a: Share of KIBS in total intermediate consumption

Source: OECD Input-Output tables.

Also
when only looking at the manufacturing sector, KIBS prove to be important inputs:
In 2005, the share of KIBS used by manufacturing industries amounted to 9% in
the EU-15, 5% in the EU-6, roughly 9% in Japan and 10.5% in the US, in this
case above the EU-15 level. Development trends between 1995 and 2005 resembled
those in the total economy: In Japan, the share of KIBS first increased but
then fell again, while in the EU-15, the EU-6 and the US shares increased
during the whole period, with the US experiencing a sharp rise between 1995 and
2005 (see Figure 2.3b). The large increase of KIBS in the US in intermediate
consumption has come around without any significant changes of industry
structure. Earlier and more intensive outsourcing of certain activities by the
US manufacturing industry compared to the EU and Japanese manufacturing industries
could explain this pattern.[29]

Figure 2.3.b: Share of KIBS in
manufacturing intermediate consumption

Source: OECD
Input-Output tables.

Knowledge-intensive
business services play a significant role especially in the input structure of
high-tech manufacturing industries, under which NACE rev.1 categories 30-33
(including office machinery, electrical machinery, communication equipment and
medical & optical instruments) are subsumed. Indeed, these industries use a
larger share of KIBS than manufacturing on average: In the EU-15, KIBS
accounted for 14% of all intermediates in high-tech industries, compared to
only 5% in the EU-6. However, this share was even larger in Japan and the US
with about 16%. Trends between 1995 and 2005 were largely the same as in
manufacturing; however, the share in the EU-6 countries slightly decreased
between 2000 and 2005 due to an increased share of industries which used
relatively less of KIBS' products for intermediate consumption (see Figure 2.3c).

Figure 2.3.c: Share of KIBS in high-tech manufacturing (NACE 30-33)
intermediate consumption

Source: OECD Input-Output tables.

Overall, when comparing the KIBS usage
between the EU-average and the US, it is about the same in the total economy,
slightly less in manufacturing and somewhat lower in high-tech industries. When
compared to Japan, KIBS usage is higher in the EU in the total economy, about
the same in manufacturing and somewhat lower in high-tech industries in which
Japan is more specialised. What is more striking than differences between these
three countries/regions are distinct differences within Europe: The difference
between EU-15 and EU-6 is pronounced and takes about 5 percentage points
difference in the share of KIBS in total intermediates and in manufacturing
intermediates and almost 9% in high-tech industries’ intermediates. While this difference
between the EU-15 and the EU-6 seems to have become somewhat smaller for the
use of KIBS in the total economy between 2000 and 2005 or at least remained the
same in manufacturing, the difference increased in high-tech manufacturing
where the EU-15 is more specialised in than the EU-6.

2.3.
Embodied and sectoral linkages between
Manufacturing and the Knowledge-intensive services
2.3.1.
Introduction

The analyses in this section concern direct
and indirect flows of knowledge between the manufacturing industries and
knowledge-intensive business services (KIBS). Flows of knowledge between these
two sectors represent a bilateral learning process or what might be called a
coproduction of capabilities. KIBS often facilitates the innovation process in
the manufacturing industries and they have considerable potential in creating
new knowledge and transforming firms into learning organisations (Hauknes,
1998). Statistical evidence, particularly from input-output tables, shows that
global technological and organisational capacity is a function of its use of
software and other business services.

While manufacturing appears to be an engine
of productivity growth, this growth depends to a great extent on services in
general and KIBS in particular. Kaldor (1966) and later Cornwall (1977)
suggested that manufacturing is the main source of new technical knowledge and
that this knowledge diffuses from there into other sectors, including the
service sector. This argument presumes that the backward and forward linkage
effects from manufacturing to services are strong. Hauknes (1998) and Fagerberg
and Verspagen (2002), however, suggest that manufacturing may no longer be the
‘engine of growth’ and that services have become much more important. This
argument would imply that the direction of the linkage between manufacturing
and services is the other way around. This chapter shows that the interlinkages
go both ways and are tending to become stronger, which suggests that the
distinction between manufacturing and services is becoming less relevant.

2.3.2.
Inter-industry technology flows

Input-output analysis provides a way to
measure the interdependence of the manufacturing industries and the service
sector (Miller and Blair, 2009). By combining business expenditures on R&D
activity with input-output tables, it is possible to measure inter-industry
technology flows and linkages. It should be noted that public sector
expenditures on R%D allocated directly or indirectly to the business sector are
not included. This might give rise to a bias in the analyses below. Some
sectors may be more likely to receive public funding than others and some
countries may be more prone to use public R%D expenditures to promote the private
sector.

Having this reservation in mind, this
section makes use of the OECD Input-Output and ANBERD Databases to measure the
total R&D content of an industry and the embodied flows between
manufacturing and KIBS. The analysis covers twenty-two Member States of the
European Union plus Norway, the United States, Canada, Japan, Korea and China
during the year 2005 (see Stehrer et al., 2011, for details).

Product-embodied
knowledge resides in intermediate inputs that originate from both domestic and
foreign sources, and can flow both directly and indirectly through the
production of all other commodities. The total technology intensity therefore
contains five components:

(1)
1sectoral (own) R&D;

(2)
direct R&D flows from all other domestic
sectors into any recipient industry;

(3)
indirect R&D flows from domestic sectors into
a recipient industry via one or more intermediate sectors;

(4)
direct R&D flows from foreign sectors into
any recipient industry; and

(5)
indirect R&D flows from international
sectors.

Figure 2.4 ranks
countries according to total business technology intensity and shows that the
share of own R&D activity of business enterprises is about one-half of the
total business R&D content in countries with a relatively high level of GDP
per capita and below this share in countries with lower level of income.[30]

Figure 2.4: Technology intensity relative to total value added by
source, 2005

Source: OECD
Input-Output tables. ANBERD. Eurostat Input-output tables for Lithuania.

The direct R&D
flows from all other domestic source sectors into any recipient industry are
positively (and highly) correlated with R&D performed within an industry.[31] Countries with a
high share of R&D activity performed within the sector are generally
considered to be knowledge creators. Hence, the strong correlation indicates that major knowledge
creating sectors are also the major users of knowledge generated in other
sectors in the domestic economy. Sectors with weak R&D performance, and
hence weak knowledge creation, are also small users of knowledge from other
sectors. Rather than suggesting that these sectors are ‘knowledge poor’, it is
likely that this is caused by the more frequent use of non-R&D based
competences, skills and knowledge in these industries. More than 60% of the total technology intensity
in Japan and Germany has its origin in the own R&D performance of the
industry, and Denmark, USA, Austria, Finland and France depend on own R&D
performance for more than half its technical knowledge. Countries with a low
share of R&D activity performed within the sector are generally considered
to be knowledge users. Estonia, Hungary, Lithuania, Poland, Romania and
Slovakia depend on knowledge embodied in inter-industry trade for more than 80%
of the total technology intensity, whereas Japan and the USA relied on imported
knowledge for only 6% and 12% of total knowledge inputs, respectively. The size
of the country also matters as to whether the embodied technology comes from
domestic or international sources. Germany, Japan and the USA depend more on
domestic flows of embodied knowledge, whereas Ireland, Estonia and Slovenia
depend more on international flows. In general, smaller countries depend more
on international sources of knowledge than larger ones. Countries where
assembly production looms high in the national economic structure, such as most
of the east European countries and Ireland, have a very high share of knowledge
sourced from abroad. Finally, differences in the industrial structure and in
the way each country create and use technical knowledge can also be an
important factor behind the observed patterns. Countries with a relatively
higher share of knowledge-intensive industries are more prone to perform their
own R&D than countries where the knowledge-intensive industries occupy
smaller shares.

In manufacturing, imported
knowledge flows from other manufacturing and KIBS constitute the largest share
of knowledge flows (direct and indirect domestic and imported) in every
country, except in the USA and Japan.[32]
For most countries the main source of imported knowledge inputs comes from
foreign manufacturing sectors, except for Ireland, where the imports of KIBS to
intermediate use in manufacturing are more important. There are vast
differences across the countries, which are explained by differences in the way
knowledge is generated in other manufacturing industries and sourced abroad.
Three observations are made in this sector. First, the level of development is
important in manufacturing. With the possible exception of Ireland, the manufacturing
technology multiplier is highly correlated to GDP per capita, with low income
countries having a very large multiplier and the high income countries having a
very low multiplier. Second, relatively little knowledge appears to flow from
the KIBS sector, whether domestic or foreign, to the manufacturing industries,
except in Ireland where there appears to be a significant flow from abroad. Third,
size also determines whether the embodied technology comes from domestic or
international sources. Domestic sources appear dominantly important in Japan
and the United States. In all other countries imported flows dominate over
domestic flows, though domestic flows are more important in China than in other
countries. International sources of knowledge into the manufacturing industries
are much more important for the new Member States, along with Portugal and
Greece.

In KIBS, imported
knowledge inputs to KIBS dominate over technology flows from other domestic
sectors in almost every country. Estonia, Slovakia, Romania and Ireland are
almost completely dominated by imported knowledge inputs. Imports from
manufacturing and KIBS abroad are the largest source of knowledge inputs for
most countries. EU-12 Member States depend heavily on manufacturing knowledge
imported from abroad in this sector. The KIBS sector in China not only depends
on imported knowledge from manufacturing, but also domestic knowledge from the
sector. Ireland and Sweden, and perhaps Belgium and the Netherlands appear
different in that they depend relatively more on knowledge imported through the
KIBS sectors.

2.3.3.
Backward and forward linkages between
manufacturing and KIBS

This section focuses on the strength of the
linkages from manufacturing sectors to domestic KIBS sectors and from KIBS
sectors to domestic manufacturing sectors, which Rasmussen (1956) described as
backward and forward linkages[33].
Flows within the domestic economy are thus distinguished from total flows
including technology flows from foreign sources. However, Rasmussen’s forward
and backward linkage measures do not adequately take into account the
industry-to-industry interaction within technology flows, as this may lead to
double accounting (Hauknes and Knell, 2009)[34].
The backward linkages used here are the intersectoral technology flows as a
share of technology flows into the recipient sector, while the forward linkages
are the intersectoral technology flows as a share of total technology flows out
of the source sector. These measures are constructed for domestic and total
flows, where total flows are the sum of domestic and import flows.

Figures 2.5 and 2.6 show the backward
linkages between manufacturing and KIBS, and Figures 2.7 and 2.8 show the
forward linkages. The backward technology linkage measures the technology flows
from a particular sector (e.g. manufacturing) into a recipient sector (e.g. KIBS),
relative to total knowledge inputs into recipient sector. In other words, it
gives the relative size of knowledge inputs from this particular sector as
measured from the perspective of recipient sector. And the forward technology
linkage on the other hand measures the technology flows from one sector into
another, relative to total knowledge inputs from the source sector to all other
sectors. In other words, it gives the relative size of knowledge inputs into
the recipient sector, as measured from the perspective of source sector.

The backward linkages shown in Figure 2.5,
measured in terms of the total technology content of KIBS, are rather small in
countries on the technology frontier, defined as the
average R&D intensity of the OECD;[35]
10% or less, and with domestic and total backward linkages being more or less
of the same size. There is substantially larger variance between the technology
using economies, reflecting the higher dependence on imported technology flows.
The variance between domestic and total flow strengths appears to be driven by
the size of the economy, reflecting the negative correlation between size and
openness of countries on the technology frontier. This suggests that size and
national income levels are two main underlying variables. The data does not allow pinpointing the explanation of why Finland
and France lie high up in Figure 2.5, and the Czech Republic lies down towards
the lower end of the figure. However, it is likely that this reflects the high
technology intensity of ICT-related Finnish and French KIBS services, with
major inputs of foreign and domestic high-tech manufactures. The Czech case can
in a similar vein be explained by Czech KIBS sectors being dominated by
traditional labour and client intensive consultancy.

Figure 2.5:
Backward linkage of manufacturing embodied inputs into KIBS sectors, domestic
and imported supply. Ranked by total linkage, 2005

Source: OECD
Input-Output tables. ANBERD. Eurostat Input-output tables for Lithuania.

Domestic sources of KIBS embodied inputs
into manufacturing dominate over imported KIBS inputs in most countries, as
Figure 2.6 illustrates. Ireland is a notable exception as they source almost
everything internationally, most probably from other English speaking
countries. These linkages, measured in terms of the total technology content of
manufacturing, is rather small in almost all countries, and to the lowest order
do not appear to be dependent on the size of the economy. In virtually every
country, except Ireland, the total linkage is less than 5%. In countries at the
global technology frontier, including Sweden, the United States, and Japan the
domestic linkages are also marginal, and are more evenly distributed between
domestic and total backward linkages. The only countries showing a notable
technology linkage of domestic KIBS are Estonia, Slovakia and the Czech
Republic.

Figure 2.6:
Backward linkage of KIBS embodied inputs into manufacturing sectors, domestic
and total supply. Ranked by total linkage, 2005

Source: OECD
Input-Output tables. ANBERD. Eurostat Input-output tables for Lithuania.

Forward linkages from
manufacturing into KIBS are relatively small, when compared with the other
three linkage measures. Figure 2.7 shows that the linkage never exceeds the 3%
level for any country, except in Finland, whether in terms of domestic or total
linkages. This suggests that KIBS are knowledge supplying relative to most
manufacturing industries.[36]
There is a general tendency for the forward linkages between domestic
manufacturing to KIBS to be small in EU-12 Member States, but it also appears
to be the case for the Nordic countries. The reason for this may be that some
of these countries, especially Sweden and Finland, rely heavily on the
science-based industries. Most countries on the technology frontier have a
fairly even distribution of forward linkages.

Figure 2.7:
Forward linkage of manufacturing embodied inputs into KIBS sectors, domestic
and imported supply. Ranked by total linkage, 2005

Source: OECD
Input-Output tables. ANBERD. Eurostat Input-output tables for Lithuania.

Figure 2.8 shows that
the forward linkages from KIBS to manufacturing appear rather large when
compared to the opposite forward linkage from manufacturing to KIBS. The
domestic and total forward linkages are also more evenly distributed across all
countries. Ireland, Finland, and the Netherlands, and possibly Belgium and
Hungary, are notable exceptions to this pattern, alongside with Poland and
Romania.[37]
The reason for the different pattern in Ireland is that embodied knowledge R&D
services sourced abroad into Irish chemical industries are particularly high.

Figure 2.8:
Forward linkages of KIBS embodied inputs into manufacturing sectors, domestic
and total supply. Ranked by total linkage, 2005.

Source: OECD
Input-Output tables. ANBERD. Eurostat Input-output tables for Lithuania.

The backward linkage
from KIBS to manufacturing appears weak, while the backward linkage from
manufacturing to KIBS appears to be substantially stronger. Conversely, the
strength of the forward linkage from manufacturing to KIBS is substantially
weaker than the forward linkage from KIBS to manufacturing. The reason is that
the size of the KIBS sector is substantially smaller than the manufacturing
sector as a whole. The measures of linkage strengths reflect this size
difference. When this is taken this consideration, domestic KIBS inputs into
manufacturing outweigh domestic manufacturing inputs into KIBS in virtually
every country, except France. Total linkages from manufacturing to KIBS are, by
far, the dominant linkage in Lithuania, Slovenia, Poland and Estonia. Romania,
China, Hungary and Greece are also dominated by manufacturing inputs to KIBS.
France remains an exception among the high-income economies, although the
balance of total flows suggests that the UK, Finland and Norway may also be
exceptions. The most KIBS-intensive economies are Ireland, Japan and the
Netherlands.

2.4.
Services as output of manufacturing
2.4.1.
Introduction

Services, in particular knowledge-intensive
services, have become an important direct and indirect input for manufacturing
as documented in the previous sections. The previous chapter demonstrated that
knowledge-intensive business services (KIBS) are important carriers of new
knowledge developed in upstream sectors that diffuses into manufacturing.
Manufacturing increasingly relies on knowledge-intensives services as inputs to
their production processes. But this is only one aspect of the changing
relationship between manufacturing and services industries. Manufacturing firms
themselves more and more offer services along with - or even instead of - their
traditional physical products. This trend is often labelled ‘convergence between manufacturing and services’.[38] The convergence between
manufacturing and services is an opportunity for the European manufacturing
sector to open up new markets, find new sources of revenue around their
products, and increase competitiveness. This opportunity is recognized in
policy debates:

“European industry must move further
into the provision of services in order to remain competitive at the global
level. Companies operating in industry sectors and manufacturing need to
develop new business opportunities by spurring related services such as
maintenance, support, training and financing. In general, the growth potential
of these services is much higher than that of the product business itself.”
(Monti 2010, p. 54)

This section first provides a discussion of
the motives of manufacturing firms to offer services and then an analysis of
convergence at the sectoral level with input-output data. The end of this
section provides additional evidence of convergence on firm-level.

2.4.2.
Why do manufacturing firms offer services?

 Convergence and the phenomenon of
manufacturers becoming service providers have gained considerable attention in
the last decade, mainly in the management literature. Convergence has been
discussed in the context of product-related services (e.g. Lalonde and Zinszer,
1976; Frambach et al., 1997), product-service systems (e.g. Mont, 2002; Tukker
and Tischner, 2006), integrated solutions (e.g. Brax and Jonsson, 2009; Davis
et al., 2007; Windahl, 2007; Davies, 2004) or, more generally, ‘servitisation’
(e.g. Vandermerwe and Rada, 1988; Rothenberg, 2007; Neely, 2008; Baines et al.,
2009). Up to now, there has been neither a common term nor a standard
definition of convergence in the literature. Research on convergence has developed
independently and mostly in isolation (e.g. Baines et al., 2009; Tukker and
Tischner, 2006). Lay et al. (2009) identified three basic strands in the
literature: first, convergence has become a topic in the marketing literature;
second, there is growing attention to convergence in the sustainability
literature; third, there are various sector-specific publications that analyse
how firms are adding services to their range of physical products.

The literature offers three basic
explanations or motives for firms to introduce services in addition to their
physical products: A first motive is to gain additional financial benefits.
Services can generate additional revenues for firms and open up new sources of
income. This diversification may also help to reduce the vulnerability and
volatility of cash flows. Moreover, services may offer higher margins and have
a lower price elasticity than physical products, because services are often
more difficult to compare than physical products. A second motive is to gain strategic
advantages. The provision of services allows firms to differentiate their
product range from the products of their competitors by offering
product-service combinations (‘solutions’). A higher degree of product
differentiation may also hamper potential market entrants. Finally, there are
also marketing benefits from service offers. Complementary services may
generate additional value for customers and lead to a higher degree of customer
satisfaction. Interaction with customers in the provision of additional
services may help to maintain and foster customer relationships. Moreover,
complementary services may also promote demand for the physical goods of the
firm.

2.4.3.
Macroeconomic evidence

There is a general trend towards a higher
share of service products in manufacturing output (service content) across
countries and over time. The analysis of supply tables taken from input-output
statistics compiled by EUROSTAT and national statistical offices provides
compelling evidence that the share of services in total manufacturing output
has increased in most of the EU countries and in the US.[39] As shown in Figure 2.9, the service output of manufacturing is highest in Finland and the
Netherlands, Luxembourg, Sweden, and the UK. Services constitute around five to
eight percentage of total manufacturing output[40]
in these countries. In most other EU countries, the service share on
manufacturing output is around 2%. Countries with higher service content tend
to be small, open economies in Western Europe.

Figure 2.9:
Service share of manufacturing output in various countries, 2005

Note: latest available data: the US and the UK until
2002 and 2003, respectively. Services cover CPA 55 to 95 for the EU Member
States and NAICS 48 to 92 for the US. Data for France is incomplete and covers
only CPA 72 to 95.

Source: Eurostat
and US Bureau of Economic Analysis supply tables; author's calculations.

The output of manufacturing still consists mostly
of manufactured products. The service output of manufacturing is, however, growing
quite fast, displaying annual growth rates of five to ten per cent for the
years between 1995 and 2005. It grew in all countries under study between 2000
and 2005. The only exception is the Czech Republic. Convergence between
manufacturing and services is therefore a uniform development across countries.
It should, however, be noted that the figures from input-output tables reported
here are most likely a conservative estimate of the service output of European
manufacturing industries. Firm-level evidence from the European Manufacturing Survey
(see below) suggests that most revenues from services are not invoiced
directly, but included in the prices of the physical goods of the firm. Firms
often charge for a service/product package, instead of invoicing services and
physical products separately. Adding these indirect revenues to the direct
revenues yields an amount for the service output of manufacturing that is
considerably higher than the values reported here.

Figure 2.10:
Service share of manufacturing output broken down according to innovation intensity, 2005

Note: latest available data for the UK is 2003. Data excludes
wholesale and retail trade. Data for France covers only service products CPA 72
to 95.

Source: Eurostat;
author's calculations.

The service output of manufacturing firms
is in various ways related to research, development (R&D) and innovation.
Both, R&D and complementary service offers are strategies of firms to
differentiate their products from the products of their competitors. Moreover, countries
with high service content – examples are Finland, the Netherlands, Luxembourg,
Sweden, and the UK - have also high R&D expenditures as percentage of GDP.
In contrast, the countries with the lowest service shares in the figure above –
Romania, Portugal, Greece, or the Czech Republic – have also low aggregate
R&D intensities. However, there are also some countries, for example,
Austria, Belgium, Denmark, France, and Germany, which have a lower service
share than their R&D intensity would suggest. The relationship between
R&D, innovation and service output is stronger at the sectoral level. Services are predominantly produced by manufacturing industries with
high and medium-high innovation intensity[41]
(see Figure 2.10). These industries include, for example, machinery and
equipment (NACE 29), office machinery and computers (NACE 30), radio,
television and communication equipment (NACE 32) and other sectors. In Austria,
Belgium, Denmark, Finland, Germany, Italy, Luxembourg, and Sweden, more than
two thirds of the service output of manufacturing comes from high or
medium-high innovation intensive sectors. In a second group of countries,
including the Czech Republic, Estonia, Greece, Hungary, Lithuania, the
Netherlands, Poland, Portugal, Slovakia, Slovenia, and Spain, high and
medium-high innovation intense sectors explain approximately 50% of the service
output. One interpretation of this relationship is that sectors which are more
innovation-intensive are also more service-intensive, because the knowledge
base of the sector is cumulative and complex so that customers often do not
have all necessary knowledge available and require additional services.

But also low and medium innovation-intensive
industries produce services. Examples are the UK and Ireland, where
manufacturing industries with medium-low innovation intensity account for more
than 50 % of service output. ‘Publishing, printing and reproduction of
recorded media’ (NACE 22) accounts for a large share of total manufacturing
service output. Similar links between innovation and service output can also be
found in other industries. In general, manufacturing firms predominantly
produce knowledge-intensive business services. KIBS account for more than two
thirds of the service output of manufacturing in 14 of the 24 countries included
in the analysis. Hence, the manufacturing sector is not only a main client of
KIBS — as demonstrated in the previous section — but also produces KIBS to a
considerable degree. Evidence from firm-level surveys such as the EMS (see
below) suggests that most such KIBS are related to the physical products of a
firm.

In addition, there is also evidence that a
considerable share of the KIBS produced by manufacturing is exported. A study
by the Austrian Central Bank (Walter and Dell’mour, 2009) suggests that manufacturing
industries accounted for 15 % of total Austrian service exports in 2006.
This is about the size of service exports by the KIBS industries. In this
perspective, trade in services and trade in KIBS in particular is not only a
result of higher exports from the service sectors, but also a consequence of
the internationalisation of manufacturing industries. This may explain why
service output is highest in small, open economies with a high innovation and
R&D intensity (see Stehrer et al., 2011, for details).

2.4.4.
Which manufacturing firms offer services?

The input-output analysis above revealed
that services are predominantly offered by firms in innovation-intensive
sectors. Small countries with a high R&D intensity tend to have higher
shares of services on manufacturing output. In this section, product-related
services are further analysed with firm-level data from the European
Manufacturing Survey (EMS). The EMS
investigates product, process, service and organisational innovation in the
European manufacturing sectors. This section presents results from the last
round of EMS conducted in 2009.[42]

Firm-level
data allows for testing hypotheses about how the share of services on total
output of manufacturing firms relates to firm size, sector, and the
characteristics of the main product of the firm. A regression analysis is used
to explain manufacturing service output. The regression analysis is based on 2,
264 observations on firm level from the EMS. The sample consists of information
on manufacturing firms in nine countries.[43] Around 85% of the sample consists of SMEs.[44]

The dependent variable in the regression
analysis, service output of the manufacturing companies is measured as
the share of turnover generated with services. The following independent variables are assumed to be important to
explain manufacturing service output.

First of all, it is assumed that firm
size has a relevant influence on the service output of manufacturing firms.
The literature on product innovation points out that there are different advantages
and disadvantages of small and large firms in the innovation process, leading
to a U-shaped relationship between size and innovativeness (Kleinknecht 1989;
Cohen 1995). Small firms can react very quickly to changes in demand and are
often focussed on the needs of their clients, while large firms can benefit
from diversification and economics of scope and often have specialized
departments for continuous innovation and product development. A similar
relationship for manufacturing service output which is also a type of
innovation is assumed. To operationalize the size of the companies, the number
of employees (emp) and the number of employees squared (emp2) are chosen, both
in logarithmic form, to allow for a non-linear relationship between employment and
service offerings.

Buyers of bespoke customized products,
which are manufactured in small batches or even as single products, may
be more open to complementary services than buyers of mass-produced goods. The
reason for this can be seen in the distribution channels and consequently in
the customer-producer-relationship. Whilst high-volume producers often sell
their products anonymously to end customers, the producers of single units are
in closer contact to their customers and are consequently able to first
identify service needs of their customers, to customize service offers for them
and to promote and sell these service concepts to their customers. This
hypothesis is operationalised by a dummy variable indicating whether the main
product of the firm is produced in small batches opposed to large batch
production (sbatch). However, as it is not possible to identify the products’ target
group merely based on the batch size, a variable that indicates if the firm is
a supplier for other industries or a producer of consumer goods (supply) is
also included.

The type of products offered is
generally seen as a potential determinant of service output and servitization.
Concerning product complexity, it can be argued that a customer firm that buys
a complex product which incorporates many parts and offers various
functionalities may need more training, consulting, and maintenance or
operation services than a buyer of simple parts (e. g. Oliva and Kallenberg,
2003). This hypothesis is tested by including a dummy variable indicating
whether the products are complex (complex) and consist of many parts as
opposed to simple products.

Stehrer et. al (2011) observed that younger
firms seem to be slightly more innovative in terms of services than firms
formed before 2000, although these younger firms are less product innovative. A
potential explanation for this finding might lie in the innovativeness of
younger companies mindset and hence their open-mindedness towards innovative
service offerings. This hypothesis is tested by using a variable that indicates
if the firm has been established after 2005 (newfirm).

The discussion above indicates that there
is a relationship between the innovative propensity of manufacturing industries
and the share of services of manufacturing output in the industries. The
hypothesis of innovativeness of firms and industries is operationalized
by two variables. Sectoral dummies that represent sectoral innovation intensity
according to Peneder (2010) are used. For this, the base case is the high-innovation
intensity sector. However, there is also evidence that firms within a sector
differ considerably with respect to innovativeness. A variable which shows the
innovativeness on a firm level is therefore included. This additional variable
for innovativeness at the firm level indicates if a company has introduced a
new product to the market within the last two years (inmar).

In order to control for differences w.r.t. to servitization across
countries, country dummies are included. The base is Germany.

The table below describes all variables in
detail:

Variables || Description

Sshare || Turnover with services as a fraction of total turnover of the firm

lemp and lemp2 || ln of the total number of employees in the reference year 2009 and ln squared

Sbatch || 1 if a firm predominantly produces in small batches or single products; 0 if the firm predominantly produces in large batches

Supply || 1 if the firm is predominantly a supplier of other firms; 0 if the firm predominantly supplies final demand

Complex || 1 if the main product of the firm is a complex product consisting of many parts and offering various functionalities; 0 if the main product is simple and consists of few parts

Newfirm || 1 if the firm has been established after 2005; 0 otherwise

Inmar || 1 if the firm has introduced a new product to the market since 2007; 0 otherwise

se\_low || 1 if the firm is assigned to the Low innovation sector in Peneder’s taxonomy; 0 if the firm is assigned to the High innovation sector

se\_medlow || 1 if the firm is assigned to the Medium-low innovation sector in Peneder’s taxonomy; 0 if the firm is assigned to the High innovation sector

se\_med || 1 if the firm is assigned to the Medium innovation sector in Peneder’s taxonomy; 0 if the firm is assigned to the High innovation sector

se\_medhigh || 1 if the firm is assigned to the Medium-high innovation sector in Peneder’s taxonomy; 0 1 if the firm is assigned to the High innovation sector

Country || Country dummies at, ch, nl, fr, dk, hr, es, si for the location of the firm. Reference case is Germany

α || Is a constant

U || Are the residuals

The dependent variable can only take values
between 0 and 100. The appropriate estimation for this type for dependent
variable is a generalized linear model (GLM), which is basically a more general
form of the well-known ordinary least squares regression (see Papke and
Wooldridge 1996). The generalized linear model allows the linear model to be
related to the dependent variable, i.e. the variance function describes the
relationship between the variance of the explained variable and its mean, which
yields a non-biased estimation of the variance under non-normal conditions. In
this case, it is assumed that the dependent variable is distributed by a
binomial process and that the log of the mean of the dependent variable is
linearly associated with the explanatory variables. Therefore, the normality
assumption is violated, revoking the use of least-squares parameter estimation.

The model is specified as follows:

Regression results

The Table 2.3 below reports the results of the
analysis. For each independent variable, the table gives the estimated
coefficient, the robust standard error, the
probability that the coefficient is zero. \*\*\*, \*\*, \* denote statistical
significance of the coefficient at the 1%, 5%
and 10% test level.

Table 2.3: Determinants of the share
of services on turnover of manufacturing firms, results from a Generalized
Linear Model

Variable || Coefficient || Standard Error || P>|z| || Sig.

lemp || -0.636 || 0.109 || 0.000 || \*\*\*

lemp2 || 0.058 || 0.010 || 0.000 || \*\*\*

se\_low || -0.425 || 0.295 || 0.151 ||

se\_medlow || -0.610 || 0.120 || 0.000 || \*\*\*

se\_med || -0.221 || 0.063 || 0.000 || \*\*\*

se\_medhigh || -0.327 || 0.067 || 0.000 || \*\*\*

inmar || 0.132 || 0.052 || 0.011 || \*\*

sbatch || 0.266 || 0.056 || 0.000 || \*\*\*

complex || 0.158 || 0.054 || 0.003 || \*\*\*

supply || -0.035 || 0.051 || 0.495 ||

newfirm || 0.015 || 0.354 || 0.965 ||

At || -0.108 || 0.088 || 0.222 ||

Ch || 0.002 || 0.064 || 0.966 ||

Nl || 0.043 || 0.115 || 0.713 ||

Fr || -0.551 || 0.129 || 0.000 || \*\*\*

Dk || 0.170 || 0.108 || 0.116 ||

Hr || -0.005 || 0.165 || 0.978 ||

Es || -0.351 || 0.182 || 0.054 || \*

Si || 0.459 || 0.192 || 0.016 || \*\*

constant || -0.321 || 0.282 || 0.261 ||

No. of obs     || 2264 || || ||

Residual df || 2244 || || ||

(1/df) Deviance || .1383103 || || ||

Note: (1/df)
deviance measures the fit of the model and measures the actual deviance of the
estimated value from the observed value of the dependent variable. It should be
as small as possible, and zero in the case of a perfect fit. The value of
(1/df) Deviance is 0.1383.

Source: EMS 2009, own
calculations.

Firm size had a large explanatory
value in the regression analysis. There is a U-shaped relationship between firm
size and service share on turnover. As discussed above, this points to
different advantages of small and large firms in offering services. It also
indicates that, all other things equal, service output decreases first with
rising firm size and then increases again. The small coefficient of lemp2,
however, indicates that increases can only be seen beyond a very high
threshold.

The
relationship between service output and innovation intensity of the sector is
confirmed by the regression analysis. When holding all other factors constant,
firms in innovation-intensive sectors are more likely to realize a higher share
of turnover with services than firms in less innovation-intensive sectors. The
sector with low innovation intensity is an exception in that the negative
relationship is not significant. Taking into account that this sector only
constitutes 1.5% of the sample this result is not surprising. Due to the low
number of firms in this category the variance of the variable is small.[45]

The relationship between service
output and innovation intensity is also supported by the significant influence
of product innovativeness. Firms which have launched new products during the
last two years are more likely to realize higher shares of turnover generated
with services compared to companies who stated to not have introduced new
products. Product innovativeness seems to reinforce service delivery.

The hypotheses that firms which
produce in small batch or/and produce complex products are more likely to make
more turnover with services than firms with large batches and/or simple
products are also accepted. Both coefficients are highly significant, the
coefficient for single batch production is considerably higher.

The position
of the firm in the supply chain does not seem to have a significant influence
on the service output. Suppliers to industrial users have no higher service
output than firms which mainly supply consumers. Furthermore, the regression
provides no evidence that newly established firms or firms that are mainly
suppliers to industrial clients would have a higher share of services on output.
This effect may partially be gauged by the size variables. The fact that new
firms constitute less than 1% also affects the result. Since there are a very
low number of new firms in the sample, the variation of this variable is
limited.[46]

The hypothesis that the degree of
servitization depends on the region of the firms is rejected by the
multivariate analysis. The country dummies are not significant at a level of at
least 95%, except for France and Slovenia.

2.5.
European's position in trade in goods and
services and EU’s external competitiveness
2.5.1.
Introduction

The previous sections showed that there is
a relationship between service content, technology intensity and openness to
trade. It has also been demonstrated that KIBS play a vital role in this
context. This section takes a closer look at the EU’s external competitiveness
with respect to technology-intensive goods and particularly KIBS trade. It
begins with a description of trends in KIBS trade and technology-intensive
merchandise trade over 1996-2007. There follows a section on cross-country
comparisons and examinations of specialisation patterns and revealed
comparative advantage in EU merchandise and services trade. A third section
assesses KIBS intensity with respect to imports of production and trade, with
the aid of information from input-output tables. The imported-service
intensities of different sectors across countries are compared and analysed
over time. Also, the role of imported versus domestically produced KIBS is
analysed. This section also includes an analysis of the value added structure
of EU exports.

2.5.2.
Trends in KIBS trade

The present analysis of KIBS trade focuses
on cross-border trade (which includes services sold cross-border through local
affiliates).[47]
It compares old EU Member States (EU-15) and new EU Member States (EU-12), and
also both these groups with other markets, in particular Japan and the US. It looks
at total EU trade (meaning both extra- and intra-EU trade), as the bulk of
trade in KIBS is with third countries (80 %–90 % of trade in KIBS) —
in contrast to total services exports, where the extra-EU share has been
steadily decreasing and was less than 50 % in 2007.

As can be seen from Figure 2.11, the EU-15
is the major player on the KIBS market — its share in global KIBS exports is
around 50 %. In global imports, its share is slightly lower, but it still
is the key importer. The US has the second biggest share in KIBS exports (15 %),
while India is in third place with a 6 % share. The EU-15 is also the
biggest player in the market for technology-intensive goods. However, its share
is much smaller than for KIBS — 35 % in 2007. The second biggest exporter in
this market is China, with a share of 12 % in 2007. The US is the third
biggest exporter with an 11 % share. The EU-12, though having a small
share in the market for technology-intensive goods, has been increasing it
quite fast — from 1 % in 1996 to 3.6 % in 2007. The EU-15, US and
India are net exporters of KIBS, while Japan is a net importer. The EU-12 and
China have approximately equal volumes of exports and imports of KIBS. In the
market for technology-intensive merchandise goods, the EU-15 is again a net
exporter, along with Japan, while the US, China and India are net importers.

The value of KIBS trade is relatively low
compared to technology-intensive merchandise trade in all the regions.[48] In 2007, the share of KIBS in
global exports of technology-intensive goods plus KIBS was only 14 % —
which is about 7 percentage points lower than the share of total services trade
in cross-border trade. However, it is important to recognise that KIBS
activities represent a large share of the total cost of production in
manufacturing. The KIBS intensity of both EU-15 and EU-12 exports has risen
substantially on a value added basis, once it is recognised that KIBS are
inputs into manufacturing and are not only exported directly, but also
indirectly through goods.

Figure 2.11:
KIBS and technology-intensive merchandise exports in 2007, USD bn

Source: TSD, UN COMTRADE

As Figure 2.12 shows, the fastest average
annual growth for KIBS exports in 2007 was recorded in India. China had the
second highest growth rate. The EU-15, US, and EU-12 had been increasing their
exports of KIBS at approximately the same average rate during 1996-2007, while
Japanese growth had been considerably lower. In technology-intensive
merchandise exports, trends were different — here, China and EU-12 had the
highest growth rates, while India had the third highest growth rate. The EU-15
increased its exports on average by 8 % per year. Japan again showed the
slowest average annual growth. The US performed only slightly better with 5 %
average annual growth.

The fastest growth of KIBS imports during
that period was recorded in India, the EU-15 and the EU-12 while the slowest
rate was seen in the US. Japan was more active in the KIBS import market as
compared to the export market, with KIBS imports growing on average by 7 %
a year. In technology-intensive merchandise imports, China, India and the EU-12
again displayed the highest growth rates with average annual growth rates of 19 %-21 %.
In other regions, imports were increasing at an average annual rate of 5 %-8 %.

Figure 2.12:
Average annual growth of exports and imports of KIBS and technology-intensive
manufacturing, 1996-2007, %

Source: TSD, UN
COMTRADE

Turning to individual KIBS sectors, in
2007, KIBS exports in all the regions were dominated by other business
services, which accounted for about 70 % of EU-12 and EU-15 exports, and
more than 80 % of US and Japan exports (see Table 2.4). The common trend,
though, is a decline in the share of other business services in exports, the
biggest occurring in the EU-12 — 23 percentage points — and the smallest in the
US — 5 percentage points. This is mirrored by increased export shares for
computer and information services (apart from the US) and R&D (apart from the
EU-15).

The EU-12 had the highest increase in the
share of R&D services in KIBS exports — 10 percentage points. As a result,
in 2007, the EU-12 had the highest share of R&D in KIBS exports, the lowest
share being held by Japan. The structure of KIBS imports for the EU-12 and
EU-15 in 2007 was similar to the structure for exports, and had undergone
similar transformations. The US, however, had a very different import
structure. The share of other business services in imports for the US was only
49 %, with 31 % in computer and information services and 20 % in
R&D. For the US, the share of other business services also decreased by
about 41 percentage points during the period 1996-2007. Japan, in contrast, saw
a decrease in the share of computer and information services in its KIBS
imports — by 4 percentage points. The shares of both R&D and other business
services increased.

Table 2.4: KIBS export and import structure, %

|| USA || Japan || EU-15 || EU-12

|| 1996 || 2007 || 1996 || 2007 || 1996 || 2007 || 1996 || 2007

|| || || || Exports || || || ||

72 (computer) || 9.2 || 9.9 || 7.0 || 16.9 || 6.6 || 20.3 || 3.5 || 17.0

73 (R&D) || 4.3 || 8.7 || 0.4 || 1.7 || 13.3 || 8.6 || 0.6 || 10.3

74 (other business) || 86.5 || 81.4 || 92.6 || 81.4 || 80.1 || 71.1 || 95.9 || 72.7

|| || || || Imports || || || ||

72 (computer) || 5.5 || 31.4 || 15.7 || 11.3 || 6.7 || 20.3 || 4.0 || 19.7

73 (R&D) || 4.0 || 19.6 || 0.8 || 3.0 || 11.2 || 9.7 || 0.9 || 5.9

74 (other business) || 90.5 || 49.0 || 83.5 || 85.8 || 82.1 || 70.1 || 95.1 || 74.4

Source: TSD, UN COMTRADE.

The EU-15 is the biggest exporter in all
KIBS sectors (see Figure 2.13). It accounts for between 55 % and 67 %
of global exports of other business services, computer and information services
and R&D. The EU-12 has a very low share in global KIBS trade, but has been seeing
very fast export growth in computer and information services and R&D[49]. In other business services,
the EU-15 outperformed the EU-12 in terms of export growth. This is consistent
with the EU-12 emphasis on trade in merchandise rather than services in the knowledge-intensive
sectors.

India had the second largest share of
exports in computer and information services (72) in 2007. It also increased
its exports the fastest — on average by 92 % year-on-year. China, though
currently a small player in this market (3 % market share), has been
increasing its exports of computer and information services at a rate second
only to India’s (48 % average annual growth). The EU-12 was number three
with 31 % average annual growth. The average annual growth of computer and
information services in the EU-15 was on a par with the world average (25 %),
while other advanced economies — the US, Canada, Japan — had much slower
growth.

The R&D (73) market is dominated by the
EU-15 and the US (the latter having an 18 % share of global exports in 2007).
It is worth noting that the EU-12 has been seeing the fastest growth of exports
in this sector — on average 46 % per year. On the one hand, this can be
partially explained by the low starting base. On the other hand, the share of the
EU-12 in the global R&D market is currently almost on a par with Canada’s,
which makes it an important player in the world market. In contrast, the EU-15
has been seeing relatively sluggish growth in R&D exports — on average 8 %
per year, which is lower than the world average. The US outperformed the EU-15 on
this indicator.

In the market for other business services
(74), the US is again the second biggest player after the EU-15. The market
share of the EU-12 is comparable to those of India, Korea, and China. China has
been establishing itself as a serious player in the market, with the fastest
export growth — during 1996-2007 its annual exports of other business services
increased at an annual average rate of 52 %. India had the second highest
growth rate — 27 %. The EU-12, along with the advanced economies of the EU-15
and the US, showed moderate growth for exports in this sector — around 10 %-12 %
per year. Japan had the most sluggish dynamics in exports of other business
services — less than 1 % average growth per year.

Figure 2.13:
Shares of global exports and import in 1997 (%)

2.5.3.
Patterns of specialisation

Patterns of
specialisation in the EU’s technology-intensive merchandise and KIBS trade are
analysed with Balassa’s Revealed Comparative Advantage (RCA) index, also known
as an export specialisation index.[50]
According to the calculated indices (see Figures 2.14, 2.15), the EU-15 has on
average stronger revealed comparative advantages in KIBS exports than in
technology-intensive merchandise exports. The strongest comparative advantage
for the EU-15 is found for R&D. Comparative advantages in R&D gradually
declined during 1996-2003, but have picked up after 2004, which might be
related to efficiency gains brought by EU enlargement. Also, the EU-15 has
increasingly specialised in computer and information services exports, in
contrast to the US, which has lost this specialisation. At the same time, the EU-15
has the weakest comparative advantages in all the technology-intensive
merchandise sectors as compared with the US and Japan. Only in exports of
machinery n.e.c. (NACE 29) and motor vehicles (NACE 34) does the EU-15 display
strong RCAs. The EU-12, in contrast to the EU-15, seems to have more
comparative advantages in technology-intensive merchandise trade than in KIBS. Among
the KIBS sectors, it has revealed comparative advantages only in R&D, which
is a new specialisation pattern that has developed since 2004. The conclusion that
the EU-12 has a higher specialisation in manufacturing than in services is also
confirmed by a comparison of the dynamics of KIBS and technology-intensive
merchandise exports during 1996-2007, which shows that KIBS exports grew more
dynamically than merchandise trade in the old Member States, while in EU-12 the
situation was the reverse. Japan has no RCAs in KIBS exports, but has the
strongest specialisation of all the regions in motor vehicles (34) and radio
and television equipment (32). Overall, the country tends to specialise in all
the technology-intensive goods sectors, apart from office and computing
machinery (30), where it lost export specialisation after 2003 — apparently
reflecting the relocation of computer equipment production to other Asian
countries. The US has the strongest specialisation in other transport equipment
(35) and medical instruments (33). The country also appears to have recently
developed a stronger export specialisation in motor vehicles (34), while
revealed comparative advantages in office and computing equipment (30) and
radio and television equipment (32) seem to be gradually fading away.

Figure 2.14:
RCAs in KIBS

Source: TSD, authors’ calculations

Figure 2.15:
RCAs in technology-intensive goods

Source: UN COMTRADE, authors’
calculations

2.5.4.
KIBS intensity of production and trade

KIBS shares in gross production costs
accounted for between 5 % and 15 % of total direct costs in
manufacturing in EU-15 in 2007, and from 3 % to 9 % of total direct
costs in manufacturing in the EU-12. In this context, KIBS are particularly
important for competitiveness in electrical machinery in the EU-15, and in other
transport equipment and paper and printing in the EU-12. A notable feature is
that KIBS intensity increased in all the industries of both regions as compared
with 2001.

While technology-intensive trade is much
greater than direct KIBS trade as shown above, it is also important to recognise
that KIBS activities also represent a major share of the total cost of
production in manufacturing. Indeed, in this chapter it is shown that, on a
value added basis, KIBS are highly important to the competitiveness of European
manufacturing, and to the overall value added embodied in European exports.
Indeed, the KIBS intensity of both EU-15 and EU-12 exports has risen
substantially on a value added basis, once it is recognised that KIBS are
inputs into manufacturing, so are exported not only directly, but also
indirectly through goods.

Cross-border KIBS trade is important in
both the EU-15 and EU-12 in terms of the impact on manufacturing costs. In the
background study (Stehrer et al., 2011), cost shares of 9.8 per cent in the
EU-15 and 4.5 per cent in the EU-12 are reported.[51] As noted earlier, the EU is
more KIBS-intensive than the US or Japan. Imports account for between 5.3 per cent
(EU-12) and 5.5 per cent (EU-15) of these total costs. Together, the data in
this chapter point to the importance of KIBS for the competitiveness of
European manufacturing, especially in comparison to the US and Japan. This is
particularly true for electrical machinery and equipment in the EU-15, though
KIBS is an important aspect of the cost structure across manufacturing. There
has been a rapid growth in imports in KIBS-intensive service categories.
Indeed, the growth in the EU has been 12.2 to 12.6 per cent per year from 1996
to 2007. This is far greater than the KIBS import growth rate in Japan and the
US, which was only 6.8 per cent and 2.8 per cent, respectively. This means the
EU has become increasingly dependent on imported service inputs in order to
maintain the cost-competitiveness of its KIBS-intensive industry, in comparison
to both the US and Japan.

The KIBS intensity of trade is also
analysed in terms of the contribution of KIBS to the value added contained in
European exports. Focusing on value added emphasises the direct contribution made
by exports to demand for labour and capital in Europe, rather than counting the
value of imported (extra-EU) inputs in production costs. Also, focusing on
value added makes it easier to trace the indirect linkages between KIBS demand
in manufacturing and the value added contained in exports.

Figure 2.16 presents the share of KIBS in
total EU value added contained in exports. Two sets of figures are presented.
The first set of figures presents KIBS as a share of direct exports, measured
in terms of sector value added — see Stehrer et al. (2011) for technical
details. This is the share of direct value added, following from the value
added (capital and labour) needed to produce direct EU exports in KIBS sectors
and ignoring the EU value added in intermediates that feed into the sector.
However, this is not a complete picture. Because, as seen above, KIBS are also
important inputs to manufacturing, this means that the value added in KIBS
activities that feed into manufacturing is also reflected in the exports of the
manufacturing sector. Therefore, the second measure presented, which reflects
forward linkages from KIBS production into other downstream sectors, includes
not only the value added of direct exports but also the KIBS value added
embodied in other European exports, such as machinery and equipment.

Figure 2.16 —
KIBS shares of direct costs in manufacturing, 2007

Source: GTAP

On a direct basis, KIBS activities
accounted for between 4.4 per cent (EU-12) and 10.9 per cent (EU-15) of EU
exports on a value added basis in 2007. This differs from gross export shares,
because gross exports also reflect the cost of intermediate inputs. For both
the EU-12 and EU-15, these value added shares of direct KIBS exports have risen
from 2001 levels. Including indirect exports, where the KIBS value added is
embodied in manufacturing exports, the KIBS intensity of EU exports is even
greater, ranging from 8.8 (EU-12) to 18 per cent (EU-15) of the value added
contained in European exports in 2007. Like the direct shares, these values are
up from 2001 levels. These trends underscore the importance of KIBS activities for
EU competitiveness, in this case as measured by exports.

2.5.5.
Conclusions

This chapter considered the role of
knowledge intensive service sectors in the EU economies as compared to other
major economies like the US and Japan. This was done from different
perspectives pointing towards the various trajectories the phenomenon of
‘quarternisation’ (Peneder et al. 2003) might take. Particularly, it was
outlined that, first, this ‘quarternisation’ process is not to be seen as a
mere increase of the shares of services in the overall economy but that these
services play an increasingly important role of intermediate inputs into
manufacturing and into high-tech manufacturing in particular. This was
documented by studying the overall shares of intermediate inputs, the
respective backward and forward linkages between KIBS and manufacturing and
their role in carrying product embodied knowledge flows. Second, there is also an
important role of manufacturing industries and firms in the process of an
increase of the general share of services as there is evidence that more and
more manufacturing firms (in particular firms in high-tech innovation intensive
sectors) provide more and more service outputs along their manufacturing goods.
Finally, the analyses pointed towards the increasing role of service trade in
overall trade, related it to the patterns of trade in high-tech manufacturing
goods and the relative importance of imported KIBS services in production costs
and the increasing share of KIBS in value added exports.

In more detail, the analyses in Section 2
pointed towards the increasing importance of KIBS in the EU economies and
compared these to Japan and the US. Though the increasing importance of KIBS
for all economies considered here is clearly seen in terms of rising shares in
employment and value added, the regions having lower shares have not increased
them in a particularly faster way. The second issue covered in this section was
on the role of KIBS as inputs into the total economy and into high-tech
manufacturing in particular. The analyses found some evidence on the growing
importance of KIBS as inputs in the total economy and particular subsectors,
but also a difference between the EU and the US with the EU lagging behind in
high-tech manufacturing.

Section 3 outlined the
structure and strengths of domestic and international inter-industry knowledge
flows. R&D performed within the sector determines only part of the total
technology flows in the economy. Technical knowledge embedded in intermediate
goods, sourced both domestically and abroad, makes up an important part of the
total technology flows, especially in those countries attempting to catch-up
with the technological leaders. It is equally important for countries on the
global technology frontier and considerably more important for those countries
below it. Product embodied knowledge plays an important role in the catching-up
of economies below the global technology frontier. At the frontier, economies
rely more on domestic R&D performance than on inter industry, domestic or
international, technology flows, while for the countries below the frontier,
international embodied technology flows are relatively more important. Two dimensions
determine the structure of embodied technology flows and their relative
importance to intra-industrial R&D performance. The first is the openness
of the national economy to international trade, having a strong co-linearity
with the size of the economy, and the second is the national position vis-à-vis
the global technology frontier. For the catching-up knowledge users, Kaldor’s
argument that manufacturing is the engine of productivity growth remains valid,
as shown by downstream links from manufacturing to KIBS sectors. Inter-industry
technology flows from abroad are particularly important. However, for the
knowledge supplying economies at the technology frontier, the forward impact of
manufacturing on KIBS is substantially diminished
relative to the catching-up economies. KIBS have a
stronger forward, downstream impact on manufacturing. In these economies KIBS appears to be a significant source of knowledge
into the manufacturing industries, alongside the technology generation within
these manufacturing industries along with their own R&D performance.

The next section, Section 4, then provided
evidence that European manufacturing firms increasingly offer services along
with their physical products. The share of services in the output of
manufacturing industries increased in the large majority of countries over
time. However, service output is still small compared to the output of physical
products. The service share tends to be larger in smaller
countries and higher in countries with a higher R&D-intensity. EU-12 Member
States have lower shares of service output compared to the EU-15. At the
sectoral level, there is a higher service share in innovation-intensive sectors,
such as the manufacturers of electrical and optical equipment, machinery, or
the chemical and pharmaceutical industry. Service output is highest among small
and among large firms. Producers of complex, customized products tend to have a
higher share of services in output than producers of simple, mass-produced
goods. The results clearly show the manifold interactions between KIBS and
manufacturing. KIBS are not only an important input for manufacturing, but are
also offered by manufacturing firms to gain competitiveness, increase
profitability, and generate additional value for customers by offering product-service combinations. KIBS produced by manufacturing firms have a considerable share on
total KIBS exports and contribute to trade in services.

Finally, in Section 5 the analyses pointed
towards the increasing importance of trade in services and the particular role
EU countries play in this field. In particular, the EU-15
has on average stronger revealed comparative advantages in KIBS exports, than
in technology-intensive merchandise exports. Further the analyses pointed
towards the increasing importance of imported KIBS in the costs structures of
manufacturing and the KIBS shares of European and other countries value added
exports. The latter show an increasing tendency which points to the particular
role KIBS play in EU’s external competitiveness.

From a policy perspective this study
therefore pointed towards the increasing importance of KIBS in various respects
and that, overall, the EU and particularly the EU-15 does not underperform to
other major economies like the US and Japan. However, the study also pointed
towards the significant differences across EU member states and the lack of any
kind of convergence process which might be expected to take place. Thus, the
investigated structures and relationships seem to be quite persistent thus that
one might be allowed to speak of a general ‘quarternisation’ process across
countries. With respect to the EU countries there have been however significant
achievements with respect to the Service Directive which has been fully
implemented in most countries over the last years. There are however
differences as regards the comprehensiveness and quality of implementation, and
these will need to be thoroughly assessed.

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Annex 2.1

Measuring direct and indirect flows of
R&D activity in the Input-Output framework

Input-Output analysis is ideal for
measuring the diffusion of product-embodied R&D. The open Leontief model is
best suited for the task as it considers technology and final demand
separately. Assuming that the economy is composed of n industries, the output
vector x is either consumed as final demand y or used by other
industries. In matrix notation, it appears as:

x = Ax +
y,

where A is the technical coefficients
matrix. If A is non-singular, it is possible to obtain the Leontief inverse or
total requirements matrix B through matrix algebra:

x = (1 – A)-1y ≡ By,

which shows the input requirements, both
direct and indirect, for all other producers, generated by one unit of output.

It is assumed that R&D intensity is the
vector with components ri in each industry i measuring
gross R&D expenditures over gross output. The intensity vector of direct
and indirect flows of R&D activity ti into each
industry i is obtained as:

t = rB

However, this
relationship measures intensity relative to final demand, and not to total
output. The expression thus implies a double-counting, when the purpose is to
estimate the technology intensity of the sector as a whole. Both the backward
linkages to industry j and the forward linkages from industry j
determine the intensity of product-embodied R&D, before ending up in the
exogenous final demand categories of industry j in this expression.
Hauknes and Knell (2009), following Miller and Blair (1985), get around this
problem by using a modified input-output matrix B\*:

t\* = rB\*,

which measures the
technology intensity per unit of total output rather than per unit of final
demand of the recipient sector j. The elements of B\* are given directly
by the elements of the ordinary Leontief inverse B, but scaled by the diagonal
elements of the B matrix (Hauknes (2011)).

Total knowledge flows  into industry j, measured relative to
total output, are in this study composed of the domestic R&D intensity
within the industry , the intensity of
domestically generated embodied technical knowledge  from other sectors, and the intensity of embodied technical knowledge  contained in imported commodities:

where b\*ij
and bij are the elements of B\* and B, respectively, represents the global technology frontier for
industry i, defined as the average R&D
intensity of the OECD, and mij is
based on imports of inputs from industry i going into industry j.
This formulation of the global technology
frontier contains a small upward bias in the estimates of international
R&D flows, as about one fourth of total trade is with countries below the
frontier. Value-added intensities can be obtained by dividing the individual
components of R&D in industry j by yi.

The formulation of the import vector is not
obvious. The choice of formulation in this study is to let imports be
multiplied in the importing country, i.e. imported R&D flows in the
transnational context are treated as similar to own R&D in the domestic
context. More explicitly

tm = rf (AmBd\*x
+ AmBd\* AmBd\*
AmBd\*x + …)

where Am
is the matrix of import coefficients relative to domestic total output, and Bd\* is the domestic B\* matrix for the
importing country. This series expansion is rapidly converging; here, just the
stated two terms are retained.

The analysis also distinguishes between direct
and indirect flows of knowledge. Embodied knowledge can flow directly
from industry i to industry j, or indirectly through other
intermediate sectors. Direct knowledge flows from domestic sources are
identified as  and indirect linkages as the residual: . Similarly, direct knowledge flows from
international sources are identified as tm(direct) = rfAmx.
Indirect linkages appear as a residual: tm(indirect) = tm
– tm(direct). The total knowledge or technology intensity of
any domestic sector j, relative to total domestic output of this sector,
can therefore be written as:

Annex
2.2

Measuring intersectoral forward and
backward linkages

Rasmussen (1957) and Hirschman (1958) focus
on the ‘use’ of inputs in a single downstream sector j to measure
backward linkages. They measure the total technology
intensity of sector j, but do not consider the originating sector. The
backward linkage measure of sector j, described in Annex 1,
overestimates the pairwise inter-linkages between a source sector i and
a different recipient sector j of the economy. The
measure t\* = rB\* gives the total technology
intensity of the downstream recipient sector j, across all originating
upstream sectors i. B\* gives rise to double counting when the analysis
focuses on the intersectoral linkage between i and j. This
suggests that it is necessary to extract the impact of paths that include
upstream sectors relative to sector i to capture the true total inter-linkage
of the pair of sectors i and j. Given the inter-industrial
network structure, the Leontief matrix, the task is then to sum up all direct
and indirect paths between the two sectors that start in the source sector and
end in the recipient sector, and never pass through any of them along the way.
From the perspective of the upstream industry i, this is the forward
linkage (in the sense of along the flows of traded goods) of this
sector into sector j, while from the perspective of the (relative) downstream
sector j, the same measure describes the backward linkage — in
the opposite direction of trade flows — of j into sector i.

B+ is a matrix very similar to
B\* and measures the downstream impact of R&D performed in any industry i.
The i-component of the total downstream impact t+ in
units of total output of sector i is:

The full intersectoral linkage
matrix of the economy, given the basic input-output matrix A, is described
by a matrix L, whose matrix elements lij measure the
aggregate linkage amplitude l between any two industries i and j:

with bij being as before
the matrix elements of the Leontief inverse B of A (see Hauknes, 2011, for
derivation). The denominator is the determinant of the (i, j) 2 x
2 submatrix of B:

Scaling the components of the B matrix
eliminates the double counting that results from the interaction between
sectors i and j. The components of the matrix B\* (see Box 1) make
mathematical sense, but do not make economic sense, because a sum over rows is
always assumed to produce a measure of economy-wide impacts on sector j.
The linkage matrix L above, however, is economically meaningful at the
component level, measuring the strength of interaction for the link i à j,
but not when summed. Sums along rows or columns of L have no direct economic
meaning.

Import flows need to be included to close
the economy. Adding the domestic and import flows together does this, which
creates a Leontief A matrix of ‘total’ flows. Standard procedure generates a
total Leontief inverse B, which is then used to calculate the total L matrix.
Producer or backward linkages are calculated on the basis of the total
connections. Following Jones (1976), the analysis uses the domestic linkages
for calculating the user or forward linkages. This procedure implies that
imports are treated at the same level as domestic inputs, i.e. the input-output
flow structure and its accumulation of the exporting country by the same
structures in the importing country is mimicked. The implicit assumption is
that all countries are structurally similar in a certain sense. Though
conventional and valuable, this is a rough first-order approximation. However,
an extension along these lines quickly runs into large data and estimation
challenges, even though it is a fairly straightforward extension.

The following modified Rasmussen measures
are created in order to describe the strength of intersectoral technology
linkages. The relative forward linkages pab and
backward linkages uab between the two industry
groups a and b (with the trade flow direction a à b) can be constructed as:

and

The forward linkage p
measures the accumulated technology volume from a to b as a share
of the total technology deposits emanating from source sector a. The
backward linkage u measures the same nominator as a share of the total
economy-wide deposits into the recipient sector u.

.

Annex
2.3

Description  of the dataset used in the
regression analysis.

The tables below show the distribution of
the firm-level observations across countries, manufacturing industries, sizes
of the firms and formation of the firms for different time periods. A taxonomy
of firms in different innovation intensities is also provided. This taxonomy
builds upon Peneder (2010).

Table A – 2.3.1 Population of the data set. Distribution across
countries

Country || Number of observations || Percent

Austria (AT) || 188 || 8.3

Croatia (HR) || 63 || 2.8

Denmark (DK) || 154 || 6.8

Finland (FIN) || 0 || 0.0

France (FR) || 93 || 4.1

Germany (DE) || 993 || 43.9

Netherlands (NL) || 186 || 8.2

Slovenia (SI) || 43 || 1.9

Spain (ES) || 56 || 2.5

Switzerland (CH) || 488 || 21.6

Sum || 2,264 || 100

Table A – 2.3.2. Distribution of population over industries

NACE Rev. 1.1 || Sector || Percent

15+16 || Food and drink and tobacco || 4.8

17-19 || Textiles, clothing and  leather  and footwear || 3.0

20+36 || Wood and wood products and furniture || 7.5

21+22 || Pulp and  paper  and printing and publishing || 4.6

23+26+37 || Refined petroleum, non-metallic mineral products and recycling || 5.3

24 || Chemicals || 5.1

25 || Rubber and plastics || 8.0

27+28 || Basic metals and metal products || 21.1

29 || Machinery n.e.c. || 21.0

30-32 || Office machinery, electrical machinery and Radio, TV & communic. Eq. || 8.6

33 || Scientific and other instruments || 7.9

34+35 || Transport equipment || 3.1

|| || 100.0

Table A – 2.3.3. Distribution of population across sectoral
innovation intensity

Innovation intensity || Percent

Low || 1.6

Med-low || 8.1

Med || 26.9

Med-high || 25.8

High || 37.5

|| 100.0

Table A – 2.3.4. Distribution of population across firm sizes

Firm size || Percent

up to 49 employees || 39.7

50 to 249 employees || 46.4

250 and more employees || 13.9

|| 100.0

Table A – 2.3.5. Distribution of population across firm age

Firm age || Percent

Formed before 1991 || 74.9

Formed in 1991 to 2000 || 18.6

Formed in 2001 to 2001 || 5.8

Formed in 2006 to 2009 || 0.8

|| 100.0

3.
European Competitiveness in Space Manufacturing and
Operation
3.1.
Introduction

Two of the momentous events of 1957 were
the signing of the Treaty of Rome and, a couple of months later, the start of
the space age. In other words, the space age and the EU are the same age and are
both now in their sixth decade. It is however only in the last quarter of a
century that the EU has developed an interest in space policies, starting with
a 1988 communication in which the Commission outlined a coherent EU approach to
space (European Commission 1988). Member States had by that time developed
their own space policies, as had the European Space Agency (ESA) and its
predecessors, the European Space Research Organisation (ESRO) and the European
Launch Development Organisation (ELDO), both established in 1964.

Following the 1988 communication, a common
EU approach to space gradually took shape (European Commission 1992, 1996,
2000) and the cooperation between the EU and ESA intensified, manifesting
itself in joint task forces, joint preparation of ESA and Commission documents
(e.g. European Commission 2003a), the 2004 framework agreement on cooperation
and coordination, and the creation of the European Space Council drawing
together ministers from EU and ESA Member States. The Space Council held its
first meeting in 2004 and has since met on six more occasions.

Over the years, as the EU approach to space
progressively crystallised there was a growing insight among European
policymakers about the need to step up space cooperation activities and
establish a truly European space policy (European Commission 2001, 2003a, b).
This insight should also be seen in the context of the decisions by the EU to
create large-scale development programmes for two flagship projects, Galileo
(satellite navigation) and GMES (Earth observation), as well as EGNOS (European
Geostationary Navigation Overlay Service). In 2007, the 4th Space Council gave
its political blessing to the first European Space Policy (European Commission
2007a). This represented a real step change: prior to 2007 the strategic importance
of space had been expressed in several EU documents, whereas the European Space
Policy is the first common political framework for space activities in Europe.
The resolutions adopted by the 4th and 5th Space Councils in 2007 and 2008
formulated priority areas for Europe with respect to space. More recently, the
new role of the EU in space policy is reflected in the Treaty on the Functioning
of the European Union which gives the European Space Policy a legal basis and
confers on the EU competence, shared with its Member States, to ‘draw up a
European space policy’ in order to promote, among other things, industrial
competitiveness (Article 189 TFEU). The same article also mandates the European
Parliament and the Council to ‘establish the necessary procedures, which may
take the form of a European space programme’.

Against the backdrop of these developments
and with a view to the future, this chapter reviews the competitiveness of EU
space manufacturing and operations. It also identifies the factors that are key
to the future competitiveness of the sector, as well as potential obstacles to
further development.

3.1.1.
Recent developments reflecting the new Treaty
provisions

In 2011 the Commission adopted a
communication taking stock of the new situation and outlining the way forward.
It listed the following objectives of the European Space Policy: the promotion
of technological and scientific progress; industrial innovation and
competitiveness; enabling European citizens to reap the benefits of space
applications; and a higher European profile on the international stage in the
area of space (European Commission 2011). Moreover, it made the case for a
European space industrial policy, the main objectives of which would be
‘the steady, balanced development of the industrial base as a whole, including
SMEs, greater competitiveness on the world stage, non-dependence for strategic
sub-sectors such as launching, which require special attention, and the
development of the market for space products and services’ (European Commission
2011).

In response to the Commission
communication, the Council on 31 May 2011 adopted a set of conclusions in which
it confirmed as the top EU priority the implementation of its two flagship
programmes: on the one hand GMES (Global Monitoring System for Environment and
Security), on the other EGNOS and Galileo. Security and space exploration were
also mentioned as priority areas. The Council lent its support to the
Commission with regard to the need for a space industrial policy along the lines
outlined in the Commission communication. The conclusions ended with an
invitation to the Commission to organise broad consultations and discussions on
the main elements of a possible future European space programme.

3.1.2.
Interaction with other EU policies

The European Space Policy is intrinsically
linked to other EU policies and should be seen in the context of the Europe
2020 strategy (European Commission 2010a). Two of the flagship initiatives of
the strategy are the Innovation Union (European Commission 2010c), to which the
space sector contributes by virtue of its innovative potential, and the new
industrial policy for the globalisation era (European Commission 2010d) which
singled out the space sector as a target for sector-specific initiatives under
the new competences conferred by Article 189 of the Treaty.

Other EU policy areas which the European
Space Policy supports include transport, agriculture, security, crisis
management and humanitarian aid, telecommunications, environment and climate
change. In these and other areas, there is an opportunity for the European
Space Policy to help achieve policy objectives.

3.1.3.
Defining the EU space sector: space
manufacturing and operations

Before defining the sector, it is important
to underline that the atypical character of the space sector means that an
analysis of its competitiveness will differ from more traditional analyses and
will need to take into account its specificities. The most striking difference
is that the space sector is to a large degree financed by public funds while at
the same time many of its customers are public institutions. Another
distinguishing feature is that production series are often very short and
sometimes a single unique product is required. The technical and financial risks
in space activities are higher than in most other sectors (BIS 2010). Finally, specific
and divergent procurement policies are in place, in Europe as well as globally,
and there is a growing trend towards self-sufficiency, notably due to the
strategic and dual-use character of the space sector and the arrival on the
international stage of emerging space-faring nations.

Notwithstanding the specific
characteristics of the EU space sector, this chapter will illustrate its
performance in comparison with its competitors and how it contributes to EU
competitiveness in general.

Box 3.1: Definition of the EU space sector

For the purposes of this chapter the EU space sector is defined as
three manufacturing segments – satellite, launcher, ground segment
manufacturers – and four operation or exploitation segments: communication
satellites, navigation satellites, Earth observation satellites, launching
services. This definition is illustrated below.

The definition excludes upstream suppliers (for instance of
electronic components) as well as downstream service providers and applications
based on space data but operating without space assets of their own. In several
previous analyses of the space sector, such downstream service providers and
application producers have been defined as part of the space sector by virtue
of their importance in terms of turnover, job creation, etc. In this chapter
they are defined as customers of the space sector. In other words, the sector
definition used in this chapter excludes the part of the value chain with
possibly the greatest impact on the EU economy: space-enabled services and
applications.

3.2.
Characteristics of the EU space sector
3.2.1.
Turnover

In 2009, the consolidated turnover of the
EU space sector as defined in Box 3.1 was EUR 10.3 billion (final sales),
an increase of 1.9 % from 2008. The breakdown by segment is illustrated in
Figure 3.1. Satellite manufacturing and communication satellite services are
the most important segments, between them generating more than two thirds of
total final sales, followed by launcher manufacturing and launching services
with almost a quarter of total final sales between them. Ground segment
manufacturing, Earth observation services and satellite navigation services are
much smaller in terms of turnover.

Figure 3.1:
Final sales 2009, EU space sector by segment

Source: Background study.

Turning specifically to the three
manufacturing segments, for which better data are available than for the
operation segments, Figure 3.2 illustrates annual turnover from 2003 to 2009.
Turnover in manufacturing was considerably higher in recent years than in
2003–2006 (also in volume terms when expressed in constant prices) but sales
have not yet reached the same volumes as the peak in 1999–2001 (not shown in
Figure 3.2).

Figure 3.2:
Consolidated final sales of the EU space manufacturing segments, 2003–2009

Source: Eurospace (2010).

The three manufacturing segments make up
just over half of total sector turnover, the four operation and exploitation
segments making up slightly less than half. In spite of data on the latter four
segments not being available to produce a graph such as in Figure 3.2, the
general impression is that sales in those four segments have been increasing
over time in line with the three manufacturing segments depicted in Figure 3.2.

3.2.2.
Profitability

No profit margins for the different
segments of the EU space sector are available, but according to estimates the
average profit margin (as a percentage of turnover) is low, around 3 per cent.
This comparatively low level is due less to fierce international competition
than to the structure of the sector, with a large proportion of public funding
and influence (see 3.4.1 below) resulting in contractual profit agreements.

3.2.3.
Employment

The EU space sector as defined in
Box 3.1 is estimated to have directly employed around 35 730 persons
in 2009 (full-time equivalents). Figure 3.3 illustrates how the vast majority
are employed in satellite manufacturing, followed by launcher manufacturing.
The operation and exploitation segments account for a relatively small part of
employment despite generating nearly half the turnover of the sector.

Figure 3.3:
Direct employment in the EU space sector, 2009

Source: Background study.

Again concentrating on the three
manufacturing segments, Figure 3.4 illustrates how employment in space
manufacturing has evolved from 2000 to 2009. Since 2005, direct employment in
space manufacturing is increasing again after years of consecutive job cuts,
but even so the number of jobs in 2009 stood around 10 per cent lower than
at the peak in 2001.

Figure 3.4:
Direct employment in EU space manufacturing, 2000–2009

Source: Eurospace (2010).

From a geographical perspective, employment
in space manufacturing is relatively concentrated in a few countries. In 2009,
France employed more people in the space sector than any other Member State (11 225),
followed by Germany (5 270) and Italy (4 490).

3.2.4.
Turnover per employee as proxy for labour
productivity

A major shortcoming of most analysis of the
space industry, including this chapter, is the lack of data on productivity.
Because space manufacturing is capital-intensive rather than labour–intensive,
the best measure of productivity would be total factor productivity but
unfortunately data on capital intensities are not available. Labour
productivity therefore is only a small part of the picture, but even there data
availability is a problem. Ideally, it ought to be calculated as value added
per hour worked, but neither is available for the space sector. Analysts have
in the past resorted to using turnover per full-time equivalent employee as a
proxy for value added per hour worked, but as a proxy it has several potential
shortcomings (apart from ignoring the capital intensive-nature of the sector as
outlined above):

·
Turnover in a high-technology sector such as
space is higher than in other sectors because the value of inputs is higher.
Any comparison across sectors based on turnover per employee is therefore
flawed, as is any comparison of segments within the space sector.

·
Turnover encapsulates a multitude of factors
unrelated to labour productivity such as the business cycle, market
developments, and competition.

·
Specifically for a sector driven by public
institutions such as space (or defence), turnover can go up or down depending
on political decisions and as a consequence of contractual price agreements
between public institutions.

With these
caveats in mind, Figure 3.5 depicts the evolution of turnover per employee in
EU space manufacturing (full-time equivalents) in recent years. It can be seen
that turnover per employee has increased in all years except 2005, when it was
unchanged, and 2009, when it fell. Falling labour productivity in 2009 is
however only one of several possible causes for the fall in turnover per
employee.

Figure 3.5: Turnover per employee
(thousand €) in EU space manufacturing, 2003–2009

Source: Background study.

Average
turnover per employee in EU space manufacturing in recent years has been around
€ 160 000 per year. This is comparable with international figures for
space manufacturing but clearly higher than other sectors of the EU economy,
for the reasons outlined above.

3.3.
Policy and regulatory environment of the EU space
sector and framework conditions
3.3.1.
Policies

In 1975, the
European Space Agency (ESA) succeeded the European Space Research Organisation
and the European Launch Development Organisation, both with their origins in
the 1960s. ESA is an intergovernmental organisation providing and promoting
cooperation among European states in space research and technology and their
space applications. Since the establishment of ESA, European space policy has
been successfully developed within its framework by its Member States. At the
brink of the new millennium European leaders recognised the need for a more
comprehensive and truly European space policy. In 1999, ministers asked the ESA
Executive and the Commission to develop a coherent European strategy for space
(European Commission 2000). The strategy was built around three objectives:

·
Strengthening the foundations for space research

·
Enhancing scientific knowledge

·
Reaping benefits for market and society

This was
followed by the establishment of a joint Commission-ESA task force to further
develop the strategy and draw up proposals for its implementation (European Commission
2001). The cooperation between ESA and the Commission was strengthened through
the establishment of a framework agreement between the two parties formalising
their cooperation and coordination. The agreement entered into force in 2004
and has since been extended until 2012. The framework agreement defines the
roles of ESA and the Commission as follows:

·
ESA will continue to focus on space launches,
science, exploration and human space flight.

·
The Commission will concentrate on space
applications and the overall coordination of the European Space Policy.

ESA has made
significant research efforts, including in the Ariane and ARTES (Advanced
Research on Telecommunication Satellite Systems) programmes which have driven
research, development and innovation in the relevant parts of the EU space
sector.

The European
Space Policy concerns the medium and long-term use of space for the benefit of
Europe, notably in terms of the environment, security and competitiveness. In
this respect, the development of flagship programmes such as the satellite
navigation system Galileo/EGNOS and the Global Monitoring System for
Environment and Security (GMES) has been a cornerstone and has influenced the
EU space sector tremendously, in particular through the vast research effort
that has gone into these two programmes (Alberti 2008). As set out in European
Commission (2011), the aims of the space policy are to promote technological
and scientific progress, stimulate industrial innovation and competitiveness,
enable European citizens to reap the benefits of space applications, and raise
Europe’s profile on the international stage in the area of space. In order to
achieve these goals, Europe needs to ensure independent access to space.

3.3.2.
 Regulatory conditions

There are six
regulatory conditions with a major impact on the European space sector:

·
Standardisation and interoperability with
respect to satellite operations. Standardisation improves industrial
competitiveness and efficiency and is important for all three application
sectors of the satellite industry (communication, navigation, Earth
observation).

·
The national space law of the Member States,
which is not uniform across the EU.

·
Export control rules, especially concerning
dual-use goods.

·
WTO law concerning space goods and services
(Euroconsult 2010).

·
Legislation on the transfer of space objects.

·
Code of conduct for outer space activities
(Listner 2011).

Additionally, procurement policy is
an important regulatory condition, as the principle of geographical return
(applied by ESA) has an important impact on the space sector, while at the same
time current EU procurement rules may not be ideally suited for major flagship
programmes such as Galileo and GMES (Hobe et al. 2010).

Finally, the availability of radio
frequency spectrum is a factor which might hamper the development of satellite
communication and satellite navigation. On the one hand, there are spectrum
shortages in terms of competition between space users as well as with
terrestrial technologies; on the other hand there is a risk of potential
overlaps on certain bands used for satellite navigation (US National Security
Space Strategy 2011).

3.3.3.
Framework conditions

The most relevant framework
conditions affecting the sector are:

·
Labour market: the high-technology engineering
industry depends on the availability of a flexible and highly skilled labour
force, the supply of which is scarce in the EU.

·
Openness of third markets: main parts of the
non-European market are closed to European manufacturers and operators, for
instance the satellite and launch segments of the market.

·
Access to finance: a range of financial
instruments can offer a competitive advantage.

·
Research, development and innovation are also
essential for the functioning of the space industry, have made the EU industry
what it is today, and are key to maintaining its position in a competitive
environment in which emerging space nations with their own space industry are
trying to gain market shares.

3.4.
Results of the analysis

This section
addresses the competitiveness of the EU space sector, its industry structure
and, in that context, customer types and concentration developments in the
sector. Furthermore, the topic of R&D and innovation in the space sector is
reviewed. In addition, the EU space sector is benchmarked against its US competitor
as well as against two reference EU sectors, followed by an assessment of its
strengths and weaknesses, as well as the opportunities and threats facing the
sector.

3.4.1.
Largely institutional customer base

The space
sector is to a large extent driven by public funding and institutional
customers, globally more so than in the EU. As Figure 3.6 illustrates, half of
final sales of the space manufacturing industry in 2009 went to European
institutional customers. However, the share of European institutional customers
for the European space sector as a whole declined from 2003 to 2009. The figure
shows that as a percentage of total turnover, the share of institutional
programmes has declined, while sales to commercial programmes and exports have become
more important (sales to non-European institutional customers are included in
the export share). That only half of final sales go to institutional customers
is unique by international standards: in other parts of the world, the industry
depends much more on institutional orders.

Figure 3.6: EU space manufacturing, final
sales by customer category, 2003–2009

Source: Eurospace
(2010).

The operation
and exploitation segments of the EU space sector are less institutionalised
than the manufacturing segment. This is due to the satellite communication
industry which serves many commercial customers. Earth observation and
satellite navigation, on the other hand, are characterised more by
institutional than commercial demand.

A more
detailed look into the composition of final sales in 2009, the final year in
Figure 3.6, reveals that launchers and communication satellites between them
made up virtually all sales to commercial customers and around a quarter of
sales to European institutional customers. Earth observation systems made up
roughly another quarter of institutional sales. Navigation systems, science
systems, ground stations and human space infrastructure (notably the
International Space Station) accounted for most of the remaining half of final
sales to European institutional customers in 2009.

Of all
institutional sales within the EU, roughly two thirds were destined for ESA, here
again mainly in areas such as Earth observation, human space infrastructure,
scientific systems and launcher systems.

Unlike its
competitors, by far the largest share of sales of the European space industry is
accounted for by civilian systems. Table 3.1 shows that in 2009 military
systems made up only 12.7 percent of total final sales of nearly EUR 5.5 billion.
Half of the military systems were purchased by military customers (6 per cent
of final sales) while the other half (also 6 per cent of final sales) were sold
to civilian customers.

Table 3.1: Sales of civilian and military systems to civilian and
military customers 2009

Final sales (EUR million) || Civilian systems || Military systems || Total

Civilian customers || 4766 || 341 || 5107

Military customers || – || 350 || 350

Total || 4766 || 691 || 5457

Source: Background study.

3.4.2.
High degree of concentration

The EU space
sector is dominated by a few large companies, a direct result of the special
nature of this niche sector with relatively high intensities of technology and
capital, producing strategically important output with in many cases dual uses,
and a high reliance on specific technology components along the value chain.
Consolidation and industry verticalisation have been the logical responses to
such characteristics – over the past decade there have been a high number of
mergers and acquisitions within the sector, both in the manufacturing segments
and in operations and exploitation. The 30 largest space business units in the
EU space sector account for 78 per cent of total sector employment. A large
number of smaller players employ the remaining 22 per cent. On the whole though,
the barriers to entry – costs, infrastructure, know-how and risks – are very
high and this is a sector where SMEs are rare, notably due to the small market.
The sector also has a history of SMEs being acquired by and integrated into
existing large companies. This process of vertical integration is driven by a
desire to secure permanent access to strategically critical components and
systems and deprive competitors of such access. On several occasions the
integration process has been guided by EU competition rules.

For much the
same reasons, and also for historical reasons, the EU space industry is mainly concentrated
in a small number of Member States with a long-standing commitment to invest in
it, notably France, Italy, Germany, the UK, Spain and Belgium. There are
several Member States with virtually no involvement in the EU space sector as
defined in Box 3.1.[52]

3.4.3.
 Strong EU research effort but
modest by international standards
3.4.3.1.
Research, development and innovation

Due to the innovative nature of the sector,
research, development and innovation are of crucial importance. Total R&D
is estimated to account for 10 per cent of unconsolidated sales turnover of the
EU space sector. Internal R&D investments by companies in the sector
account for roughly one third of the total. In general, the industry prefers
improving existing products and technologies over inventing new groundbreaking
technologies (ESA 2010), possibly due to the large scale of space project
investments, which could cause companies to be more risk-averse, but possibly
also due to the involvement of ESA in technology development. In fact, ESA is
the source of most of the funding of R&D in the EU space sector.

Figure 3.7
illustrates the priorities of ESA as reflected in its annual budgets 2003–2010,
and in particular how its priorities have evolved over time. It shows how the
budget resources allocated to human space flight have been cut in favour of
areas such as Earth observation, telecommunications and navigation. It is also
interesting to note that throughout the economic and financial crisis the
members of ESA have made sure to maintain ESA funding at a higher level than in
previous years (Euroconsult 2010). A similar development has taken place at
other space agencies around the world in response to the crisis.

Figure 3.7: ESA budget, 2003–2010
(million €)

Source: ESA annual reports; ESA (2010).

In parallel
with ESA, space continues to be an important thematic area in the EU framework
programmes on research, technological development and demonstration activities,
notably in the thematic area ‘Space’ under the current framework programme
(FP7). Specifically, FP7 provides R&D support to the ‘exploration of space’
area as well as research and technological development support for facilitating
the development of space foundations. Over the entire 2007–2013 period covered
by FP7, around EUR 670 million will be allocated for services and strengthening
space foundations, mainly for GMES development. A total of EUR 710 million will
be spent on improving space infrastructure.

In an
international context though, the funding of European R&D pales into
insignificance in comparison with the US where the 2009 budget of NASA alone
was more than USD 18 billion and a considerable share of public resources
for space research comes not from NASA but directly from other public agencies.
ESA is in second place in terms of budget, followed by its Japanese counterpart,
whose budget was USD 3.7 billion in 2009. The space research budgets of
China and Russia are not known but can be assumed to be of at least the same
order of magnitude as those of ESA and Japan. India is in sixth place with a
budget of just over USD 1 billion in 2009.

3.4.3.2.
Technology development and non-dependence

Partly because
of a desire to have unrestricted access to space and to downstream application
markets, partly as a result of stricter US export control requirements – the USA
being the leading space technology producer in the world – a growing trend
towards non-dependence in space has been observed around the world over the
last decade. The central piece of legislation in this context is the International
Traffic in Arms Regulations (ITAR), designed and implemented by the United
States in the 1970s but since the end of the Cold War extended to apply also to
the export of US satellites and components.

The EU space
sector uses a number of components and technologies produced outside Europe,
mainly in the United States. These include state-of-the-art technologies that
are essential for the optimal performance of the space systems produced in the EU.
Less-than-perfect substitutes are occasionally available but compromise the
overall performance of the systems. There is an increasing political awareness
in the EU that the availability of critical technologies should not be subject
to political or economic decisions beyond EU control. Although most US
technologies are available to EU producers, significant delays and
(administrative) costs can occur, as well as complications if systems
containing ITAR components are re-exported. Such delays and complications have
given rise to the trend towards EU non-dependence, which differs from
independence in that its aim is for the EU space sector to have free,
unrestricted access to any needed space technology. The purpose is to avoid
depending on a single source of supplies.

A similar
awareness has emerged also in other parts of the world, notably as a result of the
stricter export control requirements in the United States. Emerging space
nations such as China, India, South Korea and Brazil are therefore making great
strides to develop their own space industries and become independent of the EU
and US space sectors, until now the main exporters.

In 2008, the
Commission, ESA and the European Defence Agency (EDA) set up a Joint Task Force
with the aim of addressing critical space technologies for European strategic
non-dependence. The task force drew up a list of priorities for critical space
technologies for 2009 and proposed a methodology for a coherent EU-wide
approach to technology development. For example, JTF (2010) lists 25 critical
items for which immediate action is required. The overall aim of harmonising
technology development at EU level is to fill strategic gaps and minimise unnecessary
duplications, consolidate capabilities and arrive at a coordinated European
space technology roadmap for the future. Given the role of technology as a
crucial performance factor in the space sector, this effort aimed at achieving
synergies in R&D investments and minimising duplications in technology
development has consequences for the functioning of the sector. It underlines
the special nature of the sector, driven more by political and public considerations
and dual-use aspects than by economic factors, especially with regard to
hardware development.

While
politically such non-dependence efforts may be understandable, some might argue
from a strictly free-trade point of view that such efforts lead to considerable
inefficiencies globally, however from the point of view of the involved space-faring
nations and regions it is rational. Technology development is expensive and so
is parallel development of state-of-the-art technologies in several fields in
several countries (reversing in part the earlier trend of specialisation). Even
so, in all likelihood the political reality will continue to determine future
developments of critical technologies and non-dependence, and the actions of
China and the United States will influence future developments in this area
more than any other space-faring nation or international organisation.

3.4.3.3.
Patents

Patent
analysis provides another means of assessing the innovative strength of the EU
space sector. In particular, the number of patents filed at the European Patent
Office (EPO) by country gives an indication of how many new successful
technologies are brought to the market, bearing in mind that not all patents
are commercialised. Figure 3.8 shows the total volume of patent applications
filed by geographic location for the patent classification B64G, ‘Cosmonautics;
Vehicles or equipment therefor’. Cosmonautics in this definition encompasses
‘all transport outside the Earth’s atmosphere, and thus includes artificial Earth
satellites, and interplanetary and interstellar travel’. The scope of this
analysis is limited to these rather technical products, but because patents are
usually only required for innovative manufactured products, a more technically-oriented
definition of the space sector is likely to capture most patent activity.

Figure 3.8: Space patent applications
filed at EPO by country of applicant, 1999–2009

Source: European Patent Office Espacenet.

Japan and the
United States filed the most EPO patents applications during the period
1999-2009, followed by the EU and Russia. This gives an indication of the
relative innovative strength of these three countries and the EU in the
cosmonautics sector, notwithstanding the well-known criticism of patent
analysis that the number of patent applications does not say anything about the
value of the innovations protected by the patents.

The contribution
of European countries to total EPO patent applications filed in the industry is
relatively small, around 21 per cent. In Europe, German applicants were the
most active, having applied for 659 patents during the period (9.9 % of
the world total), followed by France (333), Austria (137) and Spain (108). The
dominance of German patent applications in this sector is somewhat surprising
as France has the largest space manufacturing industry in Europe and the German
space industry is relatively more focused on space services.

The share of
patent applications emanating from EU applicants is surprisingly small, notably
in comparison with other high-technology sectors such as nanotechnology,
photonics, micro and nanoelectronics, industrial biotechnology, advanced materials,
and advanced manu­facturing technologies. As reported in last year’s European
Competitiveness Report, European researchers and institutes were behind between
a quarter and half of all patent applications at EPO in these six key enabling
technologies (European Commission 2010e). It would therefore be reasonable to
expect a similar share of EPO patent applications in the space sector, in
particular as several of the key enabling technologies are directly or
indirectly linked to space applications (ESPI 2010 b).

Finally, it
needs to be borne in mind that although the European Patent Office is an
internationally renowned patent office, there are other patent offices around
the world with an international catch­ment area, notably the USPTO and Japan’s JPO.
Due to potential home bias, EPO data may actually exaggerate the importance of
European applicants on the global market for patents. Therefore Figure 3.8 may
exaggerate the true relative weight of Europe in international patenting in the
space sector.

3.4.4.
Trade balance of the EU space sector

The EU space
sector has a strong export position on the world market. Figure 3.9 shows EU
exports of space systems and components worldwide as well as to non-EU
countries from 2001 to 2008. It also shows EU imports, worldwide as well as
from non-EU countries, for the same period. The difference between the two
export curves can be interpreted as intra-EU exports, while the gap between the
two import curves shows intra-EU imports (and as such should be the same as the
distance between the two export curves). The distance between the two solid
lines represents Europe’s trade surplus with the rest of the world.

Figure 3.9: Total European exports and
imports in value (million €), 2001–2008

Source: ITC Trademap.

In line with
the findings for employment and turnover in the sector, the trade flow analysis
shows that the EU space sector was growing strongly in 2008. Figures 3.10 and 3.11
below show the main trading partners of the EU in 2008. Figure 3.10 shows the
countries of origin of the space products imported into the EU and indicates
that apart from intra-EU imports, the only country with a significant export value
in 2008 was the United States, which exported € 146 million worth of space
systems and components to the EU. The importance of the internal EU market is
highlighted by the fact that EU customers (final customers or the space
industry) imported most of their final or intermediate products from other Member
States (worth € 189 million). The predominance of intra-EU over US imports
might give credence to complaints from the US space sector that its worsening
competitive position is due to the US export control rules described in Section
3.4.3. According to the analysis presented here, EU companies import thirty per
cent more from companies in other Member States than from the United States. Export
control rules are however unlikely to be the only factor holding back US space
exports to Europe.

Figure 3.10: Main origins of EU space
product imports, 2008 (million €)

Source: ITC Trademap.

Figure 3.11
shows the main trading partners for EU exporters of space systems and
components. Out of the total EU export value of € 1.6 billion in
2008, most went to the United States and Russia. Unlike imports, EU exports were
destined for a more diverse set of countries which included fast-developing
space nations such as Kazakhstan, Brazil, China and Turkey. In addition to the
six importing countries in Figure 3.11, there were also significant exports
within the EU (not shown in Figure 3.11), as discussed in the context of Figure
3.10.

Figure 3.11: Main destinations for EU space product
exports, 2008 (million €)

Source: ITC Trademap.

3.4.5.
The EU space sector benchmarked against its US
competitor

The US space manufacturing
and operation sector is the world’s largest and most established space industry
with revenues of close to $ 40 billion in 2006, significantly more
than the € 10 billion turnover of the EU space sector. However, the
US space sector is heavily supported by domestic institutional spending. In
2009, the US government injected $ 64 billion into the space
industry, almost ten times the $ 6.7 billion from the European Space
Agency and the EU combined in support of the EU space sector. Such funding
obviously helps inflate turnover of the US space sector, and because only part
of the global space economy is accessible to European space companies, the
spillover effects on the EU space sector are limited.

Concerning the
ratio of R&D to turnover, the EU space sector seems to be investing
slightly more in research and development than the average US firm, but the
numbers are not strictly comparable. EU space firms spend on average 10 per cent
of turnover on R&D compared to around 5 percent in the United States;
however, the latter share increases if US (indirect) public funding via
military projects or from other government sources is included.

In absolute
terms though, Figure 3.12 shows that more than half of all publicly-funded
space R&D in the world is funded by the United States, while EU public
funding accounts for around a quarter of international public funding of space
R&D (OECD 2007).

Figure 3.12: Breakdown of total OECD
R&D for space, 2004

Source: OECD (2007).

The USA is
also the country with the highest proportion of space research in the total
composition of publicly-funded R&D, followed by Belgium, France and Italy
as shown in Figure 3.13.

Figure 3.13: Space R&D as a share of
government R&D budget in selected OECD countries, 2004

Source: OECD (2007).

As pointed out
in Section 3.4.4, US companies claim to suffer from stringent export control
rules and are only moderately optimistic about their future competitiveness in
the world market. In a study of more than 200 companies or business units in
the US space sector in 2007, 58 per cent gave US export control rules as the
most important barrier to entering foreign markets (US Department of Commerce
2007). Even so, the United States is the largest exporter of space products in
the world with a market share in 2004 of 32 per cent (OECD 2007), followed by
France (23 %), Germany (16 %), the UK (9 %) and Italy (7 %).
The EU as a whole exported considerably more than the US space sector and had a
market share of more than 55 per cent. The EU and the United States are the
only major exporters in the world, with a combined market share of almost 90
per cent.

Figure 3.14: Space product exports from selected OECD countries in
2004 (export value and share of total)

Source: OECD (2007).

In 2008, the
bilateral trade balance between the EU and the USA showed a surplus for
European companies, but in other years the United States has had a surplus in
space products (in 2007, for instance). An analysis of the bilateral trade
flows shows Europe and the United States to import and export more space
products than any other part of the world, with large fluctuations in export
and import values from year to year. The fact that the two main exporters run
large trade surpluses with respect to the rest of the world is a signal of
their importance on the world market. It is likely though that the export
control requirements in place in the USA significantly hamper its export position
on the world market, especially in satellite manufacturing and for certain
export destinations. Without these strict requirements, it is reasonable to
expect that the US position in global trade could be stronger. The EU space
sector has to some extent been able to benefit from the self-imposed US restrictions
by offering ‘ITAR-free’ systems and components for export to destinations
affected by the restrictions. At the same time EU exports have been adversely
affected by the restrictive rules as the rules make it difficult to re-export
systems containing ITAR components.

3.4.6.
The EU space sector benchmarked against the
aeronautics and defence sectors

A comparison
between three related and in some respects similar EU sectors – space,
aeronautics, defence – reveals that the EU aeronautics industry is the largest
of the three in terms of employment and turnover, while the space industry as
defined in Box 3.1 is the smallest:

–
EU space sector turnover: EUR 10 billion;
employment: 36 000;

–
EU defence industry turnover: EUR 55 billion;
employment: 300 000 (European Commission 2007 b);

–
EU aeronautics industry turnover: EUR 105 billion;
employment 467 000 (ECORYS 2009).

The EU space
and aeronautics sectors face the same challenges of maintaining a highly
skilled workforce and keeping up with a changing environment in such a way as
to maintain or enhance their technological positions. R&D spending in these
two industries is however considerably lower than in the defence industry.

The EU space
and aeronautics sectors exhibit a number of similarities in trade patterns. In
both sectors the EU internal market is of pivotal importance and the United
States the most important non-EU trading partner. Nevertheless, the share of non-EU
exports to turnover is higher in the aeronautics industry than in the space
sector. Furthermore, the EU aeronautics industry has a slightly higher number
of non-EU trading partners than the space sector. The EU defence sector imports
heavily from its US counterpart but exports much less to the United States due
to strict regulations (European Commission 2007 b, Decision-CREST 2009).

The regulatory
environment also influences the openness of third markets in the space and
aeronautics industries, in particular through standardisation and technical
requirements.

While the
financial crisis has had little impact on the EU space sector – in fact the ESA
budget has increased during the crisis – the EU aeronautics industry has been
severely affected (ESPI 2010a, ECORYS 2009). In the defence industry, government
expenditure has followed a declining trend since the end of the Cold War
(European Commission 2007 b); a trend which is set to continue. R&D
expenditure is however considerably higher in the defence sector than in the
other two industries, for example around 20 times higher than in the space
sector, despite turnover being only five times larger (European Commission 2007 b).
The R&D intensity is consequently several times higher in the EU defence
industry than in the EU space sector.

3.4.7.
Strengths and weaknesses of the EU space sector

The EU space sector is a world
technological leader in certain segments such as heavy launchers and satellite
communication services. The sector has a number of strengths:

– Its strong heavy launching sector offers independent access to space,
which is key to achieving the objectives of the European Space Policy,

– It can offer all types of products and services demanded by
institutional and commercial customers,

– Its products are highly advanced,

– The strong satellite communication segment influences other sectors
in the value chain,

– The sector combines major system integrators and innovative SMEs,

– The sector is not restricted by EU rules equivalent to ITAR.

At the same time
the analysis has identified a series of weaknesses:

–
The weak ability of the EU space sector to move
from research to operational products,

–
The sector remains dependent on critical
components from the United States,

–
The number of European launches each year is on
the low side: a higher number would benefit the strongly linked launch services
and launcher manufacturing segments,

–
Other countries with launching capabilities –
USA, Russia, China, Japan – use mainly their own launchers for institutional
missions and are in many cases prepared to pay above going commercial rates for
institutional launches.

Despite its weaknesses, the EU space sector
has a number of opportunities in the future:

–
Europe (EU, ESA, Member States) has high
ambitions in space,

–
New launchers (VEGA, Soyuz) have been added or
will be added,

–
The sector has access to financing, including
innovative financial arrangements and venture capital, but could benefit from
further instruments being developed,

–
Demand for satellite communication bandwidth is
expected to continue growing,

–
Technological progress in the space sector will
continue to spill over to other sectors, thereby benefiting the EU economy as a
whole while at the same time providing secondary revenues for the EU space
sector as well as spin-in opportunities.

There are however a number of challenges and
risks for the EU space sector to address:

–
The future supply of highly skilled staff in
sufficient numbers,

–
A potential risk of decreasing budgets for space,

–
Emerging space nations such as China and India,
with strategic aims for their space sectors,

–
Technical dependence: on average 60 per cent of
electronic components on board European satellites are imported from the United
States,

–
Radio frequency spectrum is a scarce resource
and needs to be allocated with care and on a pan-European basis,

–
Procurement rules differ between institutions
and are not always ideally suited for large-scale operational programmes,

–
The next generation of heavy launchers
(succeeding Ariane V) needs to be developed,

–
Communication satellites are the most important
products but may come under pressure from competing technologies for communication,
including terrestrial technologies,

–
The sustainable use of space is not ensured
(notably with respect to space debris and space weather) and the EU needs to
develop its own space situation awareness capability.

3.5.
Conclusions and policy implications
3.5.1.
Conclusions

The following
conclusions can be drawn on the basis of existing literature and the preceding
analysis:

Turnover
and employment: The EU space sector generates turnover
of over EUR 10 billion (2009, consolidated) and directly employs nearly 36
000 persons (full-time equivalents). The operator services segment (not
including downstream applications and services) makes up about half the
turnover and is an important driver of the space economy. Turnover generated by
manufacturing-oriented companies has been relatively stable in the past ten
years. The contribution of the satellite communication segment (both satellite
manufacturing and operator services) to total EU space sector turnover is important,
more than 70 per cent of the total. In terms of employment though, satellite
manufacturing accounts for the largest part, around 60 per cent, followed by
launcher manufacturing. Operations and exploitation account for a much smaller
share of employment. After a gradual decline in direct employment in space
manufacturing between 2001 and 2005, the numbers have since been increasing
again. Space manufacturing employment in the EU is concentrated mostly in
France, followed by Germany and Italy. With respect to spacecraft produced, the
EU is the second largest manufacturer in the world after the United States,
with Russia in the lead as far as launcher production is concerned (Soyuz,
Proton and other launchers).

Industry
structure: The sector is to a large extent driven
by public funding and institutional clients. However, the relative importance
of institutional clients for the EU space industry has been declining over the
past decade while its exposure to commercial markets and exports has increased.
The military market in the EU is relatively small. The US industry is more
heavily dominated by domestic institutional spending, including military
spending. Commercial sales are concentrated mainly in telecommunications
systems and launcher systems, while Earth observation systems make up a large
part of institutional sales. The vast majority of EU space product exports
consist of telecommunication systems. ESA is the largest institutional client
in Europe, accounting for two thirds of institutional spending. Globally as
well as in the EU, the space sector is characterised by high barriers to entry,
considerable opportunities for economies of scale regarding technology
development and know-how, and strategically important output with in many cases
dual uses. Supply is largely dominated by a few large companies at the centre
of clusters of smaller specialised suppliers. EADS Astrium, Thales Alenia
Space, Finmeccanica, OHB, RUAG and Safran together account for over 75 per cent
of employment in space manufacturing. The high entry barriers and a history of
acquisitions and integration are reasons why SMEs represent only around 8 per cent
of sector turnover, even though the smaller entities play an important role
especially in (innovative) space services and software applications. Horizontal
and vertical integration (concentration) in the sector has increased in the
past decade, as illustrated by the various large mergers and acquisitions.

R&D and
innovation: R&D intensity in the EU space
sector as a whole is about 10 per cent (R&D as a percentage of total
turnover). The launching industry is by far the most R&D intense of the
different segments. Roughly half of R&D funding is corporate funding and
half comes from public sources (mainly ESA). Public funding for the Earth
observation (GMES) and navigation (Galileo) programmes has increased recently.
Although absolute R&D investment by the US is the highest in the world and
considerably higher than that of the EU, R&D intensity is slightly higher
in the EU. The share of patent applications filed by EU applicants in the space
industry in the last ten years is relatively small, 21 per cent. The United
States, Japan and Russia account for 75 per cent of patent applications. Within
the EU, most patent applications are filed by German applicants, followed by France.

Technological
non-dependence: Partly due to stricter US
export control requirements, an increased political pressure for non-dependence
in space has been observed over the last decade. The EU space sector uses a number
of state-of-the-art components and technologies produced outside Europe, mainly
in the United States. As a general rule these US components are available to EU
industry (unlike for China, for instance) but with significant delays and
(administrative) cost implications as well as subsequent complications if
systems containing ITAR components are to be re-exported. In reaction to
non-dependence considerations, Europe is coordinating the development of
critical space technologies more strictly, in particular through the
Commission-ESA-EDA Joint Task Force. The aim of such harmonisation is to fill
strategic gaps and minimise duplications, consolidate capabilities and achieve
a coordinated EU space technology roadmap for the future. Such considerations
may be sound from a strategic political perspective but from a strictly economic
perspective some might argue that such non-dependence efforts around the world
lead to considerable inefficiencies due to parallel development of expensive
state-of-the-art technologies in several countries. It is likely that US and
Chinese activities in the political sphere will determine the road ahead for
the whole world regarding non-dependence.

Trade: The EU runs a significant trade surplus with the rest of the world
in the space sector. Extra-EU trade is larger than intra-EU trade. The United
States and Russia are the two main export destinations for EU space products.
The bilateral trade balance between the EU and the United States has been more
or less in balance in recent years – both have shown bilateral surpluses and
deficits three times over the past six years. Both the EU and the United States
run considerable trade surpluses with the rest of the world. In relative terms,
the export intensity of the EU industry (relative to total turnover) is
considerably higher than for the US industry, mainly due to strict US export
control requirements. On the one hand ITAR is hampering easy EU access to
critical technology components made in the United States, on the other hand it
is likely to give EU firms a relative advantage over their US competitors in
the supply of specific products (notably telecommunication systems) and to
specific countries.

3.5.2.
Framework conditions and regulatory environment

The main
issues relevant for the performance of the EU space sector as a result of the
framework conditions and regulatory environment in which it operates are:

Impact of
EU-US regulatory divergence: The global space
sector is heavily regulated. The relative impact and restrictiveness resulting
from regulatory divergence between the EU and its main competitor and partner
is high in relation to other sectors (Berden et al. 2009). This restrictiveness
results mainly from regulations in the areas of public procurement, government
support for R&D activities, and safety and functional standards. In the
aerospace sector analysed in Berden et al. (2009) this could result in
considerable deadweight surplus losses, which may also be the case in the space
sector as defined in Box 3.1.

Regulatory
conditions with a major impact on the EU space sector: (i) Standardisation and interoperability with respect to
satellite operations; standardisation improves industrial competitiveness and
efficiency and is important for all application segments of the satellite industry.
(ii) National space law of EU Member States. (iii) Export controls.
(iv) WTO laws on space goods and services (Euroconsult 2010). (v)
Legislation on the transfer of space objects. (vi) Procurement policy. (vii)
The global allocation and management of radio frequency spectrum. (viii)
The code of conduct for outer space activities (Listner 2011).

Framework
conditions: Regarding the labour market, the
high-technology engineering industry depends on the availability of a flexible
and highly skilled labour force, a scarce resource in the EU. The openness of
third markets is another issue, as main parts of the non-European market are
closed to European manufacturers and operators. Access to finance is crucial,
as are R&D and innovation for the functioning of the space industry and for
keeping its competitive position as emerging space nations are in the process
of building up their own industries.

Policy: Starting from the ESA policy focused on major programmes with the
aim for Europe to be one of the world’s main space players, space policy has
always had a large influence on the EU space sector. The Ariane programme in
the 1970s and 1980s was prominent in this respect and laid the foundations for
the current strong competitive position of Ariane V and Arianespace. The
ARTES programme also had a positive impact on the ability to develop state-of-the-art
communication satellites in Europe. In parallel, other European cooperation
projects resulted in, for example, the establishment of Eutelsat, originally
set up in 1977 as an intergovernmental organisation to develop and operate a
satellite-based telecommunications infrastructure for Europe. These days the
strong space sector in Europe drives demand for communication satellites from
European industry and subsequent launching capabilities. This in turn enables
the EU satellite manufacturing industry to apply part of the knowledge gained
from producing communication satellites (such as knowledge about platforms) to
the development of Earth observation/GMES and Galileo. Over the last decade or
so, the EU space sector has been increasingly influenced by Commission
policies, notably in the form of major EU flagship programmes such as Galileo
and GMES but also other programmes (e.g. EGNOS).

3.5.3.
Policy implications

Based on the
preceding analysis and the conclusions on the current competitiveness of the EU
space sector, the following seven factors can be identified as key for the
future. They are accompanied by six policy recommendations.

1.         Satellite communication drives the EU space
sector along the value chain. The associated services segment has the highest
turnover per employee in the EU space sector as well as a strong market
position worldwide, and a strong demand for satellites and launching services.
This in turn has enabled the EU satellite manufacturing industry to innovate
and arrive at the qualitatively sound product portfolio it now offers and reach
a strong worldwide market position, while also being able to apply key
technologies in other satellite manufacturing domains. This position must not
be lost. However, competition from outside the EU in the satellite
communication segment is prominent in manufacturing and service provision.
Given the critical dependence on state-of-the-art technology and know-how, insufficient
investment might harm the sector permanently. Temporarily reducing budgets
might have long-lasting effects on performance; such reductions should be
avoided or at least considered with caution. In order to stay ahead, constant
innovation is required, hence sufficient R&D funds must be secured to
ensure that innovative satellite communication solutions are found that fulfil
the new technological needs in the communication satellites sector.

Policy recommendation: secure R&D funding for satellite communication
development in times when government budgets are under pressure and there is a
tendency to cut down on R&D expenditure.

2.         A weak point of the EU space sector is the
transfer from the R&D phase to the operational phase and providing concrete
products. For the communication satellite segment this concretely means that demonstrated
flight heritage is required.

Policy recommendation: ensure that new satellite communication technology is
actually put into orbit before reaching the market.

3.         There is increasing demand for communication
satellite bandwidth following digitisation in the TV market (HDTV, 3DTV) as
well as growing broadband demand. There is also pressure from competing
technologies (IPTV for TV distribution, fibre for broadband distribution) as
well as competition for radio frequency spectrum use from terrestrial
technologies.

Policy
recommendation: increase the efficiency of radio
spectrum management (European Commission 2010 b), defending the interests of the EU space sector as far as
possible in compliance with the common practice of technology neutrality. For
the space sector as a whole, communication satellites are an essential driver
and the interests of communication satellites for the competitiveness of the EU
space sector need to be included in policy discussions on radio frequency
spectrum management (European Commission 2010 b).

4.         The EU space sector is heavily
institutionalised, half of its final sales going to European institutional
clients. This concerns especially Earth observation, navigation satellites and
related launches. Budgets cuts in these areas will reduce the performance of
the sector significantly. Establishing an ‘anchor tenancy’ would represent an
important step in the development of systems that can be sold outside Europe.

Policy recommendation: review whether it is feasible to put in place a stronger
anchor tenancy policy, especially in areas where the EU space sector is weak.
This would enable the industry to develop competences and competitive strengths
that could strengthen its position on markets outside the EU.

5.         The strong institutional demand for Earth
observation and navigation systems stems from the GMES and Galileo flagship
programmes. In order to ensure sound implementation of these programmes and
enable the EU space sector to benefit as much as possible, EU and ESA
procurement policies need to take into account from the start the requirements
of these large operational programmes.

Policy
recommendation: continue reviewing how procurement policies can be optimised
in view of the new policy responsibilities in terms of realising large
operational programmes such as Galileo and GMES.

6.         The heavy launcher segment is competitive but
under pressure. As a result of the strong link between launch services and launcher
manufacturing, close to 10 000 employees in the launching industry are
dependent on a relatively small number of launches by Arianespace. One of the
prerequisites for a competitive launch segment (manufacture as well as
services) is as many launches as possible. As stated in European Commission
(2011), independent access to space is a key prerequisite for achieving the
objectives of the European Space Policy. These key aspects will be addressed in
the space industrial policy which the Commission is currently developing in
close collaboration with Member States and ESA.

7.         There is a general perception in the entire EU
space sector that it is difficult to attract skilled labour and that this will
become more difficult in the future. Many engineers will retire in the near
future and the general perception of space engineering is unlikely to help
trigger a swift influx of new engineers into the sector (Space Foundation 2010).
This endangers the technological development and implementation capacity of the
EU space sector.

Policy recommendations: initiate and coordinate between Member States the
development of space academies (such as the space academy created in the UK);
include in future R&D framework programmes dedicated actions in which part
of the research must be done by PhD candidates. This would enable a certain
number of annual PhD places in the EU dedicated to space (as is currently the
case in air traffic management).

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[1]               The sources of the data are input-output tables which
provide information on the structures of economies. Since the structure of the
economy changes gradually over time, input-output tables are not published
frequently, normally only every fifth year.

[2]               See Chapter 1 “Growing imbalances and European
industry,” in European Competitiveness Report 2010 (European Commission (2010a));
or the monograph “Economic Crisis in Europe: Causes, Consequences and
Responses,” in European Commission (2009b).

[3]               Indeed, the accession triggered an impressive
catch-up process with some EU-12 Member States displaying rates of growth of
productivity above 50 percent in 2000-07. The downturn was severe but did not
get close to compensate accumulated growth in the boom period. For details, see
section 1.3 in European Competitiveness Report 2010 (European Commission
(2010a)).

[4]               All figures mentioned in this section come from the
Labour Force Survey, Eurostat.

[5]               Here again Spain constitutes an exception. It had by
far the larger proportion of temporary contracts at the peak of the cycle, 34
percent of its employment in 2008, and this share dropped to 24 by 2010. This
is reflecting the dual Spanish labor market, in which youngsters with temporary
contracts constitute disposable labor in bad times, and is discussed in depth
in the report Employment in Europe 2010 (European Commission (2010e)).

[6]               Figures for India and China are from the International
Monetary Fund, World Economic Outlook Database, October 2010. For the strong
recovery of emerging economies, see again OECD (2011).

[7]               For an argumentation along these lines, see EEAG
(2011, chapter 4). In the previous edition of the European Competitiveness
Report 2010, chapter 1 noted how the evolution of international market shares
in 2000-10 bears a less than obvious relation with the adjustments suffered
during the 2008-10 crisis.

[8]               At this point it may be worth noting that there is no
consensus in the literature on the role of tightening credit conditions and the
recovery after a deep recession. For instance, Hayashi and Prescott (2002) show
how bank loans remained depressed in Japan long after economic activity, and
notably investment, started to recover. See the discussion in Claessens, Kose
and Terrones (2009).

[9]               To be precise, the paper notes that physical capital
cannot reproduce itself indefinitively under the assumption of decreasing
returns to capital. There has to be some (technical) change that increases
returns to capital indefinitively.

[10]             See Abraham García (JRC-European Commission), “The
importance of marketing expenditures and other tangible assets on firms'
innovation performance,” and Anders Sørensen, “Education as a Determinant for
Innovation and Productivity,” Enterprise and Industry brown-bag seminars,
Brussels, January 2011 and June 2011 respectively.

[11]             Maryland is an outlier in that half of its R&D is
public, as opposed to 80 percent of business enterprise R&D expenditures
for most R&D intensive states. The reason is this state is the home to the
National Institutes of Health. See: OECD Regions at a Glance: 2009 Edition; and
InfoBrief, National Science Foundation, June 2010.

[12]             For an argumentation along these lines see Dijkstra
(2010).

[13]             See Moncada (2010). Note, however, that this paper
refers to the EU Industrial R&D Investment Scoreboard, and hence focuses on
large firms active in international markets. Smaller firms across the Atlantic
focused on domestic markets may behave differently.

[14]             In the sense given in Nelson (1980) to codability: the
extent to which is possibly to codify the new technique in order to produce a
blueprint that can be afterwards used by anyone to reproduce the technique.

[15]             Another important point to mention is that the
scoreboard looks at R&D investment by companies, whatever the location of
the R&D performed. The Scoreboard is not about business R&D in the EU
versus in the US but it is about R&D by EU and US companies.  Hence, US
companies may in fact maintain significant R&D activities in the EU. See
chapter 4 “Foreign corporate R&D and innovation in the European Union,” in
the European Competitiveness Report 2010.

[16]             The relatively larger share of services in the US is due
to different statistical criteria that yield larger investments in services
sectors in the US vis-à-vis the EU.

[17]             See the discussion in box I.5.3 in the Innovation Union
Competitiveness Report 2011.

[18]             The key feature of Phelps’ (2006) attempt theory of innovation
and growth is the (uninsurable) uncertainty (as opposed to insurable risk)
inherent to any entrepreneurial project. A critical step is that of obtaining
finance when facing uncertainty rather than risk, and hence the importance of
“intuition” and of long-term relationships between entrepreneurs and
financiers.

[19]             European Commission communication “A Single Market for
Intellectual Property Rights. Boosting creativity and innovation to provide
economic growth, high quality jobs and first class products and services in
Europe,” COM (2011) 287.

[20]             A case in point is that of “patent clusters” in the
pharma industry. An “important objective of this approach [patent clusters] is
to delay or block the market entry of generic medicines”; excerpted from the European
Commission communication summarizing the “Pharmaceutical Sector Inquiry Report.”

[21]             In a move to purchase Nortel’s patent portfolio,
Google’s declared intention was to be “[b]ulking up on its patent holdings [to
have] a stronger defence against such attacks [lawsuits over the software].”
See “Google bids $900m for Nortel patents,” Financial Times, 4 April 2011.
Nortel was finally purchased by a consortium for $3500m. See the software
patent debate in en.wikipedia.org/wiki/Software\_patent\_debate. In the EU
software patents were rejected by the European Parliament in 2005.

[22]             Exploiting data from an interesting natural experiment,
Bronzini and Iachini (2011) conclude that R&D subsidies do not change the
investment behaviour of large firms, who receive the subsidy as a windfall
gain, but they find a positive effect for smaller firms, the interpretation
being that these are more likely liquidity- and credit-constrained.

[23]             In the Canadian case, the president of the NSERC stated
“Big firms like Bombardier or Research In Motion can afford to take the long
view. But small companies are at a demanding stage of their growth,” quoted in
Monocle, February 2011, page 87. For the Swedish example, see Riché (2011).

[24]             It should not be regarded as a mere coincidence that
those factors are also those signaled by Caselli and Coleman (2001) as being
determinants explaining the adoption of IT.

[25]             Goolsbee (1998) finds evidence that public expenditures
in R&D harm private R&D by raising the wages of scientists and
engineers, at least in the short run and because of the low elasticity of the
supply of high-skilled labour.

[26]             Since the database does not contain data which
separates data for the industry renting of machinery and equipment (NACE Rev.
1.1 71), also this industry is included in the definition of KIBS in Figure
2.1.

[27]             The 21 EU countries are EU-15 plus Czech Republic,
Estonia, Hungary, Poland, Slovakia and Slovenia.

[28]             The EU-6 is here defined as Czech Republic, Estonia,
Hungary, Poland, Slovakia and Slovenia. This definition, or aggregation of
countries, is only used for illustrating the share of KIBS in intermediate
consumption.

[29]             Even though not explicitly investigating this, the findings
of  Kakabadse, A. & Kakabadse, N. (2002) imply that American firms'
outsourcing strategies are more advanced than European firms due to for example
more experience.

[30]             Papaconstantinou et al. (1998), Knell (2008) and
Hauknes and Knell (2009) confirm these findings. The background paper to this
chapter provides an outline of the simple mathematics behind this analysis.

[31]             Across the 28 countries the correlation coefficient
between the two components is as high as about 0.87.

[32]             This is documented in detail in the background study
(Stehrer et al., 2011).

[33]             See Annex 3.1.

[34]             See Annex 3.2, which details the modified technology
linkage measure used in this section.

[35]             See Annex 2.1 for details.

[36]             Hauknes and Knell (2009) show that this applies to
manufacturing, except for the science-based industries.

[37]             Ireland becomes an outlier because of foreign KIBS
inputs into domestic manufacturing, and Finland becomes an outlier because of
foreign manufacturing inputs into KIBS sectors. R&D performed in the
R&D sector that was not distributed to the other industries may result in
an overestimation of the impact of KIBS on manufacturing. These problems appear
mostly in the EU-12, which still rely heavily on the government for performing
and funding R&D activity. Remnants of the old science and technology system
remain in these countries and appear as active research organizations in the
R&D sector.

[38]         See
European Commission (2011), ‘Databases from socio-economic research project for
policymaking’, especially section 1.2 for a thorough discussion of the subject.

[39]             The analyses in this part utilise Eurostat supply and
use tables as input-output tables (as provided by Eurostat) do not allow for
analyses of the service output of manufacturing sectors for which supply tables
(which are of dimension product by industry) are necessary.

[40]             Trade services offered by manufacturing firms are
excluded because it is simply an extension of the firm’s product range by
offering third-party products.

[41]             The classification of innovation intensity follows the
sectoral taxonomy of Peneder (2010).

[42]             EMS is organized by
a consortium of research institutes and universities co-ordinated by the
Fraunhofer Institute for Systems and Innovation Research (ISI) and takes place
every three years.

[43]             Austria, Croatia, Denmark, France, Germany,
Netherlands, Slovenia, Spain and Switzerland.

[44]             See Annex 2.3 for a description of the population.

[45]             See the description of the population in Annex 2.3.

[46]             See Annex 2.3 for a description of the population.

[47]             In this section, KIBS are also defined as NACE codes
72, 73 and 74, which are related to categories 262, 279 and 268-269-279 in the Extended
Balance of Payments Services Classification (EBOPS). See the background study
for details.

[48]             Sectors 29-35 in the ISIC 3 classification are
considered to be technology-intensive.

[49]             See Stehrer, R. et al. (2011) for more details
concerning annual growth rates.

[50]             The index for country i good j is RCAij = (Xij /Xit)/(
Xwj /Xwt), where w=world and t=total for all services. The RCA does not show
true comparative advantages, but simply compares the composition of exports of
one country to a certain market with the composition of total exports that are
absorbed by the market. A region is considered to have a revealed comparative
advantage in a certain type of services or goods if a value of the RCA index
for this sector is higher than 1.

[51]             Figures in this section are based on GTAP data.

[52]        On a related note, only 17 EU Member States are members of
ESA, while a number of the remaining EU Member States are ‘European Cooperating
States’ in ESA terminology.

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