1. November 2010 1 Klaus Desmet SPATIAL GROWTH AND THE RISING PRODUCTIVITY GAP WITH THE U.S.

2. November 2010 2 Klaus Desmet S Source: van Ark et al. (2008) Productivity gap EU-15 relative to U.S.

3. November 2010 3 Klaus Desmet Source: van Ark et al. (2008) Productivity gap EU-15 relative to U.S.

4. November 2010 4 Klaus Desmet Source: van Ark et al. (2008) Productivity gap EU-15 relative to U.S.

5. November 2010 5 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 1995-2004 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.

6. November 2010 6 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

7. November 2010 7 Klaus Desmet Deindustrialization

8. November 2010 8 Klaus Desmet Services: the hamburger- flipping economy

9. November 2010 9 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

10. November 2010 10 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 1930. 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

11. November 2010 11 Klaus Desmet Source: Hobijn and Jovanovic (2005) Not a paradox after all

12. November 2010 12 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

13. November 2010 13 Klaus Desmet Instead of hamburger-flipping

14. November 2010 14 Klaus Desmet Back to the productivity gap: Composition effect

15. November 2010 15 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 2001 2.5% in the US (Triplett and Bosworth, 2004) 0.9% in the EU-15 (Desmet, 2010) Back to the productivity gap: ICT and innovation

16. November 2010 16 Klaus Desmet ICT investment as a share of GDP (1995-2004) 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

17. November 2010 17 Klaus Desmet Not all of Europe is the same

18. November 2010 18 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).

19. November 2010 19 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).

20. November 2010 20 Klaus Desmet Innovation and spatial concentration

21. November 2010 21 Klaus Desmet Innovation and spatial concentration

22. November 2010 22 Klaus Desmet Innovation and spatial concentration

23. November 2010 23 Klaus Desmet Flanders and Wallonia

24. November 2010 24 Klaus Desmet Flanders and Wallonia

25. November 2010 25 Klaus Desmet Flanders and Wallonia

26. November 2010 26 Klaus Desmet Flanders and Wallonia

27. November 2010 27 Klaus Desmet Flanders and Wallonia

28. November 2010 28 Klaus Desmet Flanders and Wallonia

29. November 2010 29 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.

30. November 2010 30 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)