Chapter 2 : The conditions for growth and enhanced competitiveness

A. Towards global competitiveness

For the level of employment in the Community to improve, firms must achieve global competitiveness on open and competitive markets, both inside and outside Europe. It is the responsibility of the national and Community authorities to provide industry with a favourable environment, to open up clear and reliable prospects for it and to promote its international competitiveness. This responsibility is now enshrined in the Treaty on European Union. Back in 1991 the Council of Ministers adopted guidelines for a Community industrial policy geared to such an objective.

The globalization of economies and markets, which involves the intensification of international competition through the emergence of a potentially unique worldwide market for an expanding range of goods, services and factors, brings out the full importance of that responsibility on the part of national and Community authorities as regards competitiveness. We must increasingly think in terms of competitive rather than comparative advantages. Comparative advantages traditionally relate to endowment in factors such as natural resources and are therefore fairly rigid. Competitive advantages are based on more qualititative factors and can thus be influenced to a large degree by corporate strategies and by public policies. In such a context, factor mobility and the capacity to combine factors effectively and to organize the social consensus on the share-out of value added are becoming much more important than the initial factor endowment.

The Community will be able to improve its global competitiveness considerably provided it achieves a substantial recovery in its investment ratio (see Chapter 1). For this, it enjoys significant comparative advantages: the potential of its labour force and the social consensus enabling that potential to be exploited, its valuable scientific and technical know-how, its integrated market, the density and quality of its infrastructures, the improved financial structures of its firms, and the diversity of its culture and regions. An economy based on the creation, dissemination and exploitation of knowledge will be one of the dominant features of the 21st century, and against such a background a number of these competitive factors will play a crucial role in generating a recovery in growth and an increase in employment.

The completion of the Europe-wide frontier-free market on 31 December 1992 and the improvements in its operation envisaged by the strategic programme will allow firms to benefit from economies of scale, reduce their administrative and financial costs, have easier and more competitive access to private-sector and public-sector procurement, and cooperate more efficiently with one another. This will give the Community a firm and well-organized base from which to tackle the new problems posed by international competitiveness.

However, the Community will also have to overcome the handicaps which have contributed to the erosion of its competitiveness within the Triad (Community, United States and Japan) in recent years: Apart from the macroeconomic policy imbalances that have contributed to the real appreciation of Community currencies, there is firstly, as emphasized by the Member States, the problem that their industries are not sufficiently well represented on expanding new markets, either in geographical terms or in terms of products, with its firms sometimes at a disadvantage in the face of the dominant positions held by certain international groups and the growth of strategic alliances. Secondly, the regulatory environment is still too rigid, and administrative and managerial traditions too centralized and compartmentalized. Lastly, government policies are often still too defensive and do not take sufficient account of the new constraints imposed by global competition.

Four overriding objectives must be pursued jointly by industry and the authorities if the Community's industrial competitiveness is to generate the highest possible level of employment:

• Helping European firms to adapt to the new globalized and interdependent competitive situation.

• Exploiting the competitive advantages associated with the gradual shift to a knowledge-based economy.

• Promote a sustainable development of industry.

• Reducing the time-lag between the pace of change in supply and the corresponding adjustments in demand.

This chapter analyses the Community's strengths and weaknesses when it comes to tackling these challenges and then goes on to identify the main components of a policy of global competitiveness.

2.1 Views of the Member States

Among the factors having a major impact on the competitiveness of the Community economy, Member States point particularly to the following: the negative effects of public deficits on investment; impaired functioning of the labour market leading - whether in terms of cost, skills or flexibility in the organization of work - to a mismatch between supply of and demand for labour; inadequate assimilation of new technologies combined with failure to exploit properly the results of research and technological development, leading to difficulties in concentrating the production of goods and services in leading-edge and high-value-added industries.

A number of Member States report market rigidities or distortions in resource allocation caused by government intervention, either through excessive regulation or through various restrictions on competition. Some Member States point to the heavier burden which the ageing of the population is imposing on the economy, and one Member State establishes a link between competitivess and the smaller number of hours worked on average in the Community compared with its main partners.

2.2 The Community's competitive position in a globalized economy: Strengths and weaknesses

Since 1989 the Community has experienced a gradual decline in the growth rate of the production of goods and services.*1 Although the trend in its industrial competitiveness is also worrying, it does have considerable strengths on which it can draw in order to redress the position and to manage its transition to the 21st century successfully.

Weaknesses

In the fierce competition prevailing on world markets, Community industry is handicapped by the deterioration in its commercial competitiveness, by its failure to establish itself sufficiently on expanding new markets, by an unduly low level of R&D investment and by productivity rates which still lag behind those of its major competitors. Most Member States agree with this assessment.

(a) The trade performance of Community industry has deteriorated since 1980, as the downward trend in the rate of cover of imports by exports shows (see Figure 1).

In recent years, Community industry has not only lost market shares as a result of the growing power of the newly industrialized countries, as was foreseeable, but has also had to give ground to the United States and Japan

The situation has deteriorated vis-à-vis the United States because of the adverse trend of exchange rates. In the case of Japan, the reason is rather a failure to move into expanding new markets as quickly as Japanese industry. The erosion in the market shares of Community industry has been accentuated by the growing proportion of world trade accounted for by the newly industrialized countries of South-East Asia.

Community industry's trade performance is fairly uneven. A large part of industry (two thirds in terms of activity) lost market shares between 1986 and 1991, either as a result of increased import penetration of the Community market or because of losses on the export front, or through a combination of the two.

(b) Community industry improved its position on markets experiencing slow growth (railway equipment, cotton, textile and sewing machinery, miscellaneous textiles, tanning and dressing, animal slaughter and meat preparation, grain processing and ethyl alcohol distillation), while its performance deteriorated on markets with high value added such as office automation, information technology, electronics, and medical and surgical equipment. Its structure is therefore not yet geared to that of expanding new markets. This time-lag is all the more damaging in that these high-value-added markets are characterized by rapid growth in the apparent productivity of labour, high wages and salaries, and a diffusion of technological progress into other markets.

(c) Corporate investment in R&D is one area in which the Community must make major efforts. In recent years, annual average growth in R&D expenditure has been highest in Japan (10%). Next comes the Community (8.1%), followed by the United States (7.9%). The 1992 break in the trend of corporate R&D expenditure in the Community (and in Japan) is very worrying in this respect (see Figure 2).

However, Community industry can draw on major strengths to help it adapt to the new conditions of world competitiveness. It has a low level of indebtedness, and its profit margins are comparable to those of its competitors. It has been able to restructure itself in step with the moves to establish the single market. Its labour force is highly skilled. It has a high density of efficient infrastructures.

(a) Community firms have kept control of their level of indebtedness in recent years, albeit at the cost of some ageing of their capital stock. Their indebtedness is at present much lower than that of their competitors. Community firms are thus comparatively less vulnerable to any increases in interest rates, but they will also benefit comparatively less from further interest-rate reductions (see Figure 3).

Japanese firms too face major problems in adapting to the decline in consumption and to the adverse effect of the strengthening yen on the volume of their exports.

(b) When the competitive environment became tougher at the end of the 1980s, Community and US firms cut their profit margins significantly. Japanese companies, which traditionally operate with smaller profit margins than their Community competitors, also saw their profit margins squeezed, albeit to a lesser extent. These developments have had the effect of narrowing the gaps between these three trading blocs (see Figure 4).

However, in both Europe and the United States, profit margins differ appreciably from one market to another, much more so in fact than in Japan. In Europe, industries facing relatively little international competition still achieve high profit margins, whereas in industries more exposed to international competition profit margins have shrunk to worrying levels and, in some cases, have actually disappeared.

(c) Labour costs are an important element underlying the competitiveness of European industry, though by no means the only one. Unit labour costs depend on wage and non-wage costs compared with labour productivity. Thus high labour costs can be compensated for by high productivity to maintain competitive advantage. It is when costs are not aligned with productivity that problems for competitiveness arise. In relative terms, the large rises and falls in unit labour costs compared with those of the leading competitors which have taken place since 1980 are affected by fluctuations in bilateral exchange rates between the Ecu and the dollar and yen.

Labour costs affect competitiveness differently with regard to other developed countries and to those in the process of industrialisation. Non-cost items such as quality, delivery, design and customer focus can assist in maintaining competitiveness, but attention to relative costs, including labour costs remains important. Compared with newly industrialising countries, particularly those just entering that path such as China, however, the differential in labour cost is too great for any significant employment gains to be made in Europe from wage reductions in manufacturing industry. Only high productivity and superior products will enable Europe to maintain competitive advantage.

2.3 The main lines of a policy of global competitiveness

(a) Helping European firms to adapt to the new globalized and interdependent competitive situation

In the wake of the globalization of economies and markets, it is no longer possible to divide industry and geographical areas into clearly identified and relatively independent segments. European firms are engaged in production both within the Community and on third markets. Their competitors increasingly have subsidiaries in the Community. There is a multitude of international agreements between firms: more than 400 international strategic alliances have been entered into by large firms in each of the last five years.

European firms have to compete with international, polyvalent groups. The boundaries of traditional industrial sectors are becoming less and less sharply defined. This is particularly evident in the sphere of "multimedia" activities. Firms engaged in telecommunications, information technology, consumer electronics, programming and network management combine and come together in extremely complex groups and alliances which will very largely determine the creation and distribution of assets, including cultural assets, over the next decade on expanding new markets of key importance for the future.

Industrial globalization means that new balances must be sought between competition and cooperation. Four avenues are particularly important in devising a policy of global industrial competitiveness:

1. Capitalizing on the Community's industrial strengths, so as to safeguard productive and innovatory capacities as well as a diversified, job-creating industry that is spread throughout Europe, particularly on markets with a high growth potential, such as health, the environment, biotechnologies, multimedia activities and culture. This aspect must take account of changes stemming from the globalization of markets, production and operators and from the industrial policies of the Community's main competitors.

2. The development of an active policy of industrial cooperation, notably with the transition economies of Eastern Europe and with the high-growth economies along the Pacific rim. As far as the countries in Eastern Europe are concerned, much closer industrial cooperation is necessary in order to ensure simultaneously a rapid modernization of their economies, a better division of labour within Europe and optimum exploitation of mutual interests. Cooperation must be based on closer links between public support and private initiatives and on speedier progress in establishing the legal framework, investment conditions and guarantee arrangements which our firms require. For the industries concerned, this may need to be accompanied by a transitional period to allow the necessary structural adjustments to be carried out under the best possible conditions. As far as the Pacific area is concerned, increased market penetration by European firms can be greatly facilitated by concerted efforts on the part of the public authorities to remove the regulatory, administrative and indeed cultural obstacles which have hitherto impeded or deterred such penetration.

3. The establishment of a coherent and concerted approach to strategic alliances, the uncontrolled development of which could result in the creation of oligopolistic situations prejudicial to competition at world level. The growing number of industrial and technological alliances will have an impact on all markets. These effects must consequently be assessed simultaneously and in a concerted manner by the competent authorities pending the introduction of appropriate international rules, particularly in the competition field, so that the Community is not placed at a disadvantage by the strict rules it imposes on itself in this connection. In addition, Community firms must be able to rely on flexible instruments of cooperation, in legal and tax matters as well as in others, to allow them to enter into the alliances that are necessary to counterbalance the weight of some of their US and Japanese competitors.

4. The targeting of measures to remove obstacles to the smooth functioning of markets in areas that severely penalize European firms' sales and growth potential. European firms' capacity for exporting to, and setting up in, other countries is sometimes far from being fully exploited because of the difficulties stemming from the structural impermeability of certain markets. Pinpointing such barriers to growth and introducing specific measures to remove them may help significantly to improve Community industry's opportunities for selling its products on the markets concerned. This could be modelled, for example, on the "trade assessment mechanism" set up with Japan to identify the nature and causes of the Community's poor trade performance in Japan in those sectors in which Community industry is in a strong competitive position at international level.

The wealth of nations is increasingly based on the creation and exploitation of knowledge. Optimum advantage must be taken of this new form of progress available to Community firms since it is an area in which the Community enjoys a substantial head start.

The shift towards a knowledge-based economy is reflected in particular in the externalization of certain activities by industrial firms and by the faster growth of services. It does not mean that manufacturing industry is declining in importance, since this sector is at the very heart of this development and continues to determine the overall competitiveness of the productive system.

The key elements in competitiveness that are now of greatest importance are no longer confined to the relative level of the direct costs of the various factors of production. They include in particular the quality of education and training, the efficiency of industrial organization, the capacity to make continuous improvements in production processes, the intensity of R&D and its industrial exploitation, the fluidity of the conditions under which markets operate, the availability of competitive service infrastructures, product quality and the way in which corporate strategies take account of the consequences of changes in society, such as improved environmental protection.

Even more crucial is the capacity to incorporate all of these elements into coherent strategies. Between 75% and 95% of firms' total wage and salary bill is now accounted for by functions linked to organization rather than to direct production, e.g. information technology, engineering, training, accounting, marketing and research. Organizational capacity is thus one of the key components of a firm's competitiveness.

A number of these factors, such as training, research and services, may be grouped together under the heading of "non-physical" (i.e. knowledge-based) investment, to which government policies must in future accord at least the same priority as they do to physical investment. This type of investment is becoming the key element in bringing about growth that is durable, creates skilled jobs and is economical in its use of resources.

This does not entail any increase in public deficits, but it does presuppose far-reaching reforms:

• As regards taxes: The relative weight of taxation borne by the various factors of competitiveness should be adjusted in such a way as to reduce those components of taxation which act as employment disincentives and to increase those conducive to more efficient and less polluting use of scarce resources.

• As regards the criteria governing the use of national and Community financial instruments: There should in particular be a review of the criteria governing the admissibility of aid to industry, which, under most existing schemes, encourages firms to increase the capital intensity of production and to boost their physical as opposed to their non-physical investment in order to improve productive efficiency. The aim should be to take fuller account of the creation of value added and the non-physical content of growth.

• As regards the priorities governing the use of public funds: Investment in training, research, the promotion of innovation and, generally speaking, the non-physical components of value added must be treated at least as favourably as traditional forms of investment. The aim should be twofold: to promote the emergence of new generations of products that make optimum use of all the technologies available on the world market, and to encourage the dynamic incorporation of innovation into processes, products and organization. An essential precondition is that there should be an increase in research activities by Community firms and greater selectivity in government assistance.

• As regards the regulatory framework: More must be done to ensure the efficient operation of the single market, notably by streamlining and rationalizing rules and regulations so as to make it easier to establish new forms of labour organization and to move away from "Taylorism". A policy that focuses on quality and is consistent with the Community's approach to standardization must be pursued in order to exploit the know-how of Community firms and avoid market fragmentation.

(c) Promote a sustainable development of industry

A policy of pollution prevention, in particular through a generalized development of clean products and processes, will not only prevent rapidly increasing clean-up costs but also stimulate a faster diffusion of R&D results. The first-mover advantage that will result will contribute to a strengthened overall competitiveness of European industry.

The significance of the so-called Eco-industry as a quickly expanding industrial market is now widely accepted and, according to OECD studies, will expand considerably this decade. It covers not only the supply of goods and services to firms for pollution control or abatement but also the expenditures made for the environment in the general context of improved production methods or produccts, as well as the markets for environmentally sound products (green products).

In the present context of global competition, the technologies employed in, and the organizational requirements for, the successful introduction of clean technologies are often similiar to those associated with the new manufacturing paradigm. The concept of lean (e.g. less energy, fewer raw materials) constitutes a significant improvement regarding the environmental friendliness of production processes and fosters the competitiveness of the industries concerned.

Moving beyond production processes to product markets provides an additional dimension for industrial competitiveness. Markets for environmentally sound products provide an incentive for firms since they represent in any case a source of potential profits. As stricter environmental requirements are imposed on export markets, the application of clean technologies becomes a condition of access to these markets.

To promote the sustainable development of European industry, the Community should:

1. increase substantially and coordinate R&D efforts in the field of clean technology;

2. develop economic incentives to support the diffusion of R&D results into products and processes.

As in the case of previous industrial revolutions, there is an appreciable time-lag between:

• changes in supply, where faster modernization is now under way through

  the use of increasingly efficient technologies, resulting in a rapid increase in labour productivity and thus releasing substantial human resources;

• changes in demand, which are lagging behind changes in supply because of cumbersome rigidities in income distribution, in modes of consumption, in the relatively low level of receptiveness to innovation within the Community, in the geographical structure of growth and in the unsatisfactory functioning of markets.

It is imperative that an attempt be made to reduce this time-lag so as to make optimum use of the human resources released as a result of the increasing productivity of the productive system. This can be done only by helping to broaden the sales opportunities for Community industry through policies geared simultaneously to demand, to supply and to improving the interaction between them.

On the demand side, this means:

• Pursuing initiatives aimed at speeding up a concerted recovery in consumption at world level and helping to bring about a revival in demand for Community industry. The asymmetries stemming from the continuing large differences in the degree of openness of markets as between the most open areas, foremost amongst which is the Community, and those which, for structural or political reasons, remain largely protected are reflected in a chronic growth deficit at world level. Resolute support for initiatives to bring about a concerted recovery in demand and for the opening-up and industrial modernization of the protected countries is essential in order to make up this "shortfall" in growth.

• Looking at the various measures liable to promote the emergence of new markets for goods and services. This is a reference in particular to those markets geared to improvements in environmental protection (on which Community firms are particularly competitive), to the exploitation of biotechnologies and to the creation, management and dissemination of information. In this respect, the emergence of "multimedia" activities that exploit the scope afforded by the digitalization of information in all its forms (written word, image and sound) will engender major upheavals that will benefit those firms and economies capable of establishing themselves on these new markets.*2

• Encourage continuing structural adjustment in Community industry. This means facilitating privatization processes, which can in large measure help to speed up such adjustments.

  Community industry has not sufficiently exploited all the opportunities afforded by the rapid growth of markets in Asia and Latin America.

• Underpin the dynamism of SMEs. It is clearly more difficult and relatively more costly for SMEs than for very large firms to find their proper place in the globalized economy, to have access to world technological capital and to avail themselves of the most sophisticated management techniques and business services. The policies in support of SMEs must, therefore, take account of these new constraints and be strengthened accordingly.

Lastly, better interaction between supply and demand must be strongly encouraged by:

• facilitating partnerships between large firms and their subcontractors. Effective cooperation between component assemblers and suppliers is one of the essential preconditions for reducing the total time involved in innovation, optimizing R&D expenditure, reducing overheads, ensuring the technical homogeneity of products and improving product quality. The steps already taken in this direction by industry are proving extremely positive and deserve increased support from the public authorities;

• improving the interfaces between producers and users. Although wide-ranging, this objective is of particular importance for research if more rapid and more sensitive account is to be taken of market requirements in R&TD policies and if there is to be greater complementarity between Eureka and the Community research programmes. The research effort, which is insufficient overall, must be stepped up, become more focused and be more effectively exploited as regards its applications. Ensuring the broadest possible dissemination of information and facilitating contacts between all those involved through the establishment of multidisciplinary cooperation are both necessary in order to foster not only competition in the development of technologies but also effectiveness in exploiting them;

• stimulating the development of "clusters" of competitive activities that draw on the regional diversity of the Community. The proliferation within the Community of "clusters" that combine industrial, technological and geographical advantages may hold one of the keys to job creation. This requires the active involvement of all the actors concerned, something which can be greatly facilitated by structural measures taken at Community and national level. In this area as in the preceding ones, the main emphasis should be on a horizontal, transsectoral and multidisciplinary approach.

These guidelines are summarized in the attached table.

Conclusion

1. Government intervention in industry must be refocused on horizontal measures and on growth markets where there is strong potential for European industry to develop, such as health, the environment, biotechnologies, multimedia activities and culture. This also means that precise and short-term deadlines should be set for restructuring activities whose development prospects are not satisfactory in terms of markets.

2. The machinery and criteria for government intervention that creates conflict between the promotion of industrial competitiveness and job creation must be reviewed. In so doing, the tax burden must be redistributed so as to lighten the burden on labour and increase the burden on the use of natural resources. The criteria for granting public assistance must be reviewed so as to take better account of value added and so as not encourage an unjustified increase in the capital intensity of production. The regulatory framework must be transparent, stable and predictable.

3. The promotion of non-physical, knowledge-based investment must be made the top priority of the general policy in support of investment. Training, research and know-how in general must be treated as proper targets of investment in their own right. The necessary consequences should be drawn notably as regards changes in tax and accounting rules.

4. A dynamic policy of industrial cooperation must be set in motion, starting with the countries of Eastern Europe and with the Pacific area. The details of such a policy must be established as a matter of urgency in collaboration with the private-sector and public-sector operators concerned, on the basis of clearly identified mutual and reciprocal interests.

5. Measures must be taken shortly to strengthen the competitive functioning of markets. A European approach should be developed that takes account of the proliferation of strategic alliances, particularly in the field of competition, so as to prevent the development of dominant positions at world level. Machinery for pinpointing problems in the functioning of markets and for assessing their industrial implications must be set up so as to identify and tackle rapidly the obstacles facing European firms against the backdrop of global competition.

6. The coordination of moves to facilitate a revival in consumption and reinforce the interaction between changes in supply and demand at both international and Community level must be strengthened. Priority should be given to employing all the resources available, and in particular structural policies, in order to speed up the development of clusters of competitive activities that draw on the Community's regional advantages. The networks for collaboration between operators (SMEs and large firms, producers and users, public and private actors) must be improved along multidisciplinary and multisectoral lines. Lastly, there must be a European policy on quality that complements the policy on standardization and is geared to promoting activities with a high value added. GUIDELINES FOR A POLICY OF GLOBAL COMPETITIVENESS

   
   
   

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   1 In the remainder of the text, the term "industry" is used to cover the production of both goods and services.

   2 See the Chapter on "The Community as an open and reliable partner".

   3 See the Chapter on "The information society".

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