ESSAY

What are the reasons for Europe's lag behind the US in some high-technology
industries, and what can it be done to correct it?

Course name: Business in the Global Environment

Course code: MN425
Candidate number: 77800
Michaelmas Term 2008
Number of words: 2198
MN425 Business in the Global Environment Candidate number: 77800

1. Introduction
In this paper, I will try to assess the reasons for Europe's lag behind the US in high-
technology industries, and what can it be done – whether anything – to correct it. The first
part of the essay analyses the recent development of the economy and its shift towards high-
technologies. Then it describes the foundations that according to me lead to the exceptional
high-technology development in the US and the European lag in the high-tech. I define short-
term, medium-term, and long-term factors of the US dominance in high-tech industries. Then
I am going to describe some empirical data about the US and European economies. Finally I
am going to assess the policies that could correct this lag. The conclusion is that it is not
necessary to replicate the US socio-economic system. Rather, Europe should finish
liberalisation in products, services, and labour markets to achieve higher competitiveness in
general.

2. High-tech industry: What is it and why US succeeds

The term high-tech is used frequently but as Kask and Sieber (2002, p.18) note there
is no consensus on exactly which industries to include in the high-tech. There are however
several definitions:
- High-tech firms are those involved in introducing new products and processes
“through the systematic application of scientific and technical knowledge1
- The Organisation for Economic Co-operation and Development (OECD)
identifies high-tech industries based on a comparison of industry R&D
intensities, a calculation dividing industry R&D expenditures by industry
sales.
- US National Science Foundation describes two definitions of high-
technology: The basic methods use either the percentage of scientific and
technical employment in a particular industry compared to all industries or
R&D dollars spent as a percent of total sales, a measure of research intensity.

High-technology industries have a great dependence on science and technology

innovation that leads to new or improved products and services. It depends, however, also on
several external factors, such as viable business environment and the flexibility of the

1 Definition by the US Congressional Office of Technology Assessment.

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regional market. Therefore, I believe that the basis for the unprecedented US technology
growth (and the reason for Europe’s lag behind the US in high-tech) was set during the
Reagan's administration in the 1980s2 and supported by President Clinton in the 1990s. Good
economic policies during the Clinton administration and viable investment environment in
the 1990s were crucial for the outstanding economic performance that was based on high-
technology growth3. Between 1993 and 2000 the Clinton administration’s economic policy
supported record-long economic expansion4. The US economy performed strong GDP
growth, low inflation and low unemployment rate5. Strong business investment was linked
with high productivity in high-technology industries.

2.1. The New Economy

Over the past thirty years, there has been the evolution from an
industrial/manufacturing-based wealth producing economy into a service sector asset based
economy. This is actually what we now call the New Economy. It is based on information
technology, greater influences of social, economic, and political systems, knowledge
economy, accelerated growth of productivity, internet, digitalisation, E-commerce, practical
science, private R&D investments, increasing education and training. In these factors also lie
the keys for individual success. The change has not been not only economic but social as
well (for example, in the US there are now four-times less unskilled jobs than in 1950s)6.
Manufacturing had shrunk to 14 percent of total output and even smaller proportion of total
employment7. In 1990s, the age of outsourcing started; firms began to focus on their core
competencies by outsourcing certain activities8, which lead to spillovers in high-technology
across regions. Since 1980s, new technologies came up, clustered around technology and

2 President Reagan supported deregulation of big industries and allowed for better competition.
Even though he did not avoid major economic policy mistakes (Such as vast budget deficit or the Savings &
loan crisis) he understood that it is necessary to end the era of big national monopolies in several industries.
3 The key factors were the optimal mix of fiscal and monetary policy, competitive and stable financial
sector, and lots of opportunities for investment.
4 A complete business cycle can be found in 1990s. Starting with recession in 1990-1991,
continuing through “jobless recovery” in 1992 that was likely to cause George Bush losing in the 1992 election.
The years 1990-1992 set the stage for the boom in the years 1993-2000. Finally, in 2000, the economy returned
to approximately the same pint of business cycle it had been in 1990.
5 Exceptional is US economic stability of 1990s. Clinton-Greenspan mix of tight budgets and
easier money contributed to the outstanding economic performance.
6 Robinson, 2000, p.2
7 Stiglitz, 2003, p.345
8 See C.K. Prahalad and Garry Hamel, ‘The Core Competence of the Corporation’, Harvard
Business Review (May-June 1990): 79-91

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new media, as well as around biotechnology and new materials9. These new technologies
have led to a series of product (computers, CD-ROMs, microchips) and process innovations
(e.g. the use of information within organisations), as well as to the rise of entirely new
companies and industries in high-tech10.

2.2. Factors of US high-technology dominance

However, it seems that the US benefited from globalization more than Europe and
that there is a significant lag in high-technolology industry between US and the EU. So why
did US outperformed Europe in high-technology industry? The answer can be split into short,
medium, and long-term factors:

Short term factors

First the prices of computers fell down significantly in the 1990s due to several
reasons. Until 1999 prices of oil remained low, US import prices were low as well and due to
the appreciation of dollar and deflation some East Asia countries there had been put
downward pressure on inflation. As computers became available to anybody, the high-tech
industry benefits as it can find much more customers for its products than ever before.
Europe due to its inflexibility did not benefit from cheap imports that much.

Medium term factors

Skilful US macroeconomic – both fiscal and monetary – policies in the 1990s and
strong growth in income since the 1980s allowed for to restrained long-term interest rates and
boosted private investments– including investment into the high-technology industry11. The
US in the 1990s strongly benefited from new technologies, globalisation, and viable
microeconomic environment and macroeconomic policies12. The US in general is also much
more integrated economy than Europe. New technologies arose, but what was the most
striking difference was the usage of these technologies in everyday life. Not only big

9 For more, see Rob van Tulder and Gerd Junne, European Multinationals and Core
Technologies (London, and Sons, 1988)
10 Stubbs and Underhill, 2000, pp.321-323
11 As the government bonds were yielding less due to conservative fiscal policy, investors had to
look for other investment opportunities.
12 Economic successes achieved during the Clinton administration were unique. Bill Clinton had
taken economy more seriously than any other issue. The largest budget surplus in history, the lowest
unemployment rate in more than 40 years, the fastest growth in real wages for more than two decades;
economic performance during Bill Clinton’s administration was outstanding.

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businesses but small companies started to use IT in every day business which led to higher
productivity in their sector but in high-tech as well13. There are also other important factors
influencing the US high-tech dominance: Silicon Valley, R&D centres, partnerships with
universities, stronger government investments14. University clusters that take place in the US
vastly contribute to the high-tech development. Europe is not able to replicate these clusters
also due to language and cultural barriers and insufficient funding15.

Long term factors

Deregulation is certainly an issue. The US has long been regulated less than most
other industrialised economies (for example in trucking, banking, airlines, natural gas,
telecommunications). Due to this deregulation and flexibility in various fields of economy
(including the labour market) the US economy is more efficient than the European economy
in the long run. Moreover deregulations allowed companies to enter industries previously run
by monopolies. There were important steps leading to more efficient U.S. economy16. In the
1990s new technologies, globalisation, more integrated economy led to new regulatory
structure17. Moreover there is the fundamental continuity of policy across US
administrations. On the other hand Europe lacks any strong macroeconomic policy. The U.S.
socio-economic system is based on liberalism, well defined property rights, properly working
institutions, stable political and economic environment, and democracy with long lasting
tradition, respected formal and informal rights. Moreover, the US generally pro-free trade.
Therefore, the U.S. is prepared to take advantage of such an opportunity, which the 1990s
brought.

13 See Table 1. The striking difference between the US and EU is the labour productivity in
services due to increased IT using.
14 Even though the US army and NASA are important sources of innovation and high-tech
industry development, it was in the 1990s where the IT revolution took place, in contradiction to reduced
budget expenditures in these two organisations
15 Most of funding in the US comes from private sources.
16 Much of the regulatory structure that governed the U.S. economy was first established in the
1930s. However, the strength of the American economy in the fifties and sixties restored the faith in markets.
The deregulation trend began during the Jimmy Carter administration (1977-1981), including deregulation in
airlines, trucking, and banking sectors. Ronald Reagan deregulated telecommunications.
17 Although President Jimmy Carter started with deregulation in transportation (airlines and trucks),
allowing firms to set prices and standards on their own and freeing up entry, the big part of deregulation were
left upon Clinton administration in the 1990s.

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2.3. Empirics
Contrary to wide spread perceptions, in terms of high-technology productivity Europe
has done very well over the last 50 years. Figure 1 shows private sector productivity for
comparable workforce, 1950-2000. We can clearly see that France and Germany (leading
European economies) have caught up with the US over past 50 years.

FIGURE 1: Private sector productivity for comparable workforce,1950 – 2000. Indexed

to US. Note: West Germany until 1989 and total Germany thereafter. Source: University of
Groningen and The Conference Board; GGDC Total Economy Database, 2002.

The 1990s brought a change in technologies. New technologies arose, but what was
the most striking difference was the usage of these technologies in everyday life. When you
look at the Table 1, you can see that while the US dramatically increased the usage of IT in
services between 1995 and 2000, in the EU we could not see such increase. This is one of the
explanations of the high-technology superiority of the US: The simple fact that technologies
were made accessible for business all around economy.
TABLE 1: Labour productivity growth, IT producing/IT using,
Manufacturing/services: U.S. and EU, 1990s. (Percent per year)

US EU

Share 1990- 1995- 1990-1995 1995-2000

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1995 2000

Overall 1.1 2.5 1.9 1.4

IT producing

Manufacturing 2.6 15.1 23.7 11.1 13.8

Services 4.7 3.1 1.8 4.4 6.5

IT using

Manufacturing 4.3 -0.3 1.2 3.1 2.1

Service 26.0 1.9 5.4 1.1 1.4

Non IT using 9.3 3.0 1.4 3.8 1.5

Manufacturing 9.3 3.0 1.4 3.8 1.4

Services 43.0 -0.4 0.4 0.6 0.2

Source: Blanchard (2004)

Part of the Euro–pessimism in high-tech industry18 is based on evolutions since the

mid1990s, and the feeling that the U.S. is again gaining advantage on Europe. Again, I have
to stress the exceptional period of the US and Europe having their own problems19.
Manufacturing productivity growth outside the IT producing sector has indeed declined.
When we look at the Table 2, the level of productivity is roughly equal to that of the United
States. However, some sectors (trade in particular) have done very well in the US; such an
increase in productivity growth has not been visible in Europe.

18 And the reasons that led to the creation of policies such as the Lisbon agenda
19 Reunification of Germany, strong regulation, far from perfect common market, various trade
obsacles

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TABLE 2: GDP per person, per hour, and hour per person

GDP per person GDP per hour hour per person

1970 2000 1970 2000 1970 2000

US 100 100 100 100 100 100

EU15 69 70 65 91 101 77

France 73 71 73 105 99 67

Source: Blanchard (2004)

Productivity growth is the natural hypothesis to explain the good economic

performance. For the late 1990s it looks bad for Europe. But low numbers hide a more
complex picture and there is no convincing quantitative answer. The average US
productivity growth was lower in the 1990s than in 1950s and 1960s (see Table 3). However
the average was not the crucial, what is extraordinary is the low volatility. That means that
the US productivity growth avoided major cycles. Labour productivity, measured as GDP per
hour worked has increased much faster in Europe than in the United States (see Table 2). As
the EU labour productivity increased, the hours worked decreased in roughly the same
proportion, leading to a roughly constant relative GDP per capita. But the underlying
productivity growth is strong. Blanchard (2004) argues that in the 1990s Europe was
focusing on employment creation, rather than on productivity growth, under the pressure
from governments. That contributed to the lag in the high-tech industry.

TABLE 3: US productivity growth, decade by decade

1950s 1960s 1970s 1980s 1990s

Average productivity growth 2.80 2.84 2.05 1.48 2.07

Standard deviation of productivity 4.29 4.20 4.30 2.91 2.62

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growth

Source: Department of Commerce and Mankiw (2001),

FIGURE 2: Product market regulation and employment protection legislation

(Nicoletti et al, 2000)

From Figure 2, we can see that Europe was much more regulated economy in the end
of 1990s, which largely contributed to the lag in high-technology industry. However, during
the recent years, Europe became more flexible both in terms of product market regulation,
and in terms of labour market legislation. That signals slight optimism when looking into the
future of the high-tech industry20.

20 As labour unions get weaker and smarter (Blanchard, 2004, p.27), European labour market
becomes more flexible, which will affect high-technology industry performance.

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3. What can be done about the lag?

First the question is whether anything should be done about the lag in high-
technology industries. There are several reasons why not to replicate the US socio-economic
system. First, there is no requirement that Europe must compete on high-technology
industries. This states that if there are better condition for high-technology industries in the
US (or anywhere in the world), the government should not try to change this situation.21 The
fiscal policy (public expenditures) might help to support R&D in high-technology
industries22. However, government often fails to recognise which industry deserves support.
There also comes the critique that the government is picking winners and distracts the market
competition. Secondly many scholars argue that the US model is not the answer to the EU23.
Moreover when analysing the data more deeply in the Section 2.3, we see that the situation is
not as bad as it seems.
On the other hand, there are of course still several issues that have to be solved to
make Europe more competitive. There are several channels that might lead to better
performance of (not only) high-technology industries in Europe. These channels are market
based, such as price flexibility, wage flexibility, capital and labour mobility, better business
environment, better allocation of R&D resources, or better cooperation between private
sector, universities and public sector. Prices and wages are inflexible and labour mobility is
also lower in Europe in comparison to the US. Greater flexibility throughout Europe would
certainly lead to better capital allocation, including high-technology industries, helping to
ensure that the potential benefits of European common market could be fully realised.
Moreover sufficient flexibility enables the market to reap opportunities in high-technology
industry24.

21 The statement is very much linked with the concept of comparative advantage. Old trade
theory is based on the assumption of absolute and comparative advantages, first analysed by Adam Smith and
David Ricardo in 18th and 19th centuries. New trade theory is the economic critique of international free trade
from the perspective of increasing returns to scale and the network effect. It also takes into account changing
technology and imperfect competition. Government should simply not try to pick up winners on the market
22 However, I am persuaded that in general the public expenditure is not efficiently allocated.
Market should always be at the core of every economic policy. On the other hand most of primary research
would not take place without the support of public investment because for many private companies the
profitability of primary research is very uncertain and long-term.
23 See for example Palley (1998)
24 In practice, there are many different ways that workers and firms can adjust to economic and
technological change. For the worker, adjustment may require having to accept a lower wage increase, moving
into a different job in the same firm or even changing employer. For firms, adjustment may involve adjusting
prices or changing a product line. Flexibility is about minimising the costs of adjustment (HM Treasury, 2003a).

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There is still a lot to be done in the labour market integration in Europe. The degree
of flexibility of the labour is related to wage flexibility and interregional mobility of labour25.
Geographic labour mobility is low both within and between EU member states which is one
of the biggest differences between US and European economies. Language and loyalty to
nation and the national way of life mean that few people move around Europe in search of a
job in the way that they move within the US. Europe should also finish liberalisation in
products, services, and labour markets to achieve higher competitiveness. Moreover, the
common agricultural policy (CAP) has to be dramatically changed to become more effective
and not so costly and the resources can be shifted to R&D and high-technology26. Without
these issues completed, policies such as the Lisbon agenda have little chance to succeed.
Moreover the bank-centred European capital market has long constrained high-
technology firms from getting sufficient funds for starting up and development27. A flexible
and integrated capital market28 can provide financial instruments that help companies to
succeed on the high-technology markets, to become more innovative. More generally, highly
flexible and efficient financial markets ensure that capital is allocated to where it earns the
highest returns for a given level of risk, raising growth29. Firms also require capital
markets30 to be flexible to ensure access to a wider range of financing options. Venture
capital is not yet developed in Europe. It is often difficult for entrepreneurs to find financing
for their ideas. Larger financial market provides better allocation of resources.31 As with
geographic labour mobility, physical capital. mobility is a relatively more effective
adjustment mechanism in the face of long-term structural problems.

25 One such adjustment mechanism is the ability of individuals to move residence in order to
find employment – geographic labour mobility. Geographic mobility, both across borders and within countries,
is undoubtedly desirable and would support the European economy in general .
26 Alternatively it should be abandoned fully.
27 European bank-centred capital market – in the opposition to US market-centred capital
market. There are, however, differences in the EU. Germany has strong bank-centred capital market, while the
UK has more market-centred capital market.
28 Capital is more mobile where wages adjust and where markets are efficient. If these
conditions are in place, capital can be quickly reallocated across regions, industries or countries in response to
changing economic conditions.
29 HM Treasury, 2000a
30 Capital markets play an important role in efficient allocation of capital, in the provision of
important funds for start-up companies. Financial market integration is important in an integrated economy as
companies should not be constrained with their local country-specific financial market.
31 Integrated financial market is also important in a monetary union because it can function as
insurance mechanism facilitating adjustment to asymmetric shocks. The risk of a negative shock in one country
is shared by all countries as shares of firms of one country are held by people from all countries. Integrated
bond and equity market, integrated mortgage market, integrated banking sector lead to risk sharing within a MU
different channels of risk sharing. It makes possible for residents of a country hit by negative shock to keep their
income at relatively high level compared to output. However the counterpart of this risk sharing is that residents
of the booming country see their income increase at a lower rate than their output.

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4. Conclusion
The aim of this essay was to analyse the reasons for Europe's lag behind the US in
some high-technology industries. We analysed short-term, medium-term, and long-term
factors, out of which deregulation, good macroeconomic policies, and IT usage are of the
biggest importance. We could see that Europe was much more regulated economy in the end
of 1990s, which largely contributed to the lag in high-technology industry. European bank-
centred capital market and several inflexibilities on labour and services markets have long
constrained the opportunities of high-technology companies for development. The conclusion
is that it is not necessary to replicate the US socio-economic system. I am persuaded that
Europe needs less regulation, less government involved in business32. On the other hand as
suggested by Blanchard (2004), Europe is not performing as bad as perceived. I am
persuaded that the reason for the Europe's lag in some high-technology industry is not
because Europe is performing so badly but rather that the US were performing extraordinary
well in the second half of the 1990s. However it becomes clear that Europe should finish
liberalisation in products, services, and labour markets to achieve higher competitiveness.

32 And more government in other areas (such as primary research)

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5. References

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FRANKEL, J.A., ORZSAG, P.R., 2002. American Economic Policies in the

1990s.Massachusetts: Massachusetts Institute of Technology

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HM TREASURY, 2003a. The United States as a Monetary Union. London: HM Treasury.

HM TREASURY, 2003b, UK Membership of the Single Currency; An Assessment of the

Five Economic Tests. London: HM Treasury.

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SIEBERT, H. and M. STOLPE Technology and Economic Performance in the German

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STIGLITZ, J., 2003. The Roaring Nineties: Seeds of Destruction. New York: Allen Lane

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YELLEN, B.J., 2001. The Fabulous Decade. Century Foundation Press

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