1
SEMIFINAL3 – 12 February 2003
Transforming Enterprise in Europe –
a comparison with the United States
Presentation in the Transforming EnterpriseConference
Department of Commerce
Washington, 27 January 2003
Dr. Olli Rehn, Director of Studies
Department of Political Science
University of Helsinki
Executive Summary
The dawn of the digital era has launched a lively debate on causes and effects of the current transformation of production and enterprise in industrial economies. The ongoing economic transformation has been stimulated, apart from the breakthrough of digital technologies of communication and data processing, also by the steadily advancing economic globalisation, as well as by the shifting policies and geopolitics, especially in Europe in the recent decade and a half.
This essay analyses the transformation of enterprise in Europe in a comparative light, in particular by mirroring the European experiences to those of the United States, which in many ways is the benchmark nation of the digital economy. The analysis leans on a conceptual framework in which the dual impact of digital technologies and cross-national production networks underpins the changing business strategies and the subsequent industrial restructuring in the current and especially enlarged European Union. In the case of Europe, the shifts in geopolitics and policy are significant drivers of change. The ongoing process of Eastern enlargement will extend (has partly already extended) the EU single market and (later on) the euro area by almost 100 million people. In parallel, the making of the Single Market since the mid-1980s and the advent of the Euro in 1999-2002 have facilitated an intensified economic integration, which in turn has paved the way for cross-national production networks in a all-European scale.
The conceptual framework is coined in Figure 1 below. It is assumed that the technological dynamics of the economic transformation stem from the rise of digital technologies of information, communication and data processing. The internet and wireless technologies accelerate this development, and broadband technologies are likely further to do so. At the same time, economic globalisation has progressed thanks to the expansion of world trade and foreign direct investment; thus, the role of contract manufacturing and supply management, and other process innovations, has become critical for the competitive advantage of enterprises. The shifts in policy and geopolitics have, by and large, further accelerated these developments.
Figure 1. Transformation of Enterprise in Europe and its Technological, Economic and Political Foundations
Based on this framework, the European experience of economic transformation is explored below in more empirical terms, with a comparative view on the United States. I shall make three central arguments. Firstly, the IT-enabled change is not an instant revolution, but rather a long-lasting economic transformation. Secondly, this transformation is not merely a matter of information technologies, but more and more of process and managerial innovations. Thirdly, both IT-enabled e-business strategies and the Eastern enlargement of the Union smoothen the construction of cross-national production networks.
Finally, these general and theoretical observations are assessed in the light of empirical evidence from the European electronic communications industry. This exercise has a dual purpose: on the one hand, this industry is itself a case in point of the economic transformation, with significant and US-matching achievements of productivity growth; on the other hand, the electronic communications industry is a relatively reliable reflection of the progress of the European information society (e.g. mobile and internet penetration). My conclusion is that even if Europe is trailing behind the U.S., especially in process and managerial innovations, it is nonetheless making steady progress in the information society and its fundamentals of digital transformation are healthy. Yet, to fully capitalise on the chances provided by the digital economy, Europe needs to intensify its structural economic reforms and boost entrepreneurship.
Not an instant revolution, but a long transformation
Let me provide a personal note on the economic transformation in Europe. My Old Man is an entrepreneur, who has been in the spare parts business since 1946, first as a sales assistant, and since 1965 running his own enterprise. Since 1965 our company has been a dealer of Robert Bosch Gmbh, the German electronic and diesel parts manufacturer, in Eastern Finland. In the mid-1980s, Bosch modernised its supply chain and started to apply Electronic Data Interchange (EDI). This implied that the spare part orders, though still sent to Helsinki to the national distributor, were essentially processed in the central distribution system in Stuttgart, Germany. Thanks to just-in-time supply management, most of the orders were now sent to Eastern Finland directly from Stuttgart or from Bosch’s other central warehouse, located in Örebro, Sweden. Bosch acquired the national distributor and turned it to a subsidiary. As a consequence of these transformations, its workforce shrank from 250 to less than 50 employees. Bosch is competitive, and My Old Man is still in business.
This leads me to my first point on economic transformation. It is that IT-enabled change, the core topic of this conference, did not begin with the introduction of the internet or e-commerce. Instead, it got off the ground well before the internet was even a twinkle in Al Gore’s eye. In other words, EDI and other IT-enabled modes of business-to-business transactions preceded e-business proper.
What, then, tends to be the life span of an industrial revolution? Assuming that we are currently living through an economic transformation towards a digital era, or even an industrial revolution that is transforming production in a fundamental way, it is worth recalling how Alfred Chandler, the great American economic historian, has approached the matter. Applying Chandler, it will take not 2 to 5 years but rather 25 to 50 years to experience the full impact of an innovation on the industrial production system. We can compare the current economic transformation that stems from the roll-out of information and communication technologies to the arrival of the railroad or the electric engine. Both took half a century to make a comprehensive and profound impact on industrial production and business strategies. Consequently, the contemporary digital transformation will only take full effect once IT in all its senses will be part of daily activities in business and government activities and indeed our everyday lives.
This brings interesting insights as far as the potential of the United States and Europe are concerned.Professor Matti Pohjola[1] has led an international study on the impacts of the emerging digital economy. The study looks at its impact on Asia, Europe, theUnited States and the developing countries. The study points out that in the United States productivity gains do not only reflect increased investment in ICT but also complementary innovations in business organization and strategy. The study also argues that the productivity benefits of the digital economy should be greater in Europe than in the United States if, by increasing price transparency and competition, the internet will make businesses and markets more efficient. This is because the European economies are generally believed to be more inefficient than the US economy. Consequently, there could probably be more to gain from the emerging digital economy in Europe than on the other side of the Atlantic, provided that Europe were able to generate those process and management innovations that it would require.
As to the role the state, e-business is primarily technology- and business-driven, but public policy can either facilitate or hinder progress.
In the European debate, the arrival of the digital era in production and services has been coined in the concept of the knowledge-driven economy. The Lisbon European Council stated a bold and beautiful goal in March 2000 to make Europe the most dynamic and competitive knowledge-driven economy by 2010, with a high degree of job creation and social inclusion. This has led to numerous policy initiatives aiming at stimulating competition, new technologies and entrepreneurship, as well as actively promoting social inclusion and digital literacy of all Europeans. The Lisbon strategy and its core component, the eEurope action plan, both aim at revisiting and thus revitalising the European societal model.
It’s not only the IT, stupid … but process and managerial innovations
My second point is that the current transformation of enterprise and production is not only an IT-enabled phenomenon, but to a large extent a matter of process innovation and better management. To simplify, we can call it ”the Wal-Mart effect”. As the European Commission maintains in its Competitiveness Report of 2002: ”Wal-Mart is credited with directly causing the acceleration of labour productivity by developing a successful format based on ongoing managerial innovations and intensive use of information technologies.” According to the Commission, this has forced competitors to copy Wal-Mart’s best practice.
According to recent empirical works, that is the Achilles’ heel of Europe. In other words, Europe trails behind the United States in productivity growth, as the long period of catch-up with the US in terms of labour productivity came to a halt around the mid-1990s. In the past few years, the productivity gap was widened again; labour productivity in the EU is at present less than 80 % of the US level.[2] This seems to be particularly related to the slower adoption of IT in the services sector. In the US, productivity grew fast since the mid-1990s both in industries that produce and use IT; the IT-using industries tend to be dominated by business sector services. In Europe, only few countries, typically distinguished by the fact that they are producers of IT, especially telecoms and software, could match with the US productivity growth.[3]
Finland is a prime example of this “European dualism”: she has achieved a very high productivity growth in the late 1990s, with equally high growth rates of R&D spending and national product; yet, simultaneously she has the smallest employment share of all EU countries in business sector services.This is symptomatic to the whole EU, where the business sector services tend to be underdeveloped even in many technologically advanced EU countries.[4]
The importance of the ICT-producing sector has been underlined also in several country-specific studies. In Finland, the mobile producer Nokia accounted for 1.2 percentage points of the country’s GDP growth of 4.0 percent in 1999. In Korea, 40 % of its GDP growth originated in the ICT sector, which is five times its share in GDP. In the Netherlands, the ICT-producing sector generated about 17 % of GDP growth over the period of 1995-98, which is four times its share of GDP.[5]
Referring to the Pohjola study mentioned above, this has the upside for the Europeans, too. That is, Europe has plenty of potential to catch up with the U.S. The advent of the single currency Euro paves the way, and the next step is to complete a single market in services. There are still plenty of cross-border hurdles that inhibit competition and lead to higher prices and lower productivity. Likewise, the completion of the single market in financial services is necessary to facilitate more effective business operations in the European scale, as well as to stimulate EU-wide venture capital markets. The Commission will make a major proposal on the completion of the single market in services by the spring of 2003.
Enlargement facilitates cross-national production networks in Europe
Despite lagging behind in overall average productivity, Europe is making progress and has some competitive advantages. One of them is the Eastern enlargement, which – if we look at it as a process – has been going on for more than a decade already. The first 10 new member states[6] will join the EU on 1 May 2004. Enlargement will facilitate an expansion of cross-national production networks between the current EU companies and the candidate countries. Moreover, more and more European companies either have set up or are currently setting up truly global production networks. Apart from enlargement, the driving forces are digitization, the internet and high-speed data networks.
Take Asia, which has a well-trained and fast-growing pool of engineers, software designers and other knowledge workers. India generates $10 billion in exports of IT services, chip design, call centers and business back-office; this is expected to grow to $50-60 billion by the end of the decade. Further, the Dutch electronics producer Philips has shifted a significant part of its research and development on televisions, cell phones and audio products to Shanghai. Apart from Philips, China is becoming a key product-development centre for General Electric, Intel, Microsoft and other electronics producers. China’s strengths are hardware design and embedded software.[7]
In Europe, Nokia is a case in point of a successful corporation run as a global network. In production and supply management, it has long ago turned from mere outsourcing to strategic partnerships. It has formed hundreds or thousands of alliances with other companies, universities and research institutes. The same global networking method is applied in research and development: Nokia had R&D units in 12 countries, and 44 R&D centres worldwide already in 1999.[8]
One of Nokia’s strategic partners that has recently grown to an important producer of electronic manufacturing services is a company with likewise Finnish origins, Elcoteq. It came into being in 1984 as part of Lohja Corporation, producing densely mounted control electronics to develop flat displays. In 1991, after major divestments and refocusing, Elcoteq was sold to its executive management in an MBO. In 1993, the company started its operations in Tallinn, Estonia, by renting a local electronics plant and employing some 10 people. By 1997, it employed more than 1,300 people, and it is today the single largest private employer in Estonia. Elcoteq has been a contract manufacturer to both Nokia and Ericsson. However, it was badly hit by Ericsson troubles in 2000-2001, but has recently recovered after some significant restructuring and focusing on core competences.[9]
A point valid to our argument that “enlargement matters” is that a profound feasibility study was conducted before the move to Tallinn, mainly focused on assessing various Asian countries as a potential location. Based on the study, the executive management of Elcoteq decided that it was a better alternative to locate closer to home, in Tallinn, the capital of the newly-independent Estonia. Of course, the end of the Cold War was crucial: still in the early 1980s, Tallinn had the privilege of possessing Soviet middle-range nuclear warheads targeted at Helsinki, 40 miles north to on the other side of the Bay of Finland; 20 years later, the nuclear warheads had been replaced by production outlets.
Setting these evolvements into a more general framework of cross-national production networks provided by Zysman and Schwartz[10], it seems evident that the candidate countries of the EU are mostly at the equivalent level as ‘Asian tier 3’ or “late-late industrialization or the regional strategy of cross-national production networks”, a group constituted e.g. by Thailand and Malesia. ‘Asian tier 1’ refers to Japan and “early late industrialization” and ‘Asian tier 2’ to “Cold War late industrialization” of Korea and Taiwan, while ‘Asian tier 4’ represents a more distinct route from exports to exogenous growth, such as China. The case of Elcoteq and Estonia seems to fit to the ‘third tier’ country cases which do not have a history of domestic manufacturing (or if it existed during the Soviet era, it was qualitativelynot comparable to Western standards).
Case study: The European electronic communications industry
Zysman maintains that the story of the digital era is best understood with the transformation of the consumer electronics industry[11]. That may well be the case globally and in the United States. Meanwhile, at least if one wants to point out to a successful case in point of the adjustment to the digital era, in Europe one is bound to choose the telecommunications, or as one should nowadays call it, the electronic communications industry. Underneath it one needs to take a look at the evolution of the information society in Europe.
The state of the European information society is somewhat schizophrenic in early 2003. On the one hand, adoption of new information technologies “on the ground” is progressing steadily, both among ordinary citizens and businesses; further, revenues of the electronic communications sector are still growing faster than GDP. On the other hand, especially the telecom sector faces a complex set of factors: global economic slowdown, the burst of the dot-com and telecom bubbles, and over-investment in backbone capacity. In the mobile business, several operators are heavily overburdened by the changeover from the second to third generation (3G) and the high licensing costs of 3G operations.
In 2002, the European telecom industry had revenues of over €300 billion and employed over 1.5 million people. The sector has experienced substantial growth in the recent years. Growth rates of 13 % in 2000 and 9.5 % in 2001 in the EU telecom services market (both fixed and mobile) far exceed the growth rates of GDP. In 2002, growth of the telecom sector has slowed down and will, according to realistic estimates, vary from 5 % to 7 % in the combined national markets of the 15 EU member states. Compared to projected average EU GDP growth of 1.0 % in 2002 this can be regarded as a relatively healthy outlook.
A key factor behind the rapid growth rate of the European telecommunications industry has been the liberalisation process conducted in the 1990s. Many new enterprises have entered the market, consumers have achieved lower prices and wider choices, and the sector has created lots of new employment.
The impact of the liberalisation process is shown in a nutshell in table 1 below.
Table 1. Tariff rebalancing and consumer/user expenditure, 1998-2002
Table 1 reveals a number of interesting though expected outcomes of liberalisation. Firstly, national call charges have fallen by 49 % in the four-year period. Secondly, the price level of international calls, measured as ‘consumer international basket’, has fallen by 38 %. The average expenditure for consumers has fallen by 12 % and for all users by 23 %. This proves Adam Smith right: competition and the law of supply and demand have worked.