Member States' competitiveness performance and implementation of EU industrial policy Vesa Vanhanen Europe 2020 and National Competitiveness Policies EPG WG 21 October 2013

Share of manufacturing in EU GDP A manufacturing imperative for the EU Why is the share of manufacturing in decline? The relative price explanation: services are less traded across borders than manufactures (The graph with real values) The bubble explanation Firms consume more and more service inputs, and these have been increasingly sourced from other suppliers rather than being produced in house (The same is true for households) The rise of new industrial powerhouses? Why is it a problem? Why we cannot leave it to the market? Declining manufacturing erodes the knowledge and technology base of the economy Societal goals depend crucially on technology development Labour productivity and TFP depend on a strong manufacturing base Strong spill-over effects on the rest of the economy The role of industrial policy: industrial policy preserves its horizontal role, but with better targeting of productivity-enhancing structural change. This means steering structural change towards higher productivity in manufacturing and better positioning of EU enterprises in the global value chain based on comparative advantages in knowledge and technology intensive products and services.

Exports to the rest of the world have been the main driver of industrial activity External and internal EU trade Aggregate demand remains subdued notably affected by: Deleveraging by non-financial corporations Fiscal consolidation efforts from the public sector Exports to the rest of the world have been the main driver Faster growth of SMEs oriented towards export markets would contribute to the recovery and increase competitiveness of our industry.

Clusters of Member States Consistent cluster: Core: Germany, Denmark, Luxembourg, Austria, Sweden Others: Belgium, Spain, France, Ireland, Finland, United Kingdom Moderate cluster: Greece, Italy, Cyprus, Malta, Portugal, Slovenia Catching-up countries: Bulgaria, Czech Republic, Estonia, Croatia, Latvia, Lithuania, Hungary, Poland, Romania, Slovakia

Change in competitiveness performance (2007-12 where 2007=100)

Innovation performance has improved, but convergence has ended Change in innovation performance (2008-12; 2008=100) Many Member States have increased their innovation performance since 2008: Sweden, Germany, Denmark and Finland are the most innovative economies. They are followed by other consistent performers that are all more innovative than the EU average, except Spain. On average, moderate performers lags behind the EU average, although there are differences between the countries. Except for Malta and Greece, the moderate performers improved after 2008, but this process seems to have slowed down. The catching-up countries are less innovative than the EU average, although Estonia and Czech Republic outperform several of the moderate performers. There is no longer a convergence of innovation performance Danger of a growing innovation divide within the EU. This danger is the more acute as budgetary restraints have led many Member States to squeeze their R&D budgets.

Business environment has improved Business environment (0=least attractive, 1=most attractive; 2012) Member States have improved their business environment considerably The EU average is high but many glbal competitors are improving even faster. The UK, Sweden and Germany show that even the best can improve further, but half of the consistent performers had a worse business environment in 2012 than in 2007. The moderate performers have caught up markedly since 2007, with the business environment in Portugal now higher than the EU average and better than in some of the consistent performers. The catching-up Member States have narrowed the gap to the best business environments in the EU, Some Member States have been focusing on the narrow set of indicators of the World Bank’s Doing Business This is not enough to achieve a fully favourable business environment.

Most Member States have improved the skills base of their workforce Percentage of people employed in manufacturing with high qualifications The upgrading of sjkills is key to foster the transfer of resources from declining industries to areas of growth Member States are increasingly responding to the demands of the market Many are involving the private sector in skills policy. Most Member States improved the skills base of their workforce: In a majority of the consistent performers, manufacturing employs more highly qualified persons than in 2006. Ireland, Spain, and Finland are leading consistent performers. All moderate performers are below the EU average. The position of Portugal, Italy and Malta reflects their specialisation in labour-intensive low education and low innovation industries. Most of the catching-up Member States have a below-average percentage of people with high qualifications but all of them have improved since 2006, in particular Latvia, Poland and Romania.

Investment in the EU is not responding (Index; 2005=100) Economic recovery requires investment to pick up. The EU investment level has fallen by over three percentage points of the EU GDP, from 21.1 % in 2007 to 18 % 2012. This is mostly due to the collapse of investment related to construction, as investment in equipment, metal products and machinery has remained relatively resilient during the crisis. Until now, investment remains unresponsive to policy measures in the EU. It is very difficult to identify when investment will recover but cost conditions and uncertainties have been identified as major factors delaying this recovery.

Electricity prices for mid-sized enterprises (excluding VAT) High energy prices are one of the factors contributing to the deindustrialisation process. Electricity prices for SMEs represent one of the most significant costs of inputs and therefore directly affect industry competitiveness. As Member States rely on various fuel mixes and different infrastructure, electricity prices for industrial consumers vary considerably in the EU: Most of the consistent performers enjoy below-average electricity prices. However, prices have increased in Germany due to increasing power generation from renewable energy sources that has set feed-in prices, and bottlenecks in infrastructure. A majority of the moderate performers have seen major increases in electricity prices since 2007, with Italy, Cyprus and Malta having the highest prices in the EU. In almost all catching-up economies, mid-sized enterprises enjoy below-average electricity prices. Electricity is particularly cheap in Bulgaria, due to regulated prices. Deficiencies in the internal market for energy have also contributed to high prices. Indeed, electricity prices have risen less where markets have been liberalised and where distribution networks have been linked.

Access to finance has deteriorated Change in bank loans to non-financial institutions Banks have tightened credit standards Reasons: risk perceptions, cost of funds and balance sheet constraints. Add borrower risk and macroeconomic uncertainty, This has led to constrained lending volumes and high interest rates, in particular in crisis countries. A stabilisation of the banking sector is needed, Meanwhile policy measures can help Including loan guarantees and equity investment programmes, In the short term, there is no alternative to bank financing. In the long term, corporate finance will probably be more market and less bank-based, The agreements to pay public sector arrears in crisis countries have been positive for many SMEs. 11

Restoring growth requires continuing public administration reforms Government effectiveness An efficient public administration is an essential factor. Goal is effective, client-oriented, and forward-looking public administrations. The most prominent areas of reform are: reducing the administrative burden on firms, enhancing capacity for strategic and budgetary planning ensuring strategic and effective human resources management improving coordination between levels of administration, in particular for countries with multi-tiered administrative structures