A new productivity strategy for Europe

Crisis measures to promote recovery in Europe must begin to address its underlying productivity challenge.

Europe faces a productivity problem. Its upward curve has flattened in many European economies in recent years, with negative effects on growth, competitiveness and distribution. And divergent productivity developments within the EU are endangering ultimately the political stability of the economic and monetary union.

In view of the looming sharp downturn as a result of the Covid-19 pandemic, a new European productivity policy must be at the heart of economic-policy responses. Experiences from the financial and eurozone crises have shown that a crisis policy that is too short-term and does not tackle the structural problems of European economies with sufficient determination increases the risk of “secular stagnation”.

So far national and European emergency measures have provided government protection for individuals and expanded the scope for fiscal action. When this first phase of crisis response is over – hopefully sooner than later – it will be of utmost importance to bring economic activity in European economies back to pre-crisis levels and stabilise this growth. This might require stimulating the business cycle.

We then have to address the underlying, pre-crisis productivity problem in a way that Europe emerges stronger in the long term. A new productivity strategy for Europe should focus on ambitious innovation policies, targeted promotion of technology diffusion and comprehensive and sustainable investments.

Innovation-friendly

For European economies innovation is a prerequisite for sustainable productivity growth. This requires targeted measures to create innovation-friendly market structures in the EU and more intensive co-ordination among member states. Building on Nicholas Bloom’s meta-analysis of innovation policies, European policy-makers – above all the European Commission – should focus on the key levers for technological innovation.

Public expenditure on research and development has medium-term effects on innovation. As part of the “Europe 2020” strategy, the commission had set the goal that private and public investment in R&D should reach 3% of gross domestic product by this year but the target will clearly missed. The commission must work towards the strongest possible commitment by member states to define and track national targets for public R&D spending. At the same time, R&D funding within the framework of European cohesion policy, which in recent years predominantly benefited already highly innovative regions, should be directed towards regions in member states with low R&D rates. Furthermore, the commission should coordinate mission-oriented R&D investments – the European Innovation Council, which will be fully operational from next year, could play an important role.

Improved access by young people to technological research and contact with innovation ecosystems have long-term effects on innovation. There are big differences among EU countries and regions in this respect. The commission should promote more exchange of good practice on how to modernise schools and higher education in this direction. The digital-education action plan it intends to publish in the middle of the year should address this issue.

Positive innovation effects can be achieved in the short term through skilled immigration. The obstacles to granting a European “Blue Card” must be removed and regions enabled to develop a strategy to attract highly qualified immigrants.

Finally, market openness has a clear positive effect on innovation, whose costs can be refinanced more easily via a larger market. For the EU, this applies above all to the integration of digitised services markets. Here, the free flow of data within the EU plays a central role – the commission must enforce the European legal framework on this, while at the same time preventing regional differences in productivity becoming further entrenched. A first step is its data strategy, which focuses on sector-specific European data spaces and an overarching governance framework.

Technology dissemination

The promotion and dissemination of technologies aimed at human-machine complementarity is the second component of an advanced European productivity agenda. Productivity policy will only be socially and economically sustainable if it can increase the productivity of all employees, rather than reducing employment.

Analogous to public R&D investment, tax incentives for private investment in “human capital” could stimulate its systematic development, especially among low-skilled workers, and diffuse innovations without shedding workers. The commission should take up the Anglo-Saxon discussion on human capital tax credits, for example in updating its competences agenda.

Basic innovations do not translate into productivity gains until the necessary, sometimes lengthy, implementation steps have been taken in organisations.There are great differences among countries, industries and company sizes in the speed and quality of implementing innovations and modern management practices. While in some EU countries the dissemination of organisational innovations to a broad range of companies is part of economic-policy instruments, in others the state plays hardly any role.

The commission’s SME Strategy published in March includes measures aimed at the adoption of innovative practices by small and medium enterprises, such as “digital innovation hubs”. The commission should also promote dissemination of best practices from leading countries, such as Sweden and Finland, among member states.

Investment is key

Investment is key to basic innovations and their cross-sectoral use. It is a prerequisite for sustainable productivity growth. This makes the impact of weak investment in many European economies since the financial crisis all the more devastating. A third component of a promising productivity strategy is therefore a comprehensive investment policy, in which the national and European levels interlock. This is of particular importance when it comes to decarbonising the economy, shaping digitalisation and urbanisation, and providing sustainable infrastructure and mobility as well as comprehensive health systems.

All companies benefit from a functioning business-related infrastructure, regardless of their position in the productivity distribution. This is particularly the case for public transport and network and regional infrastructure. A focus on maintaining and modernising infrastructure, especially in rural areas, contributes in the long term to reducing regional disparities in productivity, while ensuring local services of general interest. In particular, a rapid implementation of already existing plans for European cross-border infrastructure is important. One of the promising projects is the Trans-European Transport Network which aims at developing a Europe-wide network of railway lines, roads, inland waterways, maritime shipping routes, ports, airports and railway terminals.

European investment policies will only lead to a sustainable increase in productivity if the conditions for private-sector investment as wells as the steering function of public investment are addressed. With regard to private investment, the security for companies and employees of long-term planning must be underpinned by concrete regulatory conditions, targeted national and European funding programmes, venture capital for growth and state support for R&D. With respect to public investments, empirical findings on key investments that can trigger “investment chains” can be drawn upon. This concerns in particular the restructuring of the European economies in future energy production and mobility. Here, a public European hydrogen corporation could be one of the starting points for the development of new cross-border infrastructure. In addition, focused and institutionalised spending reviews can serve as an effective instrument for identifying and prioritising promising investments.

Concrete investment projects designed to increase productivity must be matched by financing instruments and commitments. Sovereign wealth funds, public enterprises and other forms of state shareholding to implement central modernisation projects should play a stronger role. They offer longer-term domestic investment opportunities in European member states, which tend to be less risky than short-term financial investments outside Europe.

At European level, for example, the European Investment Fund, which specialises in supporting SMEs, could be developed into a “Future Fund” to address key investment needs. After all, today’s financing must always be set against future profits: the literature shows that government investment can generate high fiscal returns and increase distributive justice. These investments are therefore worthwhile even at significantly higher interest rates than those observed before the current crisis.

European stabilisation instruments are needed to counteract the reduction of public investment in a downturn, as is foreseeable in the wake of the coronavirus pandemic. An initial approach is temporary modulation of co-financing rates for important investments in employment and growth, as provided for in the new budgetary instrument for convergence and competitiveness (BICC) for euro-area countries, should a member state find itself in a recession. Linking specific investment projects with individual structural reforms to increase productivity is also a step in the right direction. The BICC’s planned volume is however likely to have only minor effects on macroeconomic stabilisation. Other possible steps to create financial leeway for investments during crises would include a common reinsurance system for unemployment benefits or a European recovery fund, allocating resources to regional productivity-enhancing investment projects.

Transformative effect

The member states and the commission currently focus on emergency measures to cushion the massive economic consequences of the Covid-19 pandemic, primarily by providing state protection for individual economic risks and expanding the scope for fiscal action. In view of the foreseeable plunge in economic activity in Europe, the guiding principle for European and national stabilisation policies has to be to take timely, targeted and temporary measures.

Yet a further “T” should be taken into account when formulating economic-policy measures in the coming months: these should also have a transformative effect in addressing the underlying productivity problem, so that Europe emerges stronger from the crisis in the long run.

Europe has to agree soon on measures within the union that will quickly get economic activity back on track and at the same time increase productivity systematically and across the regions. In this way, crisis measures can also contribute to ensuring long-term competitiveness, growth and convergence of living conditions across the EU.