November Klaus Desmet SPATIAL GROWTH AND THE RISING PRODUCTIVITY GAP WITH THE U.S.

November Klaus Desmet S Source: van Ark et al. (2008) Productivity gap EU-15 relative to U.S.

November Klaus Desmet Source: van Ark et al. (2008) Productivity gap EU-15 relative to U.S.

November Klaus Desmet Source: van Ark et al. (2008) Productivity gap EU-15 relative to U.S.

November Klaus Desmet Much of the increase in the productivity gap since 1995 can be explained by the different performance of the service industry. Over the period the annual contribution of services to labor productivity growth was 1.8% in the United States 0.5% in EU-15 Productivity gap EU-15 relative to U.S.

November Klaus Desmet Baumol (1967) argued that the structural transformation from manufacturing to services would lead to economic stagnation. Argument: Services suffer from an inherent lack of innovation. Higher productivity growth in manufacturing implies that a shrinking share of the labor force can produce all the manufactured goods needed. The economy becomes increasingly specialized in the low- productivity growth sector: services. In the long-run the economy is condemned to stagnation. Services and economic stagnation

November Klaus Desmet Deindustrialization

November Klaus Desmet Services: the hamburger- flipping economy

November Klaus Desmet During the 1970s and the 1980s the dismal view of Baumol (1967) seemed to be validated as developed countries suffered from a productivity slowdown. This happened in spite of ICT taking off sometime in the beginning of the 1970s. Recall Robert Solow in The New York Times Book Review in 1987: “You can see the computer age everywhere except in the productivity statistics” ICT and the productivity paradox

November Klaus Desmet There were two major General Purpose Technologies (GPTs) in the 20th century: electricity and ICT. David (1990) analyzed the process of electrification: The diffusion process of electricity took 2 to 3 decades, roughly speaking from 1900 to The transformation of industrial processes by electric power took time and was not automatic. Something similar happened with computers: At the end of the 1980s, nearly two decades after the introduction of Intel’s microprocessor, it was estimated that only 10% of the world’s businesses were using computers. Not a paradox after all

November Klaus Desmet Source: Hobijn and Jovanovic (2005) Not a paradox after all

November Klaus Desmet Although GPTs are pervasive in the sense that they tend to spread to the entire economy, their effect may differ depending on the sector. Electricity affected mainly the manufacturing sector. In the decade after WWI, economy-wide TFP in the U.S. grew 22%, whereas in manufacturing it grew 76%. In the case of ICT, the service sector is being the big beneficiary. Already in 1996 ICT intensity (the share of ICT equipment in total equipment) was 42% in services and 18% in manufacturing (Hobijn and Jovanovic, 2001). Between 1995 and 2001 labor productivity in the U.S. grew by 2.5% in service-producing industries and by 0.8% in goods-producing industries. Electricity: Manufacturing ICT: Services

November Klaus Desmet Instead of hamburger-flipping

November Klaus Desmet Back to the productivity gap: Composition effect

November Klaus Desmet The share of ICT in total equipment in the EU in 2000 was similar to that of the US in 1980 (van Ark, 2002). Annual growth in labor productivity in services between 1995 and % in the US (Triplett and Bosworth, 2004) 0.9% in the EU-15 (Desmet, 2010) Back to the productivity gap: ICT and innovation

November Klaus Desmet ICT investment as a share of GDP ( ) United States4.1% EU-152.4% Sweden3.8% Finland3.6% Denmark3.3% Belgium3.1% UK3.1% Source: Timmer et al. Not all of Europe is the same

November Klaus Desmet Not all of Europe is the same

November Klaus Desmet Spatial concentration and productivity Spatial concentration of economic activity enhances productivity and innovation. Examples: Silicon Valley. Particapation in the Internet became rapidly widespread across locations, but the more complex applications, such as e- commerce, located in urban areas where they had access to coinventions (Goldfarb and Greenstein, 2005).

November Klaus Desmet Spatial concentration and productivity Mechanisms Agglomeration economies: knowledge spillovers, input-output linkages,… (Marshall, 1890; Krugman, 1991). Survival of the fittest: larger markets lead to tougher competition and only the most productive firms survive (Melitz and Ottaviano, 2006) Competition and innovation: larger markets lead to larger firms (through increased competition) and to more innovation (Desmet and Parente, 2010).

November Klaus Desmet Innovation and spatial concentration

November Klaus Desmet Innovation and spatial concentration

November Klaus Desmet Innovation and spatial concentration

November Klaus Desmet Flanders and Wallonia

November Klaus Desmet Flanders and Wallonia

November Klaus Desmet Flanders and Wallonia

November Klaus Desmet Flanders and Wallonia

November Klaus Desmet Flanders and Wallonia

November Klaus Desmet Flanders and Wallonia

November Klaus Desmet Conclusions The growing productivity gap with the U.S. is mainly due to the lackluster productivity growth in the European service industry. The service industry has high productivity growth potential thanks to the impact of ICT. The spatial concentration of the service industry is conducive to productivity gains through several channels: agglomeration economies, survival of the fittest, and innovation spurred by tougher competition.

November Klaus Desmet Policy recommendations To increase competition and spatial concentration in the service industry Europe needs (i) to create a truly integrated market for services (ii) to further deregulate the service industry (e.g., liberalizing opening hours in the retail sector) (iii) liberalize zoning policies that slow down the emergence of large service clusters. Given that larger plants and establishments innovate more, there is a need to eliminate distortionary regulation and tax policies that protect small-scale firms (Restuccia and Rogerson, 2008) Policies should stop looking backward (by subsidizing declining manufacturing industries) and start looking forward (by realizing that future innovation will happen mainly in the service industry)