Towards Sustainable Industrial Competitiveness policy

Issues paper to EU Ministers of Industry

LOUVAIN-LA-NEUVE, 14-15/7/2010

Sommaire

Towards Sustainable Industrial Competitiveness Policy
Issues paper to EU Ministers of Industry Council Part I Genera framework

1.

Towards Sustainable Industrial Competitiveness policy
Issues paper to EU Ministers of Industry Part II A SMEs, Innovation and Growth

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Towards Sustainable Industrial Competitiveness policy
Issues paper to EU Ministers of Industry Part II B Transformation and Resourceintensive Industries

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Towards Sustainable Industrial Competitiveness Policy
Issues paper to EU Ministers of Industry Council Part I General framework

Client: Ministre de l'Economie, des PME, du Commerce extérieur et des Technologies nouvelles du Gouvernement Wallon

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Table of contents

Preface Sustainable industrial competitiveness policy: context, challenges and future directions. 1.1 Introduction 1.2 Trade performance, external competitiveness, technology and innovation 1.3 Underlying policy challenges for sustainable industrial competitiveness policy 1.4 Towards an outline framework for Sustainable Industrial Competitiveness Policy 1.4.1 Industrial competitiveness and transformation 1.4.2 Elements of Sustainable Industrial Competitiveness Policy 1.5 Key messages Annex: EU industrial policy: background, underlying issues and key concepts 1.1 Introduction 1.2 ‘Old’ versus ‘new’ industrial policy 1.3 The scope of EU industrial policy 1.4 Policy for industry or policy for enterprise? 1.5 Industrial policy and competitiveness 1.6 Industrial policy and structural adjustment 1.7 Industrial policy and sustainable development

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8 8 10 18 21 21 25 28 31 31 31 33 41 43 48 53

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Preface

In the current economic climate, and with a new European Commission just starting, expectations about the EU's ability to advance in the development and implementation of coherent and coordinated economic and competitiveness policies is high. There is a clear need to revisit the key components of an integrated industrial policy for sustainable competitiveness. It is important to further define the Europe 2020 ambitions and translate them into concrete policies that will contribute to recovery and long-term competitiveness of EU industry as a whole. Within this context the EC is preparing a Communication on Sustainable Industrial Policy in the autumn of this year. This issues paper is being prepared on request of the Belgian Presidency. It aims to inform the preliminary conclusions of the Industry Council of the EU, based on evidence which can be confronted with the European Innovation Plan and the Commission’s Communication on Industrial Policy. This Issues paper consists of the presentation of a general framework for Sustainable Industrial Competitiveness Policy (this Part I), followed by two contributions where this framework is applied to specific situations: SMEs, Innovation and Growth (Part IIA) and Transformation and Resource-intensive Industries (Part IIB).

Brussels, 18th June 2010 Paul Baker Jan Maarten de Vet Vincent Duchêne

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Sustainable industrial competitiveness policy: context, challenges and future directions.

1.1
The 2007 analysis that industry is generally healthy and dynamic no longer applies…

Introduction
In 2007, when the European Commission undertook its mid-term evaluation of industrial policy 1 – as set out in the 2005 Communication on an integrated approach to industrial policy 2 – it was able to point to rather benign conditions under which “in general, industry is healthy and dynamic, contributing substantially to growth and jobs in the Community”. Fatefully, the subsequent financial and economic crisis has had a dramatic impact on European industry, with industrial output falling by around one-fifth and employment in manufacturing decreasing by around ten percent. While there are currently signs of improvement in the economic situation, the prospects for a return to sustained growth remain fragile, not least due to the poor state of public finances that has already led to major problems in Greece and still threatens other Member States. One feature of recent events has been the rapid transmission of problems across different areas of the economy, further revealing the extent and depth of interdependence that is inherent in economic globalisation. What began as a home-loans crisis in the US quickly spread to the financial sector in Europe. In turn, as credit markets were squeezed and business and consumer confidence fell, the ‘real’ economy slumped. With economic growth stalled, the repercussions have spread from the private to the public sector. While policy makers appear to have been caught ‘off-guard’ by the speed of transmission of the crisis, they have also found themselves largely impotent when trying to halt its spread. At the same time, it has proved beyond the capacity of individual countries to respond effectively to the crisis, highlighting the need for coordinated supra-national responses, not just at a European level but also at a broader international (global) scale.

The EU is now at a crucial moment of transformation …

While globalisation, together with many of the other underlying long-term challenges facing society (e.g. environment and pressure on resources, technological development, demographic change) are well recognised, the financial and economic crisis has served to drive home the reality of this situation. Certainly, such a view appears to underlie the explicit appeal contained in the Preface to the Commissions EU2020 Strategy 3 that the crisis should provide a “wake up call” for the EU. The Strategy presents the EU as being at a “moment of transformation”, for which policies need to be developed to redress the losses that have resulted from the crisis, to respond to structural challenges, and to cope with the increasing speed of global economic and technological change. Beyond seeking
1 2

COM(2007)374 COM(2005)474 3 COM(2010)2020

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to instil a sense of urgency for the development of policies necessary “to deliver smart, sustainable and inclusive growth”, the Strategy is also carried by an undercurrent of sentiment that achieving the necessary transformation of the European economy will require actions – both by policy makers, the private sector and citizens – that go beyond incremental adjustments and tinkering with conventional practices. In outlining the scope of the Flagship Initiative for ‘An industrial policy for the globalisation era’ (see Box 0.1), the EU2020 Strategy sets out the Commission’s ambition – in collaboration with stakeholders – to develop “a framework for a modern industrial policy”. The Commission will thereto issue a new Communication on industrial policy in the autumn of 2010. Aim of these papers: a broader reflection on the longer term needs to combine sustainable development with industrial competitiveness policy Given the forthcoming Communication, it is an opportune moment to evaluate whether the current EU-level approach to industrial policy and the approaches pursued at national and sub-national levels by Member States are both adequately aligned and sufficient to meet current and future challenges. At the same time, while policy priorities over the recent past have largely been determined by the need to respond to the impact of the economic and financial crisis, it is perhaps also a moment to take a ‘step back’ from immediate concerns in order to identify some of the key issues that will need to be addressed by a ‘modern’ industrial policy. In this respect, there are some fundamental questions to be asked about the long-term objectives of industrial policy, the changes within industry and the supporting business environment seen as necessary to deliver economic growth and secure jobs, and the contributions that can be made by public policy to facilitate the successful transformation of industry to meet the challenges of the future. While it is possible to identify a host of challenges facing EU industry and European society as a whole, it is evident that central among these are the challenges resulting from the pressures created by economic development – from local to global levels – on the environment, on energy consumption and on resource utilisation. The articulation between sustainable development and industrial competitiveness is inevitable going to be among the central themes – and most likely the main overarching theme – for future industrial policy. It is for this reason that we have chosen the label of ‘Sustainable Industrial Competitiveness Policy’ to encapsulate a new (or ‘modern’) approach to industrial policy. We consider that the primary role of sustainable industrial competitiveness policy is to facilitate the adaptation and transformation of industry while contributing to achieving (and maintaining) the competitiveness of industry in accordance with sustainable development objectives 4. The two papers that accompany this first introductory paper take forward the idea of sustainable industrial competitiveness policy in the context of the specific themes of ‘SMEs, innovation and growth’ (Part IIA) and ‘Transformation and resource-intensive

Now is a good moment to take a 'step back' from immediate concerns…

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Narrowly defines, these objectives imply that competitiveness should be achieved while using resources (including energy) in an efficient and sustainable way while minimising negative environmental impacts. More broadly, competitiveness should be achieved while respecting broader social welfare objectives, such as social equity and cohesion. For further discussion, see Section 1.7

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industries’ (Part IIB). These two themes are closely linked to two of the Flagship Initiatives proposed under the EU2020 Strategy, namely “Resource efficient Europe” (see Box 0.2) and “Innovative Union” (see Box 0.3). As background to the current EU industrial policy environment and, hopefully, to provide some clarity regarding key concepts related to industrial competitiveness and sustainability, the Annex to this paper provides a description of the current status of EU industrial policy as developed over the last decade or so. Further it tries to outline some of the main issues relating to the scope and content of current industrial policy measures. In this present paper, we will attempt to set in a broader and more general context some of the key issues that we consider should – or at least could – be addressed by an EU Sustainable Industrial Competitiveness Policy. In this regard, the following sub-section looks at some of the implications of technology-driven developments for the external competitiveness of EU industry. While far from comprehensive, the purpose is to illustrate some of the factors leading to changes in global competition and competitiveness and that will shape the future policy-setting environment.

1.2

Trade performance, external competitiveness, technology and innovation
If external trade performance provides a ‘litmus text’ for industrial competitiveness and the effectiveness of industrial policy then, although EU industry has been severely hit by the financial and economic crisis, there are some positive signs that the EU has performed relatively well compared to its main (advanced economy) competitors; for example, the EU’s recent trade performance appears somewhat better than that of the US and Japan 5. While it is too early to draw clear conclusion, this suggests that the overall external competitiveness of EU industry is stronger than some may have presumed. In trying to understand the factors driving the external competitiveness of EU industry, it is perhaps instructive that even though EU industry has been chastised in the past for not occupying a sufficiently strong position in so-called ‘high-tech sectors’, it is precisely sectors such as semi-conductors and electronic components, computers, radio and television equipment, that have proved amongst the most vulnerable to the crisis and, more structurally, to the challenge of emerging economies. The ability of emerging economies to position themselves as major competitors in so-called ‘high-tech’ sectors has demonstrated that the intrinsic technological level of a sector is not a shield against competition. We have seen, for example, that when emerging country competitors have been able to finance the major capital outlays required to invest in ‘high-tech’ production facilities (e.g. semi-conductors) or where technologies have been applied through standardised and repetitive high volume production processes (e.g. consumer electronics), they have become major – and in many cases dominant – competitors. Explanations of the increasing presence of emerging economies in ‘high-tech’ sectors can be linked to the accelerating speed of technological development and technology diffusion. As new technologies are superseded by even ‘newer’ ones and competitors are
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Despite the economic and financial crisis, the external competitiveness of EU industry may be stronger than presumed

The intrinsic technological level of a sector is not a shield from competition from emerging economies

European Commission (2010) “EU Manufacturing Industry: What are the challenges and Opportunities for the Coming Years”

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Rapid technological development as a 'double edged sword'…

able to access, replicate and apply new technologies, the specific competitive advantage that they confer disappears. When this occurs, technologies essentially become ‘commoditised’ and more similar to other factors of production whose impact on competitiveness is largely determined by their cost and the efficiency of their integration in production processes. In turn, this raises the pressure to shift production of ‘commoditised’ technologies to low cost production locations. Here we can see the importance of the rapid advances that have been made in information and communication technologies (ICT) that have considerably increased technological mobility 6. Thus, while developments in ICT have expanded the possibilities for creating competitive advantage through new technological developments and innovation, it represents something of a ‘double edged sword’ that can simultaneously hasten the demise of specific technologybased – or, more broadly knowledge-based – competitive advantages. Following from the above, we have seen that developments in ICT, which have resulted in rapidly falling communication and coordination costs for businesses, have profoundly altered the global organisation of production for industrial and service activities alike. Not least, they have facilitated the fragmentation of production processes, both in terms of vertical segmentation within value chains and their geographical distribution. The impacts on competition have often proved complex, unpredictable, and resulted in sudden changes of in the relative competitiveness of countries and regions 7. Today, it is possible to identify a whole range of further enabling technologies – biotechnology, nanotechnology, new materials, etc. – that may similarly bring about further major changes in the organisation of production, in competition, and in the determinants of international competitiveness 8. From a positive perspective, these technologies have the potential to generate new products, new activities and create the basis for new industries to evolve, as well as transforming existing ones. A more negative view can point to their potential to render existing competitive advantages obsolete and, eventually, to further expose industry to increased cost-driven competition as the technologies become more widely available. Overall, the experience of the transformations brought about as a result of ICT provide a strong argument for giving more attention to identifying the wider potential impacts of new emerging technologies for international competition and competitiveness.

The external competitiveness of EU industry is linked to capabilities rather than to sectors…

Looking behind the overall relatively strong recent trade performance of EU industry, perhaps one lesson to be learnt is that technologically orientated explanations have arguably less to do with the technology categorisation of sectors per se (i.e. low-, medium- or high-tech) and more to do with capabilities of EU enterprises to successfully integrate and to apply technologies in innovate ways (i.e. product differentiation), or to adapt technologies to specific market requirements (i.e. product specialisation) irrespective of the aggregate level of technological sophistication of a sector. The fact that
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In particular, ICT has expanded the possibilities to codify – or formalise – knowledge underpinning an increasing range and complexity of technologies, making such knowledge more mobile and facilitating its transfer to different production locations (e.g. emerging economies). At the same time it has significantly reduce the coordination costs inherent in operating and integrating geographically spread production activities. 7 See Section 1.6. 8 In fact, such developments have led some commentators to contend that the world economy is evolving towards a new techno-economic paradigm. See, for example, Freeman, Chr. and Louçã, Fr., As Time Goes By. From the Industrial Revolutions to the Information Revolution, Oxford: Oxford University Press, 2001; Tunzelmann G.N. (von), Technology and Industrial Progress. The Foundations of Economic Growth, Cheltenham, Lyme: Edward Elgar 1995, Perez, C., Technological Revolutions and Financial Capital. The Dynamics of Bubbles and Golden Ages, Cheltenham, Northampton: Edward Elgar, 2002.

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the EU has proved able to remain competitive in specific segments within many ‘medium-tech’ and sometimes even in ‘low-tech’ sectors demonstrates that competitiveness is not just about generating new technologies but it is also about successfully implementing new technologies in specific and innovative ways, even in sectors with lower average technology levels.
There is more than simply encouraging 'bright innovators' and 'young innovatie hightech SMEs'…

It follows from the preceding paragraph that technology driven – or supported – transformation processes not only involve high-tech manufacturing sectors but also involve innovative applications of technology in lower-tech sectors, both in manufacturing and services. It is also aligned with the idea of smart-specialisation. Smart specialisation also emphasises the importance of (local) entrepreneurial actors able to identify opportunities and to develop (innovative) complementarities and synergies with available existing capacities and competences 9. This, in turn, is not simply about encouraging ‘bright innovators’ and ‘young innovative high-tech SMEs’, even though these may be important. Rather, it reflects the much broader context and diversity of enterprises that make-up the overall industrial base and that are subject – directly or indirectly – to the pressures of international competition. Technology-related and entrepreneurial capabilities are, however, far from alone in explaining the external competitiveness of EU industry. Other factors such as quality, branding, customisation and provision of product-related services, can also be identified as crucial for enabling EU industries to position themselves in ‘up-market’ and ‘high value-added’ product segments 10. This points to the importance for competitiveness of a wider range of ‘softer’ competences or ‘know-how’ – such as cultural or market awareness, communication and marketing skills, customer service quality and so forth – that go beyond technical knowledge and expertise in a classic sense.

… Intangible factors increasingly underpin the ability of firms to differentiate themselves from their competitors

The above assessment should not be taken to imply that tangible production factors (e.g. labour, physical capital, raw materials and intermediate inputs) are unimportant, as it is evident that their cost, quality and the efficiency of their use are crucial determinants of productivity and relative cost competitiveness for many industries. Rather, while tangible factors provide the bedrock for (external) competitiveness, increasingly the factors that underpin the ability of firms to differentiate themselves from their competitors are intangible. At the same time, the variety of sources and mechanisms by which intangiblebased competitive advantages may be derived points to the importance for firms to be able to access a wide range and often complex set of production inputs, skills and knowhow. While it is possible that the relevant knowledge and ‘know-how’ may be created internally within firms, often – particularly for SMEs – it will necessitate drawing upon specialised competences from outside the firm.

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See, for example: Dominique Foray, Paul A. David and Bronwyn Hall (2009) “Smart Specialisation – The Concept”, Knowledge Economists Policy Brief n° 9, June 2009 10 See: Louise Curran & Soledad Zignago (2009) “Evolution of EU and its Member States’ Competitiveness in International Trade”, CEPII WP 2009-11, June. Comparing the unit values of trade to assess the relative product positioning of EU and its competitors and based on 2004 data for non-energy trade, they estimate that the EU accounted for 31% of world trade in ‘up-market’ product segments, compared to only 15% for the US and 13% for Japan. Moreover, while some 46% of EU exports are categorised as ‘up-market’, the corresponding proportions for the US and Japan are only 35% and 38%.

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A broad-based, diversified and interlinked business tissue is important for industrial competitiveness

This points to the importance for industrial competitiveness of a broadly-based business tissue able to provide both the necessary technological inputs and a full range of supporting competences. This can be related to intra and inter-industry linkages (e.g. the breadth and depth of the technological and industrial base) and – as many of the required competences are more closely related to service activities as opposed to industrial production processes – the strength of inter-linkages between industry and (businessrelated) services 11. As pointed to recently by the European Commission:
“The traditional view that treats industrial sectors as homogeneous, independent and national thus no longer seems to be an adequate basis for policy development. Excellence at all levels has become much more important and increasingly suppliers and innovation partners from different sectors, regions and with complementary competences are needed”
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This statement points to the importance of maintaining a diversified industrial base. At the same time, this need not necessarily be seen in terms of the diversity of (traditional) industry sectors but, rather, on the diversity – and specialisation – of industrial and supporting competences.
As emerging economies increase their own technological capabilities it is less evident to identify those activities and market segments where they will become major competitors

Looking forward, the challenges to the external competitiveness of EU industry can be expected to increase, both in terms of the general magnitude of pressures on industry and in terms of increasingly affecting those industrial sectors and activities where the EU industry currently maintains a competitive advantage. It was always fairly predictable that globalisation would reinforce the competitive advantages of emerging economies derived from low production costs – particularly for labour – and that they would occupy a strong position in low-technology market segments. However, as has been seen, the sector strengths and positions of emerging economies in other market segments has sometimes been far from predictability and is likely to become even less obvious as these economies seek to move to higher value-added market segments. As emerging economies, such as China, India or Brazil, increase their own technological capabilities, it may become far from evident to identify those industrial activities and market segments where they will become important competitors in the future. At the same time, the rise of emerging economies will pose similar challenges for industry in other ‘advanced’ economies as those that face EU industry. Moreover, with low growth prospects for ‘advanced’ economies they will also be looking to take advantage of faster growth and increasing market size in emerging regions. Once again this is likely to increase the pressure of competition in international markets, in particular in those ‘up-market’ and ‘high value-added’ product segments where EU industry is present. On the one hand, this will increase the need for EU industry to maintain cost competitiveness and productivity at levels that enable it to remain competitive vis-à-vis these competitors. On the other, it can be expected to emphasise the importance of technological development and innovation as a source of competitive advantage. The prospect that the EU’s rivals may steal the lead in areas of technology where EU industry is currently well-positioned cannot be discounted, particularly as they also search to take advantage of opportunities in prospective growth markets. This may further increase the

Competition from other ‘advanced’ economies can be expected to emphasise technological development and innovation as a source of competitive advantage

11 12

See Section 1.4. Ibid. footnote 5.

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possibility of shifts in relative competitiveness in ways that are difficult to foresee, and which may prove more sudden and sometimes brutal than was hitherto the case. The general scenario alluded to above is reflected in the EU2020 Strategy. While reiterating the importance of international trade to EU prosperity, the EU2020 Strategy points to the need to raise productivity while emphasising the potential threat to the EUs leadership in one specific technological field – namely ‘green solutions’ – that may come from competitors from both ‘advanced’ and ‘emerging’ economies:
“The EU has prospered through trade, exporting round the world and importing inputs as well as finished goods. Faced with intense pressure on export markets and for a growing range of inputs we must improve our competitiveness vis-à-vis our main trading partners through higher productivity. We will need to address relative competitiveness inside the Euro area and in the wider EU. The EU was largely a first mover in green solutions, but its advantage is being challenged by key competitors, notably China and North America. The EU should maintain its lead in the market for green technologies as a means of ensuring resource efficiency throughout the economy, while removing bottlenecks in key network infrastructures, thereby boosting our industrial competitiveness.”

Box 0.1

EU 2020 Flagship initiative “An industrial policy for the globalisation era” Industry and especially SMEs have been hit hard by the economic crisis and all sectors are facing the challenges of globalisation and adjusting their production processes and products to a low-carbon economy. The impact of these challenges will differ from sector to sector, some sectors might have to "reinvent" themselves but for others these challenges will present new business opportunities. The Commission will work closely with stakeholders in different sectors (business, trade unions, academics, NGOs, consumer organisations) and will draw up a framework for a modern industrial policy, to support entrepreneurship, to guide and help industry to become fit to meet these challenges, to promote the competitiveness of Europe’s primary, manufacturing and service industries and help them seize the opportunities of globalisation and of the green economy. The framework will address all elements of the increasingly international value chain from access to raw materials to after-sales service. At EU level, the Commission will work: – To establish an industrial policy creating the best environment to maintain and develop a strong, competitive and diversified industrial base in Europe as well as supporting the transition of manufacturing sectors to greater energy and resource efficiency; – – – To develop a horizontal approach to industrial policy combining different policy instruments (e.g. "smart" regulation, modernised public procurement, competition rules and standard setting); To improve the business environment, especially for SMEs, including through reducing the transaction costs of doing business in Europe, the promotion of clusters and improving affordable access to finance; To promote the restructuring of sectors in difficulty towards future oriented activities, including through quick redeployment of skills to emerging high growth sectors and markets and support from the EU's state aids regime and/or the Globalisation Adjustment Fund; – – – – – – To promote technologies and production methods that reduce natural resource use, and increase investment in the EU's existing natural assets; To promote the internationalisation of SMEs; To ensure that transport and logistics networks enable industry throughout the Union to have effective access to the Single Market and the international market beyond; To develop an effective space policy to provide the tools to address some of the key global challenges and in particular to deliver Galileo and GMES; To enhance the competitiveness of the European tourism sector; To review regulations to support the transition of service and manufacturing sectors to greater

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resource efficiency, including more effective recycling; to improve the way in which European standard setting works to leverage European and international standards for the long-term competitiveness of European industry. This will include promoting the commercialisation and take-up of key enabling technologies; – To renew the EU strategy to promote Corporate Social Responsibility as a key element in ensuring long term employee and consumer trust. At national level, Member States will need: – – – – To improve the business environment especially for innovative SMEs, including through public sector procurement to support innovation incentives; To improve the conditions for enforcing intellectual property; To reduce administrative burden on companies, and improve the quality of business legislation; To work closely with stakeholders in different sectors (business, trade unions, academics, NGOs, consumer organisations) to identify bottlenecks and develop a shared analysis on how to maintain a strong industrial and knowledge base and put the EU in a position to lead global sustainable development. Source: COM(2010)2020

Box 0.2

EU 2020 Flagship Initiative “Resource efficient Europe” The aim is to support the shift towards a resource efficient and low-carbon economy that is efficient in the way it uses all resources. The aim is to decouple our economic growth from resource and energy use, reduce CO2 emissions, enhance competitiveness and promote greater energy security. At EU level, the Commission will work: – To mobilise EU financial instruments (e.g. rural development, structural funds, R&D framework programme, TENs, EIB) as part of a consistent funding strategy, that pulls together EU and national public and private funding; – – To enhance a framework for the use of market-based instruments (e.g. emissions trading, revision of energy taxation, state-aid framework, encouraging wider use of green public procurement); To present proposals to modernise and decarbonise the transport sector thereby contributing to increased competitiveness. This can be done through a mix of measures e.g. infrastructure measures such as early deployment of grid infrastructures of electrical mobility, intelligent traffic management, better logistics, pursuing the reduction of CO2 emissions for road vehicles , for the aviation and maritime sectors including the launch of a major European "green" car initiative which will help to promote new technologies including electric and hybrid cars through a mix of research, setting of common standards and developing the necessary infrastructure support; – To accelerate the implementation of strategic projects with high European added value to address critical bottlenecks, in particular cross border sections and inter modal nodes (cities, ports, logistic platforms); – – To complete the internal energy market and implement the strategic energy technologies (SET) plan, promoting renewable sources of energy in the single market would also be a priority; To present an initiative to upgrade Europe's networks, including Trans European Energy Networks, towards a European supergrid, "smart grids" and interconnections in particular of renewable energy sources to the grid (with support of structural funds and the EIB). This includes to promote infrastructure projects of major strategic importance to the EU in the Baltic, Balkan, Mediterranean and Eurasian regions; – To adopt and implement a revised Energy Efficiency Action Plan and promote a substantial programme in resource efficiency (supporting SMEs as well as households) by making use of structural and other funds to leverage new financing through existing highly successful models of innovative investment schemes; this should promote changes in consumption and production patterns; – To establish a vision of structural and technological changes required to move to a low carbon,

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resource efficient and climate resilient economy by 2050 which will allow the EU to achieve its emissions reduction and biodiversity targets; this includes disaster prevention and response, harnessing the contribution of cohesion, agricultural, rural development, and maritime policies to address climate change, in particular through adaptation measures based on more efficient use of resources, which will also contribute to improving global food security. At national level, Member States will need: – – – – – – To phase out environmentally harmful subsidies, limiting exceptions to people with social needs; To deploy market-based instruments such as fiscal incentives and procurement to adapt production and consumption methods; To develop smart, upgraded and fully interconnected transport and energy infrastructures and make full use of ICT; To ensure a coordinated implementation of infrastructure projects, within the EU Core network, that critically contribute to the effectiveness of the overall EU transport system; To focus on the urban dimension of transport where much of the congestion and emissions are generated; To use regulation, building performance standards and market-based instruments such as taxation, subsidies and procurement to reduce energy and resource use and use structural funds to invest in energy efficiency in public buildings and in more efficient recycling; Source: COM(2010)2020

Box 0.3

EU 2020 Flagship Initiative “Innovative Union” The aim of this is to re-focus R&D and innovation policy on the challenges facing our society, such as climate change, energy and resource efficiency, health and demographic change. Every link should be strengthened in the innovation chain, from 'blue sky' research to commercialisation. At EU level, the Commission will work: – To complete the European Research Area, to develop a strategic research agenda focused on challenges such as energy security, transport, climate change and resource efficiency, health and ageing, environmentally-friendly production methods and land management, and to enhance joint programming with Member States and regions; – To improve framework conditions for business to innovate (i.e. create the single EU Patent and a specialised Patent Court, modernise the framework of copyright and trademarks, improve access of SMEs to Intellectual Property Protection, speed up setting of interoperable standards; improve access to capital and make full use of demand side policies, e.g. through public procurement and smart regulation); – To launch 'European Innovation Partnerships' between the EU and national levels to speed up the development and deployment of the technologies needed to meet the challenges identified. The first will include: 'building the bio-economy by 2020', 'the key enabling technologies to shape Europe's industrial future' and 'technologies to allow older people to live independently and be active in society'; – To strengthen and further develop the role of EU instruments to support innovation (e.g. structural funds, rural development funds, R&D framework programme, CIP, SET plan), including through closer work with the EIB and streamline administrative procedures to facilitate access to funding, particularly for SMEs and to bring in innovative incentive mechanisms linked to the carbon market, namely for fastmovers; – To promote knowledge partnerships and strengthen links between education, business, research and innovation, including through the EIT, and to promote entrepreneurship by supporting Young Innovative Companies. At national level, Member States will need: – To reform national (and regional) R&D and innovation systems to foster excellence and smart specialisation, reinforce cooperation between universities, research and business, implement joint programming and enhance cross-border co-operation in areas with EU value added and adjust national

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funding procedures accordingly, to ensure the diffusion of technology across the EU territory; – – To ensure a sufficient supply of science, maths and engineering graduates and to focus school curricula on creativity, innovation, and entrepreneurship; To prioritise knowledge expenditure, including by using tax incentives and other financial instruments to promote greater private R&D investments. Source: COM(2010)2020

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1.3

Underlying policy challenges for Sustainable Industrial Competitiveness Policy
The previous subsection provided an overview of a few of the challenges for industry arising from technology and globalisation, and the implications that these may have for patterns of international competition and competitiveness. Placing these illustrations in a broader context, a number of underlying themes that should be addressed by a ‘modern’ industrial policy may be identified. Increasing complexity and internationalisation of industry linkages The fragmentation of production processes and value chains, the increasing importance of intangible factors as drivers of competitiveness, and the need to access more comprehensive and complex sets of production inputs are all factors contributing to the increasing complexity of industrial inter-linkages – including not only manufacturingtype activities but also service functions. This has a wide range of implications in terms of issues to be addressed in formulating and implementing a sustainable industrial competitiveness policy:

Increasing complexity calls for a finer resolution of industrial analysis…

The need for a finer level of resolution than traditional classifications of industrial and service sectors, which permits to look inside traditional notions of industrial sectors and to understand the drivers of competitiveness and their implications for different industrial activities. At the same time, this should also support the development of a more holistic picture that takes account of the wide ranging interlinkages that influence industry performance and competitiveness. Essentially, the increasing complexity of industrial value chains calls into question the continued use of traditional classifications of industrial (and service) sectors as an appropriate basis for analysis of developments in industrial activities, production processes and value chains. Following from the previous point, the increasing range and complexity of competences underlying the creation of competitive advantages within industry suggests the need to strengthen industrial inter-linkage that reach beyond traditional industrial sector categories and geographical boundaries. This should cover not only ‘classical’ production factors (e.g. labour, physical capital, raw materials and intermediate goods) and knowledge-based inputs (e.g. research and technology development) but also the full range of supporting production activities and services that can provide additional competences or ‘know-how’ from which competitive advantages may be derived. The feasibility of designing and implementing ‘sector-based’ policy approaches, at least where these are based on traditional notions of industrial sectors, may be brought into question by the increasingly complex inter-linkages of industrial production and service activities. The complexity of inter-linkages between industrial sectors increases the risk that policies directed towards one sector may have unforeseen or perverse effects in other sectors, where such linkages are not fully understood. Overall, increased complexity suggests that the outcomes of sectorspecific policy measures become less predictable.

The diversity of competences determining competitive advantages calls for strengthening industrial linkages beyond traditional sector boundaries

Increased inter-linkages of industrial activities may reduce possibilities to implement ‘sectorbased’ policies and their effectiveness

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Effective policy measures may require more targeted policies than is offered by sector-based approaches

Following from the last point made above, it is perhaps time to draw a line through the normally used distinction between horizontal and sector-based (or sectoral) policy approaches 13. In particular, there is a strong basis for arguing that observing traditional sector categories no longer provide an appropriate basis for designing policy when valuechains are increasingly fragmented both within and across sectors, and across geographical locations. On the contrary, effective policies may well need to be directed towards specific activities or ‘links’ within value chains, or towards strengthening linkages and creating synergies between the elements making-up value chains (e.g. ‘cluster-based’ approaches) or towards specific types of actors (e.g. based on the size and maturity of firms). In other words, policies may need more specific targeting is implied by current sector-based approaches. As a counterpart to targeted policy approaches, it may equally be a moment to consider reformulating the concept of ‘horizontal’ industrial policy. In particular, there exists a high degree of ambiguity surrounding the scope of industrial policy measure and the distinction between ‘horizontal’ and ‘framework’ aspects policy. Overall, the boundaries between ‘framework’ and ‘horizontal’ policy measures can often seem rather fluid, which simply creates confusion over ‘what is’ and ‘what is not’ industrial policy. In this respect, it may increase policy transparency if, on the one hand, policy measures are recognised by their generic terms (e.g. competition policy, trade policy, research and innovations policy, etc.), while it is accepted that a sustainable industrial competitiveness policy necessitates a ‘holistic’ approach that recognises the need to evaluate and integrate measures across the broad spectrum of policies that impact on industry. Increasing uncertainty and unpredictability of changes in relative competitiveness The issue of increasing uncertainty and unpredictability is a recurring theme when it comes to examining developments in relative (international) competitiveness. Overall, greater unpredictability combined with a faster speed of change means a more difficult and complicated environment for businesses – and policy-makers – to formulate strategies for developing and maintaining competitiveness. Again, this has wide ranging implication in terms of issues to be addressed in formulating and implementing a sustainable industrial competitiveness policy:

A Sustainable Industrial Competitiveness Policy should recognise the need to evaluate and integrate measures across the broad spectrum of ‘generic’ policies that impact on industry

Increased uncertainty and unpredictability places a premium on efforts to anticipate changes in international competition and competitiveness

An increasing premium is placed on anticipating future developments in order to be able for industries to be able to adapt accordingly. In this respect, it seems that (industrial) policy should increase the emphasis placed on anticipation of potential future developments – be they derived from technological or other factors – and the nature of their possible impacts on international competitiveness. For example, perhaps one lesson to be retained is that it is unwise to pursue ‘technology for the sake of technology’ policies without giving sufficient consideration not only to the competitive advantages that technologies may bestow – including institutional factors such as intellectual property rights enabling these advantages to be retained – but also to existing competitive advantages that they may destroy. In this respect, policies to position the EU as a technologically-sophisticated and knowledge-based economy arguably need to look beyond the immediate short-run gains from technology and

13

See Section 1.3 for more discussion of ‘horizontal’ and ‘sectoral’ industrial policy.

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innovation and integrate assessments of the implications for future trajectories of industrial competitiveness.
Policy frameworks need to support industry to react rapidly and implement transformation strategies … … but this may require horizontal rather than sector specific policies

The speed with which industries are able to respond to sudden changes in competition and drivers of competitiveness is likely to become increasingly important. This implies that policy frameworks need to support the flexibility of industry to react rapid to sudden changes and to facilitate their implementation of transformation strategies. At the same time, admission of the unpredictable nature of factors that may influence industrial competitiveness and uncertainty about the activities that may be affected, imply that it will be difficult for policy frameworks to target specific vulnerable sectors or activities in advance. This suggests the need for increased attention to general policies to support industrial transformation, rather than selective measures targeted towards specific industry sectors. In an environment characterised by rapid, sudden and unpredictable changes in business conditions and competition, enterprises still need to develop a long-term view as the basis for business planning and investment decisions. In this respect, stability – or at least predictability – and transparency of regulatory conditions are important. Frequent changes in regulatory conditions exacerbate problems of uncertainty and unpredictability, which can delay decisions that may have important implications for competitiveness and slow down processes of industrial transformation.

Stability and transparency of regulatory conditions supports long-term business planning, thus promoting competitiveness and industrial transformation

Industrial policy governance in a globalised world As was noted in the introduction to this chapter, the economic and financial crisis highlighted the need for multi-level governance approaches to economic (and industrial) policy. More generally, we can observe increasing policy ‘spill-over’ effects – both positive and negative – across regions and countries, across sectors and business activities, and across policy areas. While the EU has important responsibilities in some key areas of policy that affect industry (e.g. trade, competition, internal market), many of the policy areas that can impact most directly on the broad business environment for industry are determined at the level of Member States or even at sub-national (i.e. regional or local) levels. At the same time, many of the challenges faced by industry – and, in turn, by policy-makers – are defined at an even higher international level. For example, addressing environmental and energy issues, and access to raw materials and international markets necessitate fostering agreements and policy actions at a supra-EU (or global) level. This raises a central issue for the development of an EU-wide Sustainable Industrial Competitiveness Policy of how to effectively and efficiently ensure coherence, coordination and integration of policy approaches across different policy domains and governance levels:
A need for multidimensional policy governance frameworks

The increasing geographical complexity of industry value chains, the integration of markets, and the global nature of many of the most pressing policy challenges for industry argue for establishing multi-dimensional policy governance frameworks (i.e. multi-level and multi-policy).

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1.4

Towards an outline framework for Sustainable Industrial Competitiveness Policy
The preceding sections have attempted to raise some of the broader issues that arguably need to be addressed by an EU Sustainable Industrial Competitiveness Policy. Drawing on these, and on some of the general features of current EU industrial policy and some of the associated key concepts (see Annex) this section aims to provide a general framework for describing and analysing Sustainable Industrial Competitiveness Policy.

1.4.1

Industrial competitiveness and transformation Determinants of industrial competitiveness As a starting point, the competitiveness of firms, sectors and industry as whole depends both upon ‘internal’ conditions within industry itself and on the broad ‘external’ framework conditions for industry. Thus, we can distinguish two dimensions of industrial competitiveness:

Internal dynamics within industrial sectors remain important….

Within industry determinants that relate to the situation and internal dynamics within industrial sectors. A number of key elements can be identified: Firm strategies and business models, covering the different strategies followed by companies (e.g. cost-based, innovation-driven, branding & marketing); Input factor utilisation, covering the utilisation of production factors within the sector (e.g. labour, capital, intermediate goods and services, and knowledge and technology); Production process and product development, covering the management and organisation of production processes within the sector including, for example, technology utilisation, but also encompassing product and service development and innovation; Industry structure and organisation, covering the overall structure of the sector in terms of, for example, enterprise composition (size), specialisation and segmentation, economies of scale and scope, company formation and closure, etc.; Supply and value chain relationships, covering the upstream (backward) and downstream (forward) linkages between industry (and other) sectors and markets.

-

-

… but so are the conditions that shape the general context in which firms operate

Framework condition determinants that are concerned with the regulatory environment and other framework conditions that are ‘within the reach of policy’ and that shape the general context in which firms operate. Essentially this covers aspects of the business and operational environment that are external to individual (and collective) business operations of firms within the sector: Regulatory and institutional conditions: this covers the regulatory and institutional conditions that apply to the sector itself, or that influence inputs and resources into production (i.e. industry conditions), or markets and demand for the sectors outputs (i.e. market conditions). In terms of policy measures, these include aspects such as labour market regulations, competition policy, protection of intellectual property rights, industry standards, energy and environment legislation, etc.

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-

Other framework conditions: this covers a broader range of conditions shaping the business environment but that may be influenced directly or indirectly by (mainly non-regulatory) policy measures. Again we can distinguish between ‘supply-side’ conditions – particularly in relation to factor inputs such as labour force and skills, physical infrastructure, knowledge development and diffusion, access to finance, etc. – and ‘demand-side’ conditions in markets for the sectors products and services (e.g. changing consumer preferences, consumer policies, etc.)

The capability of industry to respond to external challenges will be decisive..

Industrial transformation pressures and processes14 Beyond the ‘internal’ conditions and broad ‘external’ framework conditions outlined above, European industry – and European society in general – is confronted by a wide range of fundamental challenges that influence competition and competitive conditions. These challenges – which are often interrelated – include overarching ‘issues’ such as globalisation and international competition, climate change and environment, demographic change and migration, technological change, geopolitical tensions and security, and – as recent events have demonstrated – vulnerability to economic shocks and crises. Clearly the capability of industry to effectively respond to these challenges is closely linked to its competitiveness and the various determinants of competitiveness outlined above. At the same time, responding to these challenges can lead to adaptations in the ways by which industry contribute to economic, social and environmental outcomes and objectives and, in turn, to the overall composition of economic activities. Accordingly, in parallel to creating the right conditions for industrial competitiveness, industrial policy also plays a role in facilitating the adaptation of industry to changing economic, social and environmental conditions. On the one hand, this may encompass relatively ‘neutral’ policy measures aimed at creating benign framework conditions for enterprise development and competitiveness. On the other, it may also encompass more ‘positive’ policy measures aimed at influencing and promoting the transformation development of industry in specific directions (e.g. in accordance with sustainable development objectives).

Transformation can be observed at various levels…

At this point, it is perhaps worth recalling that processes of industrial transformation can be observed at a variety of different levels 15. To start, they may involve broad changes ‘macro sector level’ changes, notably the processes of ‘tertiarisation’ (i.e. rising share of services in economic activity) and so-called ‘quarternarisation’ associated with the rise of information and knowledge-based services. Below this, transformation can occur at a ‘sector level’ (e.g. changes in the distribution of economic activity across industrial

14

We use the description of industrial transformation rather than structural adjustment. This choice has been made because the role of industrial policy in supporting (structural) adjustment is typically associated with measures directed towards mitigating the adverse social consequence associated with industrial decline. This tends to neglect the fact that industry needs to continually adapt – and not necessarily in negative ways – in response to changing economic, market, technological, social and other conditions. For example, the whole notion of moving towards more sustainable and ‘greener’ production processes and production outputs implies significant adaptation by industry, the outcome of which it is hoped will be far from negative. Accordingly, for the purposes of this paper, industrial transformation refers not so much to mitigating measures to alleviate the negative impacts of industrial decline but, rather, relates to measures to facilitate the adaptation of industry while contributing to achieving (and maintaining) the competitiveness of industry in accordance with sustainable development objectives. 15 See Section 1.6 for a more detailed description.

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sectors) or ‘within sectors’ (e.g. changes in market shares of firms, labour or product segmentation within a single industry). Finally, transformation may occur ‘within firms’, which is a phenomenon closely associated to the fragmentation of production processes (also referred to as vertical specialisation and slicing up the value chain). The main feature of transformation within firms is changes in the composition of the portfolio of activities that they undertake (e.g. focussing on those activities that enable them to develop competitive advantages whilst, at the same time reducing other activities or having them contracted-out to specialist providers).
Industrial policy can influence the channels through which external transformation pressures are translated into pressure on specific industry sectors…

It is also worthwhile to recall that pressures for industrial transformation can operate through a wide range of channels. Although (EU) public policy may have some (marginal) influence on fundamental processes such as globalisation, climate change or technological transformation, by and large such processes are outside the domain of EU public policy, and specifically outside the domain of EU industrial policy. While the underlying causes of transformation pressures may be considered as exogenous, industrial policy can influence the channels through which transformation pressure in general are translated into pressure on specific industry sectors. Overall, these channels may include supply-side characteristics such as industry institutions and regulations, factor (input) market developments, and supporting and related industries/services. While on the demand-side, this could include market institutions and regulations, and developments in downstream/final markets. Also, of obvious relevance, is the behaviour and performance of (international) competitors. Industrial competitiveness and transformation framework Bringing together the various elements described above, Figure 1.1 provides a stylised representation and categorisation of the main factors influencing and determining industrial competitiveness and transformation performance.

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Figure 1.1

Framework Conditions
Demand-side Conditions

Supply-side Conditions Within industry Conditions

Competitiveness & Adjustment Potential
FIRM STRATEGIES & BUSINESS MODELS MARKET INSTITUTIONS & REGULATIONS EXOGENOUS CONDITIONS

EXOGENOUS CONDITIONS

INDUSTRY INSTITUTIONS & REGULATIONS

globalisation, technology, climate change, demographics, … INPUT FACTOR UTILISATION FINAL MARKET DEMAND DEVELOPMENTS COMPETITOR PERFORMANCE PRODUCTION PROCESS DEVELOPMENT INDUSTRY STRUCTURES & ORGANISATION SUPPLY / VALUE CHAIN RELATIONSHIPS FORWARD LINKAGES

FACTOR MARKET DEVELOPMENTS

globalisation, technology, climate change, demographics, …

Sustainable Industrial Competitiveness framework

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ECONOMIC & OTHER 'SHOCKS' TRANSFORMATION PERFORMANCE COMPETITIVENESS OUTCOMES

ECONOMIC & OTHER 'SHOCKS'

SUPPORTING INDUSTRIES

BACKWARD LINKAGES

24

1.4.2

Elements of Sustainable Industrial Competitiveness Policy Categorisation of (sustainable) industrial policy measures Drawing on the various elements discussed in the Annex 16, three broad categories of policy measures are identified that fall within the heading of Sustainable Industrial Competitiveness Policy: • Market functioning and scope: covering policy measures – typically of a regulatory nature – that are primarily directed towards securing fair and open markets, such as competition policy, trade policy, internal market policy, consumer/market policy. In general, such policy measures tend to impact more heavily on demand side conditions affecting industry. Business environment and inputs: covering policy measures of a typically crosscutting nature that support the competitiveness and transformation potential of industry by enhancing capacities and capabilities within the business environment. These may include, for example, improving the quality, availability and access to factor inputs and improvements in the general business administrative environment. Essentially, such measures would cover non-regulatory ‘framework’ measures. In general, such policy measures tend to impact more heavily on supply side conditions affecting industry. Industrial performance and transformation: covering policy measures that also aim enhance the competitiveness and transformation potential of industry, but are more directly targeted towards enhancing conditions within industry (including specific sectors or industry value-chains) as opposed to surrounding framework conditions.

Three broad categories of policy measures can be distinguished

Coordination between various horizontal policies is vital…

Coherence, coordination, and integration – towards multi-level governance The above categories of industrial policy measures are set within the broad policy framework and objectives for economic, social and environmental development 17. At this level, it is clear that there exists a wide range of industrial policy measures that are not necessarily intended to meet sustainable industrial competitiveness policy objectives but, nonetheless, impact upon industry. Accordingly, the overall scope of industrial policy can be extended to include the evaluation of coherence between industrial and non-industrial measures and their overall coordination and integration within the context of the broad policy framework. The aspect of ‘coherence, coordination, and integration’ is not only relevant to policies and policy measures taken at an EU-level, but also extends to possible inter-relationships between EU-level and national (Member State) level initiatives and, where relevant, even at a broader – extra-EU or supra-national (global) – international level. In particular, as noted in Section 1.3, responsibility for setting and implementing policy in many of the areas relevant for industrial policy rests with Member States; this is particularly the case for policy measures falling under the headings of ‘business environment and inputs’ and ‘industrial performance and transformation’, as described above. In relation to this, the EU has an important role to play in ensuring that policy measures taken by and within
16 17

… and so is coordination between various governance levelsl…

Specifically Section 1.3 See Section 1.7

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Member States do not impinge on the integrity of the Internal Market. Furthermore, the increasing complexity of inter-relationships between industrial sectors (i.e. value/supply chain relationships) and across geographical locations, suggests that attention should also be paid to the implications of inter-sectoral – and, even intra-sectoral – dynamics of policy initiatives and potential ‘spill-over’ effects both across sectors and across geographical boundaries. In this respect, processes of globalisation and the global dimension of many challenges facing EU industry, imply that EU cannot act in isolation and that certain dimensions of a sustainable industrial competitiveness policy, require approaches and solutions defined at a broader international (global) level. Towards a Sustainable Industrial Competitiveness Framework Bringing together the various elements described above, Figure 1.2 provides a stylised representation and categorisation of the main elements of a sustainable industrial competitiveness policy.

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Figure 1.2

BROAD POLICY FRAMEWORK
ECONOMIC POLICY SOCIAL POLICY ENVIRONMENT POLICY

POLICY MIX

SUSTAINABLE INDUSTRIAL COMPETITIVENESS POLICY
Market Fuctioning & Scope (mainly regulatory)
Trade Policy, Competition Policy Internal Market Policy, Consumer (Market) Policy, ...

POLICY GOVERNANCE

Fair and open competition

Supra-National (Global) Policy

EU Policy Business Environment & Inputs
Better Regulation, Education Policy, Research & Innovation Policy, SMEs & Entrepreneurship, Finance & Risk Capital, Infrastructure Policy, ...

Sustainable Industrial Competitiveness Policy Framework

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Member State (national) Policy Industrial Performance & Transformation
Cluster Policy, Technology Policy

Capacity building and capability enhancement

Targeted strengthening and transformation

Sub-national (regional-local) Policy

Coherence, coordination & integration

Framework Conditions (Supply side)

Within Industry Conditions

Framework Conditions (Demand side)

27

1.5

Key conclusions
Drawing on the preceding discussions, we can point to a number of key conclusions relevant for the development of an EU Sustainable Industrial Competitiveness Policy. Context and background 1. In putting forward the Commission’s proposals for the EU2020 Strategy, the recent events of the economic and financial are portrayed as a “wake up call” for the EU, while the EU is presented as being at a “moment of transformation”. Beyond seeking to instil a sense of urgency for the development of policies necessary “to deliver smart, sustainable and inclusive growth”, the Strategy indicates that required actions – both by policy makers, the private sector and citizens – go beyond incremental adjustments and tinkering with conventional practices. In view of the forthcoming Commission Communication on industrial policy, it is an opportune moment to evaluate whether the current EU-level approach to industrial policy and the approaches pursued at national and sub-national levels by Member States are both adequately aligned and sufficient to meet current and future challenges. It is also a moment to take a ‘step back’ from the immediate concerns of the economic and financial crisis, in order to identify some of the key issues that will need to be addressed by a ‘modern’ industrial policy. It seems inevitable that the articulation between sustainable development and industrial competitiveness will be among the central themes – and most likely the main overarching theme – for future industrial policy. A future ‘sustainable industrial competitiveness policy’ will need to facilitate the adaptation and transformation of industry while contributing to achieving (and maintaining) the competitiveness of industry in accordance with sustainable development objectives. The ability of emerging economies to position themselves as major competitors in so-called ‘high-tech’ sectors has demonstrated that the intrinsic technological level of a sector is not a shield against competition. In fact, the external competitiveness of EU industry has less to do with its relative position in sectors with different technology categorisations (i.e. low-, medium- or high-tech) and more to do with capabilities of EU enterprises across a range of sectors to successfully apply technologies in innovate ways or to adapt technologies to specific market requirements (i.e. product differentiation and specialisation). Transformation processes linked to technology developments do not only involve high-tech manufacturing sectors but also involve innovative applications of technology in lower-tech sectors. Competitiveness may be more greatly enhanced by strategies (e.g. smart specialisation) that build upon existing assets (e.g. skills and expertise, available physical inputs, environmental conditions, market access conditions, etc) than jumping upon current technology ‘bandwagons’. While tangible factors provide the bedrock for (external) competitiveness, increasingly the factors that underpin the ability of firms to differentiate themselves from their competitors are intangible. Factors such as quality, branding,

2.

3.

4.

5.

6.

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customisation and provision of product-related services, can also be identified as crucial for enabling EU industries to innovate and to position themselves in ‘upmarket’ and ‘high value-added’ product segments. 7. Industrial sectors can no longer be treated as homogeneous, independent and national. Value chains are increasingly complex and intertwined, cutting across traditional sector-based categories and geographical boundaries. This fact points to the increasing importance of networks of suppliers and innovation partners, of maintaining a diversified industrial base, and of access to specialised supporting competences. As emerging economies, such as China, India or Brazil, increase their own technological capabilities, it may become far from evident to identify those industrial activities and market segments where they will become important competitors in the future. Moreover, as other ‘advanced’ economies struggle with low domestic growth and increased competition from emerging economies the pressure of competition in international markets, in particular in those ‘up-market’ and ‘high value-added’ product segments where EU industry is present, can be expected to increase. Accordingly, the possibility of unforeseen and sudden shifts in relative competitiveness may increase in the future.

8.

Implications for industrial policy 9. Industrial policy requires a finer level of resolution than offered by traditional classifications of industrial (and service) sectors, which permits to look inside traditional notions of industrial sectors and to understand the drivers of competitiveness and their implications for different industrial activities. At the same time, a more holistic picture is needed that takes account of the wide ranging interlinkages that influence industry performance and competitiveness, and accommodates the evaluation and integration of measures across the broad spectrum of policies that impact on industry.

10. It is perhaps time to draw a line through the normally used distinction between horizontal and sector-based (or sectoral) policy approaches. In designing and implementing Sustainable Industrial Competitiveness Policies, attention should rather be paid to combining generic policies with targeted policies, directed towards specific categories of firms or elements within value chains, or towards strengthening linkages and creating synergies within value chains (e.g. focusing on young, innovative companies or cluster-based policies). 11. Greater unpredictability combined with a faster speed of change means a more difficult and complicated environment for businesses – and policy-makers – to formulate strategies for developing and maintaining competitiveness. A sustainable industrial competitiveness policy should increase the emphasis placed on anticipation of potential future developments – be they derived from technological or other factors – and the nature of their possible impacts on international competitiveness.

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12. The speed with which industries are able to respond to sudden changes in competition and drivers of competitiveness is likely to become increasingly important. This implies that policy frameworks need to support the flexibility of industry to react rapid to sudden changes and to facilitate their implementation of transformation strategies. 13. Frequent changes in regulatory conditions exacerbate problems of uncertainty and unpredictability, which can delay decisions that may have important implications for competitiveness and slow down processes of industrial transformation. Stability – or at least predictability – and transparency of regulatory conditions are important for enterprises to develop a long-term view as the basis for business planning and investment decisions. 14. The increasing geographical complexity of industry value chains, the integration of markets, and the global nature of many of the most pressing policy challenges for industry can be observe in increasing policy ‘spill-over’ effects – both positive and negative – across regions and countries, across sectors and business activities, and across policy areas. This raises a central issue of how to effectively and efficiently ensure coherence, coordination and integration of policy approaches across different policy domains and governance levels and argues for establishing multi-dimensional policy governance frameworks for an EU-wide Sustainable Industrial Competitiveness Policy.

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Annex: EU industrial policy: background, underlying issues and key concepts

1.1

Introduction
The aims and objectives of industrial policy, the range and types of policy measures covered, and the scope of application of possible measures can be viewed from a wide range of historical, developmental, institutional and intellectual perspectives. Moreover, a variety of titles have been variously used to describe ‘industrial policy’ such as: industrial competitiveness policy, industrial development policy, sustainable industrial policy, enterprise policy, etc. the differences between which often appear rather ambiguous. Not surprisingly, therefore, a precise definition of industrial policy is somewhat elusive. In this section, therefore, we shall attempt to provide a general description of industrial policy, and identify and define some of the key issues surrounding current approaches to industrial policy development.

1.2

‘Old’ versus ‘new’ industrial policy 18
What may be termed ‘old’ industrial policy – at least within the timeframe of the EU (and previously the European Community) – is usually associated with direct and sector-specific interventions aimed, on the one hand, at encouraging the development of specific sectors identified as offering opportunities for growth and employment and, on the other hand, by efforts both at national and Community-level to prevent the decline of sectors considered to be of strategic importance for a variety of industrial, social or security-related reasons. Reflecting a combination of poor actual policy outcomes, changing economic orthodoxy, and geopolitical transformation, by the 1990s – if not already earlier – the kinds of policies associated with attempts at ‘picking winners’ and ‘bailing out losers’ had become largely discredited 19. Since the 1990’s there has been a general shift in the emphasis of industrial policy away from sector specific interventions and towards non-sector-specific policy measures. What may be referred to as ‘new’ industrial policy – in particular within the EU context – has been characterised by a focus on creating the right broad environment for industrial development based on actions of a cross-sectoral (i.e. non sector specific) nature. This approach was integrated into the Maastricht Treaty in 1992, which provided the first legal reference to EU industrial policy. Under Article 130 of the Treaty (now Article 173 of the Lisbon Treaty; see Box 1.1), the EU and Member States are

18

For a more detailed analysis of the changing concept of industrial policy see, for example: Bianchi P. and Labory S. (2006), “From ‘old’ industrial policy to ‘new’ industrial development policies” and Pelkmans J. (2006) “European Industrial Policy”, both in Bianchi P. and Labory S. (ed.) “International handbook on industrial policy”, Edward Elgar. 19 Nonetheless, even today there remains something of a ‘hangover’ in terms of the association of industrial policy with these types of intervention. At least, DG Enterprise appears to find it necessary to explicitly exclude such types of policy interventions from the scope of current EU industrial (competitiveness) policy; see Box 1.3.

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required to ensure the conditions necessary for the competitiveness of the Union’s industry and for this purpose should undertake actions aimed at: • Facilitating (speeding up) adjustment to structural changes; • Encouraging an environment favourable to business initiative and development; • Encouraging an environment favourable to business cooperation; • Fostering better industrial exploitation of innovation, research and technological development.
Box 1.1 Lisbon Treaty: Article 173: Industry

1.

The Union and the Member States shall ensure that the conditions necessary for the competitiveness of the Union's industry exist. For that purpose, in accordance with a system of open and competitive markets, their action shall be aimed at: – – – – speeding up the adjustment of industry to structural changes, encouraging an environment favourable to initiative and to the development of undertakings throughout the Union, particularly small and medium-sized undertakings, encouraging an environment favourable to cooperation between undertakings, fostering better exploitation of the industrial potential of policies of innovation, research and technological development.

2.

The Member States shall consult each other in liaison with the Commission and, where necessary, shall coordinate their action. The Commission may take any useful initiative to promote such coordination, in particular initiatives aiming at the establishment of guidelines and indicators, the organisation of exchange of best practice, and the preparation of the necessary elements for periodic monitoring and evaluation. The European Parliament shall be kept fully informed. The Union shall contribute to the achievement of the objectives set out in paragraph 1 through the policies and activities it pursues under other provisions of the Treaties. The European Parliament and the Council, acting in accordance with the ordinary legislative procedure and after consulting the Economic and Social Committee, may decide on specific measures in support of action taken in the Member States to achieve the objectives set out in paragraph 1, excluding any harmonisation of the laws and regulations of the Member States.

3.

The role attributed to industrial policy in the Maastricht Treaty – namely as a tool to be used to promote competitiveness – and the attention given to the four listed action areas have remained at the core of EU-level industrial policy developments through the 1990s and over the last decade, subject to certain changes in emphasis along the way20. At the same time, although a cross-sectoral or horizontal approach has been an underlying principle of EU industrial policy since Maastricht, this does not imply an absence of a sectoral dimension (sector-based approach). In particular, when putting forward its strategy for industrial (competitiveness) policy to accompany the relaunched Lisbon Agenda in 2005, the EC stressed the need for effective industrial policy to combine both horizontal and sector-based aspects (i.e. so-called integrated approach). Specifically, the Commission stated that:
“The Commission is committed to the horizontal nature of industrial policy and to avoid a return to selective interventionist policies. Nevertheless, the scope of policy instruments should not be seen just as only very broad horizontal measures. For industrial policy to be effective, account needs to be taken of the specific context of individual sectors. Policies need to be combined in a tailor-made manner on the basis of the
20

One change that came about with the Maastricht Treaty was a partial shift in emphasis of EU industrial policy away from a prioritisation of facilitating structural adjustment to a prioritisation on enhancing competitiveness. This distinction may seem rather semantic but it points to the fact that enhancing competitiveness is perhaps best viewed as facilitating structural adjustment rather than vice versa. We can see, also, that whereas the original Lisbon Agenda set ambitions for the EU to become the most competitive region in the world (however that may be defined), the re-launched 2005 Agenda focused – arguably more pertinently and more realistically – on enhancing competitiveness in order to stimulate growth and employment. (See Box 1.2)

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concrete characteristics of sectors and the particular opportunities and challenges that they face. This inevitably has as a consequence that whilst all policies are important, in the EU today some policies have greater importance for some sectors than others.”
21

1.3

The scope of EU industrial policy
Broadly speaking, we can say that EU industrial policy is primarily concerned with public policy measures that influence the environment – or in EC parlance the ‘framework conditions’ – in which firms (and individuals) engage in wealth creating economic activities. In turn, industrial policy initiatives that seek to affect this environment should do so in a way that is supportive to enhancing the competitiveness of (EU) industry. This is, at least, the primary role that the EC ascribes to (EU) industrial policy (see Box 1.2 and Box 1.3). The basic presumption underlying this approach to industrial policy is that the ‘right’ framework conditions will impact positively on the competitiveness of enterprises and hence their development, while the ‘wrong’ framework conditions will have the opposite effect. An obvious issue arising from the above description of the role of industrial policy is the identification of the ‘framework conditions’ for enterprise development that are relevant for industrial policy perspective. For example, the effective functioning of competition law in order to ensure ‘open markets’ and ‘fair competition’ is arguably a fundamental requirement for a marketbased economy to provide an environment in which industry can thrive. Similar arguments could be made in a whole range of policy areas, such as trade, employment, education, and even at a higher macroeconomic level (e.g. broad economic and social policy) that have the potential to affect the environment in which businesses engage in their activities.

Box 1.2

The role of EU industrial policy Role of industrial policy “The basic premise underlying the European Union’s industrial policy is to follow a dynamic horizontal approach smoothing the way for the implementation of a consistent package of policies to help make industry more competitive” Source: COM (1994) 319 “Industrial policy … aims at securing framework conditions favourable to industrial competitiveness. Its instruments, which are those of enterprise policy, aim to provide the framework conditions in which entrepreneurs and business can take initiatives, exploit their ideas and build on their opportunities.” Source: COM (2002) 714 “The main role of industrial policy is to provide the right framework conditions for enterprise development and innovation in order to make the EU an attractive place for industrial investment and job creation.” Source: COM(2005) 474 “The main role of industrial policy at EU level is to proactively provide the right framework conditions for enterprise development and innovation in order to make the EU an attractive place for industrial investment and

21

Source: COM (2005) 474

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job creation, taking account of the fact that most businesses are small and medium-sized enterprises (SMEs).” Source: COM (2007) 374

Box 1.3

DG Enterprise description of the role of EU industrial competitiveness policy Role of EU industrial competitiveness policy EU industrial competitiveness policy is about getting the right environment for industry to thrive. It is about: • • • stimulating innovation and competition and investment in know how; guaranteeing a level playing field in the Single Market and outside of it in third countries; reducing frictions and transaction cost in the European economy, such as administrative burden.

Where appropriate, it facilitates the adjustment process of declining industries or industries exposed to socially unacceptably high adjustment pressure. It is also important to be clear what EU industrial competitiveness policy is NOT: • • It is not about ad-hoc intervention, picking winners or bailing out losers, or similar concepts. It is not about more regulation or more state aid.

Instead it is about less but better regulation and about less but better focussed state aid, etc. In 2005, the Commission set out for the first time a so-called integrated approach of industrial competitiveness policy based on a combination of cross-sectoral (horizontal) and sector-specific initiatives. The mid-term review in 2007 restates the position that the main role of industrial policy in the EU is to provide the right framework conditions for enterprises and to make the EU an attractive place for industrial development and job creation. Source: DG Enterprise website

Unfortunately, there is no clear answer to the question of what policy areas, and corresponding policy instruments, fall within the scope of industrial policy and which do not. On the one hand, a broad (comprehensive) interpretation of industrial policy can be made that would subsume instruments and measures from across a wide range of policy fields within the scope of industrial policy. Thus a broadly defined industrial policy can be viewed as an amalgam of overlapping policy areas rather than a distinct and bounded policy field. A recent example of this approach can be seen in the European Council Conclusions on the need for a new industrial policy, which highlighted inter alia the priority for industrial policy to:
“… contribute to responding to the opportunities and challenges of globalisation by combining all possible instruments and measures of EU industrial policy (including for example those of the internal market, competition, skills and regional policy, trade and investment, standards and regulatory convergence)”
22

On the other hand, we can also observe a somewhat narrower (restrictive) definition of the scope of industrial policy which is more closely aligned to institutional competences and mandates, specifically those of the relevant administration(s) responsible for policies directed specifically ‘towards industry’ (i.e. DG Enterprise and Industry). In this situation, industrial policy takes on

22

“Council conclusions on the need for a new industrial policy”, 2999th Competitiveness Council meeting Brussels, 1 March 2010, 6391/10

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more of a ‘residual’ character, in the sense that the term is used to refer to those policy areas and corresponding measures and instruments that fall outside the responsibility of ‘non-industry’ administrations. To some extent the dichotomy between a comprehensive and more restricted description of industrial policy is treated within the EU context through the association of a ‘competitiveness’ principle with policy initiatives that potentially cut across administrative responsibilities. This is evident, for example, if we look at the description of kinds of horizontal measures taken in support of the re-launched Lisbon Agenda and promoted under the heading of ‘industrial policy’ 23. On the one hand, we find specific initiatives that seem to fall more obviously within a relatively restrictive scope of industrial policy; for example in the areas such as: IPR and counterfeiting, legislative and regulatory simplification, improving sectoral skills, industrial research and innovation, etc. On the other hand, broader themed initiatives that cut across policy areas are labelled – or clearly described – with regard to their competitiveness characteristics; for example: ‘competitiveness and market access’ (trade policy), ‘competitiveness, energy and environment’ (energy and environmental policies), ‘structural adjustment in manufacturing’ (regional and cohesion policies (structural funds)), ‘access to raw materials’ (trade, energy and environmental policies) etc. Essentially, this latter group of initiatives reflects the inclusion of the evaluation of the competitiveness effects of ‘other’ policies (i.e. a ‘competitiveness test’) within the scope of industrial policy. Following from the above, and drawing on Pelkmans (2006) 24 who provides an outline classification of EU industrial policy and other policy measures that affect industry, the following taxonomy may be used to categorise relevant policy measures (see Figure 0.1): • Policies not for industry but that affect industry. These cover: • Broad economic and social policy such as macroeconomic stability with fiscal and monetary instruments; re-distributional tools; tax policy etc. Policies for ‘non industry’ sectors such as agriculture, energy, services, etc.

Policies not only for industry (i.e. policies which directly help or constrain industry but are not meant (only) for industry) such as price controls, buy-national campaigns, tied development aid, or environmental policies addressing specific hazards such as poisonous chemicals. Policies for industry in a broad sense (i.e. ‘wide concept of industrial policy’) that are composed of three main blocks:  Framework aspects that determine or strongly influence the general environment in which enterprises undertake their business. It is not really possible to provide a precise definition of the scope of framework conditions, but a number of sub-themes/areas – often interrelated and not mutually exclusive –can be discerned: Market functioning (competition): covering policies – typically regulatory in nature – that govern the ‘rules of the game’ under which enterprises compete with each other. Most obviously this would include competition policy but may be extended to include, for example, rules governing the provision of particular services (e.g.

23 24

See COM(2005)474 and COM(2007)374 Pelkmans J. (2006) “European Industrial Policy”, in Bianchi P. and Labory S. (ed.) “International handbook on industrial policy”, Edward Elgar.

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network services) and products, state aid provisions, and also may include policies for competitive (‘open’) public procurement systems. Market scope and integration: covering policies – often regulatory in nature – that shape the potential scope and extent of integration of (international) markets. This would include ‘international trade policy’ (e.g. external market access) and, specifically in an EU context, ‘Internal Market policy’ (e.g. policies aimed at deepening and strengthening integration of the Internal Market). It may also include consumer/market policies or product-based policies that influence conditions in final markets for goods (and services) produced by industry. Business processes and administration: covering policies that influence the nature and costs of business processes. This would include, for example business administration requirements, and policies such as ‘better regulation’ efforts aimed at simplifying and improving the regulatory environment and reducing administrative burden on enterprises. It may also be extended to cover policies that influence specific activities (e.g. research, technology development and innovation) and processes (e.g. environment or energy efficiency requirements for production processes) within enterprises, or that influence interrelationships between enterprises and sectors (e.g. cluster policies, industrial cooperation, etc.). Business inputs and infrastructure, covering policies that influence the availability and quality of inputs used by industry. Most obviously this would include policy related to labour (e.g. education and training policies) but can also be extended to other inputs such as energy or finance. More broadly, it could be extended towards policies directed at enhancing the physical (e.g. built infrastructure) and network (e.g. telecommunications) environment 25.

-

-

Horizontal industrial policy, which are typically defined as such because of their crosscutting nature but we can also see them as complementary policies – mainly nonregulatory in nature – that are aimed at assisting enterprises to improve their performance/competitiveness. At an EU-level these cover a number of themes – often closely interlinked – such as ‘knowledge and innovation’, ‘human capital and skills’, ‘entrepreneurship and SME development’, ‘better regulation’ etc.; Sectoral industrial policy, which consist of policies that seek to address sector-specific dimensions of the framework and horizontal aspects described above, or other sectororientated policies aimed at addressing specific sector-level market failures.

It is important to recognise, however, that within this taxonomy the boundaries between the policy categories – in particular under the heading of ‘policies for industry’ – are not always well defined; for example boundaries between ‘framework’ and ‘horizontal’ policy areas can often seem rather fluid, and supposedly ‘horizontal’ measures can quite evidently have a very strong sectoral dimension. Nonetheless, this taxonomy also can be used to indicate the main types of interventions to be taken by policy-makers in support of ‘industrial policy’: • first, to influence ‘other’ policies affecting the various framework conditions for enterprises in such a way that their potential positive contribution to industrial competitiveness is maximised
Cohesion policy (or regional policy more generally) may also be included within this category since it primarily operates through measures directed towards improvements in ‘soft’ (networks and roads/bridges/tunnels) and ‘hard’ (human capital, technical schools, retraining facilities, administrative capacity) infrastructure.

25

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or, at least, any potential negative effects on the competitiveness of industry are adequately recognised and where possible minimised; • secondly, to take specific horizontal initiatives to address weaknesses in the framework conditions for industry where these weaknesses are the result of ‘market’ or ‘systemic’ failures which might justify public policy intervention; thirdly, to take specific sectoral initiatives where framework conditions (and related policy measures) and/or market failures have differential effects – either in terms of the type of effects or their magnitude – across industry sectors that might warrant more targeted (or ‘tailor-made’) approaches.

By and large the main thrust of EU-level industrial policy over the past two decades has been concerned with the first two types of interventions mentioned above. In some areas, notably trade policy and internal market policy where the EU has primacy over national administrations, the main responsibility for setting (industrial) policy is at the EU level. More generally, responsibilities are shared between the EU and national levels and often, even where the EU has a mandate to set policy guidelines, actual policy implementation – and control of the financial purse strings for funding policy initiatives – is mainly at the national level. This is the case for many of the main areas covered by EU horizontal policy initiatives, which implies that their effective implementation requires cooperation, coordination and coherence between EU and national-level policy making (see Box 1.4). In terms of sector specific policy initiatives, the EU has made clear its rejection of more interventionist approaches, and the current EU approach to sectoral policies is essentially noninterventionist, consisting largely of ‘soft’ measures such as consultation processes, high-level working groups, and combined with efforts aimed towards simplification of sector-specific legislation etc. In this regard, while the EU continues to monitor developments at the level of industry sectors and in terms of the overall composition (structure) of industry within the EU, we can see that certain industry sectors have been subject to more attention than others (see Figure 0.2). On the one hand, greater attention has been given to sectors seen as particularly vulnerable to globalisation and other ‘structural adjustment’ pressures (e.g. shipbuilding, textiles, metals, etc.). On the other hand, sectors considered to be important in terms of their growth potential – particularly high-tech and high value added sectors (e.g. pharmaceuticals, bio-technology, ICT, etc.) – have been the subject of attention; we can see, for example, some alignment of EU policy instruments (such as research funding, ‘lead market’ initiatives) towards technologies and products linked to these growth sectors.

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Box 1.4

The role of EU and Member States for industrial policy Role of EU and Member States “ … industrial policy is based on a partnership between the EU and Member states. Several industrial policy challenges need to be addressed at the European level, since individual Member states acting in isolation cannot succeed in tackling issues such as major competition cases, the regulation of the single market, or social and economic cohesion. However, Member states also have responsibilities for many elements of industrial policies …” Source: COM(2005) 474 “An effective and functioning industrial policy in the EU must be based on coherent and coordinated efforts at national and European level … Many elements of major impact for the competitiveness of European industry are set at national level. Nevertheless, important challenges such as the creation of an open and competitive Single Market, but also the industrial policy response to the energy and climate change agenda can not, or only be insufficiently addressed at national level, and hence require action at European level as well.” Source: COM (2007) 374 To strengthen the competitive advantages of its industrial base, Europe needs a solid industrial fabric throughout its territory. The necessary pursuit of a modern and active industrial policy means strengthening the competitive advantages of the industrial base, including by contributing to attractive framework conditions for both manufacturing and services, while ensuring the complementarity of the action at national, transnational and European level. Member States should: — start by identifying the added value and competitiveness factors in key industrial sectors, and addressing the challenges of globalisation; — also focus on the development of new technologies and markets. (a) This implies, in particular, commitment to promote new technological initiatives based on public– private partnerships and cooperation between Member States, that help tackle genuine market failures. (b) This also implies the creation and development of networks of regional or local clusters across the EU with greater involvement of SMEs. Source: Integrated Guidelines for Growth and Jobs (2005-2008)

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Policies (somehow) affecting industry

Policies for industry

Policies NOT for industry

Non-industrial policy measures directly affecting industry Broad economic and social policies

Policies for non-industry sectors

Source: adapted from Pelkmans (2006)
Macroeconomic  Tax / fiscal policy Redistributional Industrial relations / wages Infrastructure  Land use  ... Agriculture & fisheries  Energy  Transport  Communications  Services ...

Regional development / planning  Price controls Export promotion (overall) Specific environmental policies  ...

INDUSTRIAL POLICY (wide concept)

Figure 0.1 Industrial policy classification and relation between EU and national powers

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Horizontal industrial policy Sectoral industrial policy Competitiveness test for other policies Research strategies Innovation stimulus Entrepreneurship / risk capital Public procurement Technology policies Restructuring funds Cluster policies / initiatives Skills and human capital
National powers

Framework aspects

Trade (and investment) policy

Trade policy - sector specific aspects Sectoral interventions

EU powers

Internal Market

Strict EU constraints

Competition policy Sectoral policies

Shared, mainly EU

Better regulation / convergence Cohesion / regional policy sector specific aspects

Shared EU-national powers Shared, mainly national

Cohesion / regional policy

Consumer policy / markets

State ownership

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HORIZONTAL ACTIONS
SECTORS
TEXTILES HLG Textiles Clusters initiative AEROSPACE Advisory Group / STAR 21

SECTORAL ACTIONS

MAIN THEMES

KNOWLEDGE

R&D and Innovation Technology platforms AUTOMOTIVE HLG / CARS 21

Integrated approach to Ind. Research and Innovation

Joint technology initiative

IPR and Counterfeiting

Skills SHIPBUILDING HLG / LeaderSHIP 2015

IPR and Counterfeiting Initiative European Institute of Technology

Access to finance (SMEs) Standards action programme LIFE SCIENCES & BIOTECHNOLOGY Mid-term Strategy Review CHEMICALS HLG Chemicals PHARMACEUTICALS Pharmaceuticals Forum

Improving Sectoral Skills Pharmaceuticals Review / Comm.

Lead market initiative

BETTER REGULATION

Administrative burden

Reg. simplification DEFENCE

New Legislative Simplification Programme HLG Defence

Simplifying and improving the regulatory environment and reducing the administrative burden

European Defence Package

Internal Market SECURITY

Health and safety

Security Research Forum (ESRIF)

Standards SPACE / GMES European Space Programme

Figure 0.2 DG Enterprise main ‘industrial policy’ initiatives since 2005

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Energy intensive industries ICT Sustainable consumption Eco-industries Sustainable production ELECTRICAL ENGINEERING Taskforce on ICT Competitiveness Dialogue for Mechanical Engineering ELECTRA Initiative MECHANICAL ENGINEERING Raw material supply Sectoral aspects of global environment and climate change FOOD PROCESSING Food Initiative METALS Metals Communication FOREST BASED INDUSTRIES Forest-based industries Comm. Ongoing Initiatives pre-dating the 2005 Communication on industrial policy Initiatives highlighted in 2005 Communication on industrial policy Clusters initiative Initiatives highlighted in 2007 Mid-term Review of industrial policy Industry / services initiative Themes under sustainable industrial policy initiative

ENVIRONMENT & ENERGY

Climate change

HLG Energy, Environment and Competitiveness

Sustainable industrial policy initiative

Intensive energy use

Waste, water, air

TRADE

Market access

Raw materials access

External Aspects of Competitiveness and Market Access

Competitivenes s and market access initiative

Trade infringements

Regulation

STRUCTURAL CHANGE

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Anticipation

Managing Structural Change in Manufacturing

Structural change initiative

Tertiarisation

1.4

Policy for industry or policy for enterprise?
From a historical basis, industrial policy has typically been associated with policy directed towards manufacturing sectors, or more broadly to include primary industries such as mining and other sectors such as construction that are seen to have similar characteristics or be closely intertwined with manufacturing 26. However, to the extent to which ‘industrial policy’ is based on a horizontal approach and is concerned with providing the right environment (‘framework conditions’) for enterprise development it seems quite reasonable to presume that many potential industrial policy initiatives – for example, initiatives aimed at reducing administrative burdens, simplifying regulation, encouraging innovation and entrepreneurship, etc. – will be of relevance to a much broader scope of enterprises (and individuals) than just those within ‘industry’. Industrial policy and SMEs The relevance of nominally ‘industrial policy’ measures to a broader scope of industrial and non-industrial enterprises appears to be particularly strong in relation to initiatives directed towards small and medium sized enterprises (SMEs), for which it is the size of the enterprise rather than their sector of activity that is often more pertinent from a policy perspective. In this regard, the relationship between EU policies for, for example, entrepreneurship and SME policy – e.g. the Small Business Act 27 – and ‘industrial policy’ is rather ambiguous. It is somewhat difficult to draw a clear distinction between ‘enterprise policy’ and ‘industrial policy’. In 2000 the Commission described enterprise policy as a policy that “needs to address the entire business environment to enable enterprises, whatever their size, legal form, sector or location to grow and develop.” 28 Drawing on this description, the 2002 Communication on ‘Industrial Policy in an Enlarged Europe’ 29 stated that “Industrial policy can … be defined as the application of enterprise policy instruments to the industry sector”. By contrast, more recent descriptions suggest that the term ‘enterprise policy’ has somehow become associated with policies directed towards – or, at least that place an emphasis on – small and medium sized enterprises and paying particular attention to manufacturing industry (see Box 1.5) 30

26

It may be noted, however, that as part of the strategic initiative ‘An industrial policy for the globalisation era’ contained in the Europe 2020 strategy, the Commission proposes to work “to enhance the competitiveness of the European tourism sector”. 27 COM(2008) 394 28 Commission Staff Working Paper ‘Towards Enterprise Europe: Work programme for enterprise policy 2000-2005’, SEC(2000)771 29 COM(2002) 714. 30 It can also be noted that the European Parliament Fact Sheet on industrial policy describes industrial policy as follows: “Industrial policy is horizontal in nature and aims at securing framework conditions favourable to industrial competitiveness. Its instruments, which are those of enterprise policy, aim to create the general conditions within which entrepreneurs and businesses can take initiatives, and exploit their ideas and opportunities.” Source: http://www.europarl.europa.eu/parliament/expert/displayFtu.do?language=en&id=74&ftuId=FTU_4.8.1.html

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Box 1.5

Description of EU enterprise policy EU enterprise policy EU enterprise policy facilitates greater competitiveness and the creation of jobs. It pays particular attention to the needs of manufacturing industry and of small and medium-sized enterprises. The focus of EU enterprise policy is on creating the right environment for investment in competitiveness and innovation, an environment in which strategically important sectors like aerospace and biotechnology, but also more traditional industries, such as textiles and the automotive sector, can prosper by being at the cutting-edge of technology. Two thirds of all jobs in the EU are in SMEs. Ninety-nine per cent of all businesses in the EU are SMEs. Hence the Commission’s watchword in its enterprise policy: ‘think small first’. Source: Europa – Gateway to the European Union website

Industrial policy and services Any attempt to clarify the ambiguity between ‘industrial policy’ and ‘enterprise policy’ highlights a further, and perhaps even more vexing issue, concerning the distinction between policies for industry and policy for services. The rise of the services economy (so-called ‘tertiarisation’) has been well documented and it is abundantly clear that the relative weight of service activities – specifically market services – in overall economic activity in the EU far outstrips that of manufacturing. Accordingly, it could be argued that the focus of policy-makers attention should, first and foremost, be on the development of policy directed towards facilitating competitiveness irrespective of whether the enterprises or sectors concerned are engaged in ‘industrial’ or ‘service’ activities 31. For example, one could envisage a ‘policy for enterprise’ covering framework aspects and horizontal policy measures for all business sectors (i.e. industry and services combined). The need to address sector specific aspects could then be addressed by adopting an extended approach to sector-specific policy measures, operating either directly at level of specific industry and service sectors or in a two-step process distinguishing first between industry and services and then secondly between individual sectors within these two groups. Even if an industry-orientated perspective is retained, one can question the usefulness of an industrial policy that fails to adequately capture the close inter-linkages between industry and services. A number of lines of reasoning may be put forward as to why a closer connection between ‘policy for industry’ and ‘policy for services’ is logical and may be beneficial 32: • A substantial component of the growth of the (market) services sector is attributable to the ‘outsourcing’ of services activities previously undertake within industry to specialised service providers. This means that many service activities that previously could have been captured within the scope of industrial policy, and that nonetheless remain important for the overall performance of industry, now fall outside an industry-based definition of industrial policy.

31

In this context, it is rather difficult to see the logic of grouping together industrial and enterprise policy – however defined – within one EU Directorate (i.e. DG Enterprise and Industry) while the apparent responsibility for services, which make up the vast majority of enterprises, rests with another Directorate (i.e. DG Internal Market and Services), particularly when the latter’s primary focus covers only a rather limited scope of ‘framework conditions’ (i.e. obstacles to trade in services and financial markets within the Internal Market). 32 See, for example, ECORYS (2008) “Study on Industrial Policy and Services” undertaken for DG Enterprise and Industry and available at: http://ec.europa.eu/enterprise/newsroom/cf/document.cfm?action=display&doc_id=4046&userservice_id=1&request.id=0

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Irrespective of the ‘outsourcing’ phenomenon, many service activities – notably businessrelated service – provide inputs that can make a critical contribution to the competitiveness of industrial sectors. Thus, in turn, the competitiveness of the service sectors delivering inputs to industry becomes a crucial part of the overall ‘framework conditions’ for industry. Many service activities are undertaken within industry (manufacturing) and a large proportion of the workforce in manufacturing firms can be engaged in service activities. For many industries (either at enterprise or sector-level), while still defined on the basis of the products (goods) that they supply, derive a significant part of their competitiveness either from internal services activities that – directly or indirectly – are integrated in their products, or from the delivery of services that accompany the goods that they provide. As an extension of the preceding point, we can witness the phenomenon by which firms shift from being manufacturers to ‘re-invent’ themselves as service providers. This may take the form of a total reorientation of business or be part of an unbundling of production process – variously referred to as, or associated with, fragmentation, off-shoring, vertical specialisation and splitting-up of the value chain – through which firms disinvest themselves of actual manufacturing production processes (or relocate such processes outside Europe). Thus the activities of such firms – or the parts of their activities retained in Europe – become more closely associated with service activities rather than manufacturing activities.

All in all, the rise of the service economy is perhaps the most profound underlying structural change affecting growth and employment (i.e. wealth creation) in the EU. Moreover, services are important not only as an ‘outcome’ of structural change but also in terms of their potential role in facilitating adaptation of industry in response to broader pressures for change (e.g. globalisation, environment, etc.). Accordingly, an industrial policy that is concerned with “speeding up the adjustment of industry to structural changes” should arguably accommodate a significant services dimension. However, the development of a more integrated EU-level approach – recognising both the overall importance of services and the inter-relationship between industry (manufacturing) and services – has been quite limited to date. It appears that policy-makers are content to address the ‘industry-services dimension’ in the undoubtedly relevant but somewhat limited context of the Internal Market; for example, in 2009 the European Council acknowledged the fact that:
“…industry and the services sector are increasingly intertwined and that professional, business and product-accompanying services are of large and ever growing importance for many industrial sectors. For this reason, the full and timely implementation of the Services Directive and making further improvements to the functioning of the internal market for services are crucial for industry”
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1.5

Industrial policy and competitiveness
In the previous sections we have contented ourselves with describing the main roles of (EU) industrial policy as providing the right framework conditions for enterprise development (and innovation), and facilitating adjustment processes in industries exposed to particular (structural) adjustment pressures. Underlying the focus on increasing the competitiveness of enterprises there is a broader objective of raising the contribution of ‘industry’ to achieving the overarching policy goals of economic growth and employment. The basic mechanism by which industry can
33

Council conclusions: An integrated approach to a competitive and sustainable industrial policy in the European Union. Brussels, 19 May 2009, 10082/09

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contribute to this overarching goal is through raising industrial productivity. In other words, industrial policy – or at least those industrial policies intended to raise competitiveness of industry34 – is essentially about raising productivity. Given the importance of the concepts of ‘competitiveness’ and ‘productivity’ for industrial policy it is perhaps worthwhile to consider how they actually relate to each other. As a starting point, the basic mechanism for generating economic growth is to increase the absolute level of domestic productivity (i.e. within the economy) irrespective of how this absolute level compares relative to other countries or regions35. Raising domestic productivity implies that greater value added can be generated for a given level of inputs, thus raising the income (economic return) of inputs employed; i.e. for a given level of inputs (factors of production) employed, the rate of economic growth will be determined by the rate of domestic productivity growth. At the same time, to the extent that growth in factor incomes generates increased demand, then this will allow for additional factors to be brought into employment. Basically, increasing the absolute level of domestic productivity is the basis for economic growth and employment creation. Riess and Välilä (2006)36 summarise this argument as follows:
“… the ultimate purpose of industrial policy, however defined, is to raise domestic productivity – not productivity relative to other countries. In other words, to promote economic growth and create jobs, Europe must become more innovative and productive even if it was the only place in the Universe.”

In this context, we can see that industrial policy is not just concerned with the enhancing the performance of EU industry in terms of its ability to compete in international (global) markets. First and foremost, there is an ‘internal’ dimension which is concerned with productivity growth and increasing the efficiency of resource use within the (domestic) economy, irrespective of whether – and to what extent – enterprises or sectors are subject to international competition. Of course, there is an ‘external’ dimension to industrial policy, which is concerned with the performance of industry (and the sectors and enterprises therein) in an international context; i.e. how well do EU firms – and by extension sectors and industry as a whole – perform in international (globalised) markets? Moreover this question is of increasing relevance as markets for more and more products and services are – actually or potentially – opened up to international competition. A usual starting point to address the question of the external competitiveness of EU industry is through the examination of the relative prices of EU goods and services vis-à-vis those produced elsewhere. At the same time, although it is understandable that attention is often focussed on the comparison of international ‘price competitiveness’, it is important to recognise at the outset that competitiveness depends not only on price but also on ‘quality’ aspects of the products and services supplied. These ‘quality competitiveness’ aspects can be considered as encompassing both ‘product quality’ related to the characteristics embedded within products themselves (e.g. product performance, reliability, etc.) and ‘service quality’ related to supply performance and associated

34

There may be other ‘non economic’ objectives ascribed to industrial policy, for example in terms of other strategic objectives such as geopolitical influence and security (e.g. defence industry) or to ensure access to critical assets and technologies. 35 Of course, differences in relative productivity – specifically the comparison between European productivity levels with higher levels achieved elsewhere – provide an indication of the potential additional contribution to economic growth that could be achieved through raising domestic productivity. 36 Armin Riess & Timo Välilä (2006), “Industrial policy: a tale of innovators, champions, and B52s 10” in “An industrial policy for Europe? Context and concepts” EIB Papers Volume 11 N°1 2006

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services (e.g. reliability of supply/delivery, technical support and maintenance services, etc.). As mentioned in Section 1.4, many goods producing (manufacturing) firms increasingly rely on the services embedded in their products or on product-accompanying services as a source of competitive advantage. Bringing a quality dimension into the evaluation of competitiveness raises a further issue related to our understanding of the relationship between productivity and competitiveness. For standardised – or non-differentiated goods or services – productivity can be relatively easily assessed on the basis of the ratio between resources used and the quantity – or value-added – of output produced; in other words, productivity (and hence competitiveness) relates to the ‘efficiency of production’. However, where goods or services are non-standardised – and specifically where they are differentiated in terms of quality – the relationship between efficiency of production and productivity is less straightforward. In particular, for services it is generally recognised that productivity depends not only on the efficiency of production but also on the effectiveness of the service supplied (i.e. ‘effectiveness of production’ or how well the service activity is performed). To the extent to which services are embedded in, or supplied alongside, manufactured goods – and, by extension, if product quality is considered as analogous to a service characteristic of a good – then productivity (and hence competitiveness) will depend on both the efficiency and effectiveness of production, and their relative importance within overall production processes. Leaving aside the aspect of quality competitiveness, it is evident that international price competitiveness of firms from one country (location) will to a large extent depend on their relative costs of production vis-à-vis firms producing in another country. In an international context we can distinguish between: • ‘Cost competitiveness’, which reflects the relative costs of producing goods and services in one country vis-à-vis the costs of producing them in another country. Essentially, cost competitiveness relates to the extent to which production costs for firms in one country are lower than those for firms in another country. The assessment of cost competitiveness is based on the relative cost (price) of production inputs such as labour, energy, raw materials, capital, etc. in either nominal terms (i.e. the average cost (price) per unit of production input) or adjusted for productivity differences (i.e. the average cost (price) of production inputs per unit of output). Thus, EU cost competitiveness may be enhanced by reduction in the cost (price) of inputs used by EU producers relative to their competitors or through an increase in their relative productivity, which implies a reduction in quantity – and hence cost – of inputs required per unit of output. • ‘Price competitiveness’, which reflects the relative prices of goods and services from one country vis-à-vis those of competitor countries. Typically price competitiveness is seen as relating to the ability of firms from one country to sell their goods and services at a price that is lower than that of firms from another (competitor) country37. The assessment of price competitiveness may be based on the relative price (i.e. measured in the appropriate market currency) of goods and services from one country vis-à-vis those from another country. Using a simple model of firm pricing behaviour, we can think of individual
37

We can further distinguish an outward dimension (‘export price competitiveness’), reflecting the relative prices of EU exports in foreign markets compared to those of local (foreign) producers and/or other international competitors in these markets, and an inward dimension (‘import price competitiveness’) reflecting the relative prices in EU markets of imported goods and services compared to those produced within the EU.

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firms as setting their output price – or domestic sales price – on the basis of their costs of production plus a sales mark-up (i.e. profit margin). Leaving aside transport costs and other foreign trade costs, a firm’s output price will be converted to a foreign market sale price on the basis of the exchange rate between the domestic and foreign currency. Thus, price competitiveness can be assessed by comparing output prices (or domestic sales price) converted according to the relevant currency exchange rate(s) 38. In evaluating cost competitiveness and price competitiveness it is evidently important to recognise the influence of exchange rates on relative costs and prices across countries 39. For firms in a country whose currency is appreciating, the relative cost (in common currency) of production inputs that are determined in domestic currency terms will increase compared to firms in the country whose currency has depreciated. Most obviously, this applies to the cost of labour which is normally determined in domestic currency terms, while for other inputs that are imported or whose price is otherwise set in international markets (e.g. costs of finance) the effect of a currency appreciation on relative costs is less certain. On balance, although a currency appreciation implies a loss of cost competitiveness, the magnitude of the impact will also depend on the relative proportion of total production costs determined in domestic currency compared to those set in nondomestic currency40. The extent to which a loss of cost competitiveness translates into a loss of actual price competitiveness will depend on market conditions and on firms’ behaviour. In particular, it will depend on the extent to which goods and services from the country whose currency appreciates actually compete with goods and services from the depreciating country (in either export or domestic markets). Also, firms may respond – at least in the short run – by reducing their margins in order to absorb part of the negative impact of higher relative costs on their prices. At the same time they may try to push part of their loss of competitiveness on to their own suppliers, thus increasing the downward pressure on (domestic) input prices. At a more structural level, firms may respond by seeking to reorganise production process – including possible relocation of production activities, which may be facilitated through a higher exchange rate that reduces the cost of FDI. However, the most important basis for sustaining cost and price competitiveness in the long term will come from raising (domestic) productivity. From a productivity perspective, to be competitive in international markets the relative productivity of EU firms compared to international competitors (either incumbent domestic firms in foreign markets or other international competitors in these markets) needs to be sufficiently high to offset the additional transport costs (and other foreign trade related costs) associated with serving foreign markets and still enable them to supply their goods and services at prices that are ‘competitive’ within these markets. Similarly, the higher the productivity of foreign firms relative to EU firms then the greater will be their potential to compete in EU markets. Essentially, more
38

It should be noted, however, that actual market prices are an outcome of supply and demand conditions within the relevant market. Specifically, in assessing price competitiveness, account needs to be taken of the fact that some firms/countries may enjoy sufficient market power to influence market prices (‘price leaders) while others (‘price takers’) will have to take the price set by the market for their goods and services. 39 In this respect, one important issue – that we will not deal with here – concerns the appropriate exchange rate to be used when converting costs measured in domestic currencies into a common (comparator) currency. 40 At one extreme, if the prices (costs) of all production inputs are set in domestic currency terms then the loss of cost competitiveness will be proportional to the currency appreciation. The greater the share of non-domestically priced inputs in total production costs then the less will be the direct correspondence between the rate of currency appreciation and the loss of cost competitiveness.

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productive firms are more likely to be able to compete internationally while less productive firms will be restricted to their domestic markets and be more vulnerable to foreign (and domestic) competition. In terms of industrial policy, if we consider that exchange rate ‘policy’ remains outside the industrial policy domain and that industrial policy can have only limited influence on prices of many production inputs, then the main contribution of industrial policy to international performance will come through enhancing industrial productivity. Specifically, as firms with high productivity should be more capable of gaining international market share (and retaining domestic market share), countries that are able to create an environment (i.e. ‘framework conditions’) that encourage the development of high productivity firms are more likely to do well in terms or their (net) export performance. To quote Jean-Claude Trichet, President of the ECB:
“Countries in which highly productive firms can thrive are […] likely to do better in terms of their overall export performance, as this will allow more firms to compete successfully in international markets.”
41

To the extent that firms are able to compete successfully in international markets and expand production through exports, this will increase the employment of factors of production, which will contribute to economic growth and employment. Further, there may be an additional incremental effect if exports raise the productivity of factors already employed, for example through economies of scale or because a higher rate of value-added can be achieved in foreign markets relative to domestic markets. From the above discussion, we can distinguish an ‘internal’ contribution to economic growth that stems directly from raising domestic productivity and an ‘external’ contribution to economic growth (via net exports) that is strongly associated with – but that is not an inevitable outcome of – raising domestic productivity relative to that of other countries. Basically, raising the level of domestic productivity relative to other countries increases the likelihood of a positive external contribution to economic growth but is not a guarantee of such a contribution. The actual impact of an increase in relative productivity on external competitiveness will depend, on the one hand, on market conditions; for example, the extent to which an absolute advantage in productivity terms (i.e. lower absolute price) is necessary to be competitive in international markets. On the other hand, even if EU firms (or sectors as a whole) enjoy a productivity advantage over firms from other countries/regions, there may be other factors not linked to productivity that may prevent EU firms from competing in international markets. These may relate to a variety of (formal or informal) market access barriers (including the inherent ‘tradeability’ of products and services), or simply from the behaviour of EU firms that may not seek to compete in international markets. Finally, account needs to be taken of the impact of macroeconomic factors, notably exchange rate movements that influence the extent to which changes in domestic productivity (measured in local currency) translate into changes in relative international productivity levels. Recalling that EU Treaties frame industrial policy within the context of ensuring the conditions necessary for the competitiveness of the Union's industry then, from the preceding discussion, we can distinguish two categories of competitiveness that are relevant from a policy perspective:

41

“The external and internal dimensions of Europe’s competitiveness”, Speech by Jean-Claude Trichet, President of the ECB at the Institute of International and European Affairs Dublin, 26 February 2009. Text available at http://www.ecb.int/press/key/date/2009/html/sp090226.en.html

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‘Internal competitiveness’ which is concerned with raising domestic productivity as a basis for economic growth. The main contribution of internal competitiveness to economic growth and employment operates through increasing the value-added generated by factors of production (i.e. efficiency effect). ‘External competitiveness’ which is concerned with the capabilities of enterprises, sectors or industry as a whole to compete internationally, which can be assessed amongst other things by changes in international (and domestic) market shares. Although linked to raising domestic productivity – more specifically raising domestic productivity relative to that of international competitors – it depends on other factors as well. The main contribution of external competitiveness to economic growth operates through increasing net exports and, hence, the employment of factors of production (i.e. volume effect).

1.6

Industrial policy and structural adjustment
Beyond creating the right framework conditions for industrial competitiveness, a second(ary) role of industrial policy is to facilitate (speed-up) adjustment processes in industry, specifically in response to so-called ‘structural change pressures’. Typically, this role is associated with measures for declining industries and normally directed towards mitigating the associated adverse social consequences. Looking more broadly, policies to facilitate adjustment processes reflect a recognition that industry – whether at the level of individual firms or industrial sectors – needs to continually adapt in response to changing economic, market, technological, social and other conditions. In this context it is perhaps worthwhile to distinguish between different economic levels at which structural adjustment can be observed. At the risk of oversimplification, processes of structural change can be considered at four broad levels: • Macro sector level, which considers the patterns structural change in terms of the allocation of economic activity/resources across three broad sectors: primary (i.e. agriculture, forestry, fishing and mining industries), secondary (i.e. manufacturing, and frequently construction, also), and tertiary (i.e. all other activities, essentially services). More recently, as the service sector has grown to become the dominant component of the economy, attention has shifted to the pattern of structural change within the service sector and, specifically, the so-called process of ‘quarternarisation’ associated with the rise of information and knowledge-based services. Sector level, which is mainly concerned with changes in the distribution of activity/resources across component sectors of the three broad sectors described above. At this level, and with regard to manufacturing, there has been a wide variation in the experience of different manufacturing sectors within developed economies and, also, in the experience of specific sectors across different countries. Pilat et al (2006)42, for example, point to the differential employment impacts across industries of strong demand (e.g. pharmaceuticals and motor vehicles), international competition of low-cost countries (e.g. textiles), and proximity to market requirements (e.g. food products) as factors underlying differences in performance across manufacturing sectors. It is also worth noting another finding from this study, namely that:
“recent changes in OECD manufacturing employment do not reflect a shift from low- to high technology industries, as was the case in the 1980s. While OECD production and trade patterns in

42

Pilat, D. et al. (2006), "The Changing Nature of Manufacturing in OECD Economies", OECD Science, Technology and Industry Working Papers, 2006/9, OECD Publishing.

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manufacturing clearly demonstrate the growing importance of high-technology manufacturing, employment data show that only one high-technology industry, pharmaceuticals, has experienced employment growth over the past decade. Other high-technology industries have all experienced a considerable decline, with computers and aircraft and spacecraft having the most rapid declines in employment of all manufacturing industries, with the exception of textile products.”

Within sectors, which focuses on changes in market shares within a single industry, typically considered in terms of changes in the market shares of individual firms (or groups of firms) or types of labour. Changes in the composition of the products supplied by a sector - for example, in the form of moving up the value or the introduction of new products (and services) represents another form of structural change. Within firms, which focuses on changes in the structure of production processes within firms. Much of the recent discussion of globalisation has focussed on the fragmentation of production processes (also referred to as vertical specialisation and slicing up the value chain). Here, the process of structural change can be considered to move from outside the firm (or production unit) to within the firm. Rather than competition taking place at the level of final products, it takes place at the level of specific task or activities or tasks within production processes. This phenomenon is closely linked to processes of outsourcing and, at an international level, off-shoring behaviour (see Box 0.6). Initially associated with manufacturing processes per se, fragmentation and specialisation is seen increasingly to also encompass service activities that are associated with manufacturing; in particular where outsourcing/trade in services has been facilitated by advances in digital technologies and low telecommunication costs. The main point here is that processes of structural change can take place within the firm, with firms changing the composition of the portfolio of activities (tasks) that they undertake, focussing on those activities that enable them to develop competitive advantages whilst, at the same time reducing other activities or having them contracted-out to specialist providers. Such changes are, in turn, reflected in changes in the composition of the types of jobs, work process, and skill requirements of workers within firms and, at a more aggregated level, within the sector as a whole.

Box 0.6

Globalisation and the unbundling of production Baldwin (2006) •
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characterises the development of globalisation in terms of two stages:
th

The first unbundling, whose origins can be traced back to the end of the 19 century and with more recent impetus dating from the 1960s, was driven by rapidly falling transportation costs. The reduction in these costs has the effect of removing the necessity to make goods close to the point of consumption, thus providing a spur for international trade in goods. The second unbundling, which began in the 1980s, has been driven by rapidly falling communication and coordination costs. Initially, the reduction in these costs was observed through the removal of the need to perform manufacturing stages near to each other, thus facilitating the geographical dispersion of different production activities related to the same product; reflected, notably, in the ‘offshoring’ of labour intensive (and low skilled) production stages. More recently, the phenomenon has been seen to extend from factories to offices, and from manufacturing to services, driven by the advances in digital technologies and virtual zero telecommunication costs that have meant that service activities previously considered non-traded became freely traded.

This second unbundling, (which has variously been referred to as fragmentation, offshoring, vertical specialisation and slicing up the value chain) has important implications for the way in which we view the structural adjustment pressures of globalisation on industry. In particular, under the first unbundling (in which production processes remained spatially grouped together) global competition occurs at the sector-to-sector or firm-to-firm level. Under the second unbundling (in which production processes can be spatially unpacked), however, competitive pressures operate at the level of the production or service activity – which the author refers to as ‘tasks’ – and it is the task, rather than the sector or the firm, which becomes the common denominator for evaluating competitiveness. In other words, under the second unbundling we are moving towards a new paradigm in which production can be seen as a ‘package of tasks’ and international competition take place in trade in tasks (i.e. competition between workers

43

Baldwin, R. (2006), “Globalisation: the great unbundling(s)”, contribution to the project ‘Globalisation Challenges for Europe and Finland’, organized by the Secretariat for the Economic Council of Finland

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performing the same task in different countries). The implications from this ‘new paradigm’ are far reaching. For a start, it implies that evaluation competitiveness at a ‘traditional’ sector level (or even a firm level) becomes less relevant where the package of tasks provided by the sector can be unbundled and where, as a consequence, international competition/trade takes place at the level of individual tasks. Thus, for example, the average productivity – the traditional measure of competitiveness - of sectors becomes far less relevant than the productivity of individual tasks (production processes) for evaluating competitiveness. Furthermore, whereas changes in transport costs (i.e. the driving force of the first unbundling) can be expected to impact relatively evenly across different goods, and therefore affect sectors in a similar and reasonably predictable way, this is not the case for changes in communication and coordination costs. Changes in information technology and communication costs will impact on the ‘tradeability’ of some tasks and not others; for example, where the task is or is not amenable to a new communication technology (e.g. extent to which it can be codified), or where performance of the task still requires geographical proximity to another spatially ‘fixed’ part or the production process, supplier, or customer. Moreover, there is no reason why the changes in trade costs (i.e. communication and coordination costs) should be correlated to the initial competitiveness of the task; in other words, changes in trade costs may substantially reduce the competitiveness of some initially highly competitive tasks, while leaving some relatively uncompetitive tasks unaffected. Baldwin summarises the implications of the second unbundling under three headings: • Unpredictability: the complex interactions between different tasks are poorly understood, which makes it difficult to predict how a particular bundle of tasks will unravel in the face of changes to the cost of exchanging information and coordinating production across distance. This implies that winners and losers from globalisation are much harder to predict. Suddenness: the development of new technologies and their impact on costs of communication and coordination is difficult to foresee, as is the way and speed with which firms respond in terms of the management and organisations of tasks. Rather than a gradual change, the incremental effect of changes may arrive at a certain point (a tipping point) at which a task can, for example, be offshored to a lower cost location. Thus, tasks seen to be relatively safe from international competition can suddenly be at risk. Individuals not firms, sectors or skill groups: the forces of globalisation will operate at a finer resolution; with international competition increasingly play itself at the level of the tasks within a firm. Thus, looking at the competitiveness (productivity) of a firm as a whole, or the average competitiveness of the firms within a sector may provide poor indicators of the position and perspectives in terms of globalisation impacts. Whereas, for workers, what is important for evaluating these impacts is no longer simply the skill group to which they belong, but also the specific characteristics of the tasks they perform (and their relationship to other tasks) in terms of their ‘vulnerability’ to technological changes affecting communication and coordination costs

The types of factors identified as being responsible for creating the conditions and, in turn, the pressure on industry sectors (and the firms therein) for structural change include broad ‘persistent’ themes such as globalisation, speed of technological change, climate change and environment, and demographic change, to which may be added more ‘sporadic’ themes related to shorter-run events or specific shocks such as commodity and financial market volatility. In turn, these ‘drivers of structural change’ trigger developments such as the introduction of major technological and organisational innovations, the emergence of new competitors and increased competition, adjustments to the availability of inputs and market access, shifts in consumer demand, or changes in regulatory environments etc. that impact on the business environment and business processes. In general, the various drivers of structural change can trigger multiple developments that impact on industry and that operate through a variety of ‘structural adjustment channels’. Broadly speaking we can make a distinction between impacts of ‘drivers of structural change’ that operate through channels that influence demand-side conditions and those that operate through channels that influence supply-side conditions; with in some cases ‘drivers’ that will impact on both demand and supply side conditions. Further, we can add structural change drivers that operate through channels – normally ‘regulatory’ policy measures – that influence the functioning and scope of markets. Thus, we can distinguish three broad categories of structural change impacts leading to structural adjustment pressure:

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Market functioning and scope that are reflected, for example, in changes in conditions governing competition with the markets (e.g. competition policy and regulations); but, also, market access and market integration (e.g. trade policy, internal market, standards). Demand-side impacts that, for example, influence the level and/or scope of markets, or the nature and characteristics of demand; Supply-side impacts that are reflected in changes in production conditions within industry. These may be further differentiated according to impacts in terms of production input effects, productions process effects, or production structure effects. Where these effects will be shaped by the different strategies and business models of firms.

• •

Figure 1.3 tries to illustrate the distinction and inter-relationship between broad structural adjustment ‘themes’, adjustment ‘channels’, and ‘impact’ categories. To provide an example: rapid technological change is one of the ‘themes’ of structural adjustment, within which a specific ‘channel’ may be related to ICT developments. The impact of ICT, both in terms of changes associated with and necessitated by ICT uptake has been identified as being at the forefront of technological changes creating pressures on enterprises to adapt production and organisational structures, and to adopt new management approaches. The types of organisational change involved are multifaceted (e.g. affecting organisational structures, work process, human resource and industrial relations practices, and business practices and management techniques) but are, broadly speaking, encompassed within the heading of e-business practices (including e-commerce). This being the case, we could consider that ICT developments are primarily associated with ‘impacts’ that are related to production processes. At the same time, however, increased utilisation of ICT may be associated with changes in production inputs (e.g. investment in ICT equipment, changes in required labour skills etc.) and production structures (e.g. outsourcing and off-shoring). Furthermore, the utilisation of ICT to develop e-commerce applications, which enable firms to expand markets (or its supplier base) could also be considered under the category of impacts related to ‘market functioning and scope’.

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Figure 1.3

Structural change drivers and adjustment pressure
Structural Change 'Themes' Structural Change 'Channels' Structural Change 'Impacts'

Globalisation

Trade / FDI / Access to markets

Market scope and integration Market functioning

Scope and conditions of mark et and competition

Energy and commodity prices and availability

Commodity Markets Production inputs
Labour, capital, intermediate goods and services, know ledge and technology

Internal Market / Market integration / Regulatory reform / Standards

Rapid technological change

R&D, technology and innovation / Know ledge and skills

Production processes
Entrepreneurship / Access to finance Management and organisation, technology utilisation, intra and interindustry relations

Scope and characteristics of supply (Supply-side conditions)

ADJUSTMENT PRESSURE

Climate change & environment

Energy intensity / Energy security

Production structure
Enterprise size distribution, specialisation, segmentation

Waste / Water / Air (emmissions / pollution)

Demographic Change

Ageing / Migration / Labour Market conditions / Flexicurity

Production outputs (market demand)
Price-based, qualitybased (innovation, branding, etc.)

Scope and characteristics of demand (Demand-side conditions)

Consumer preferances / Demand-side market conditions

The overall adjustment pressure on industrial sectors can be seen as an ‘aggregate’ of the various forces operating through these channels and stemming from structural change drivers. The extent that these ‘drivers’ are translated into structural adjustment pressure will depend, however, on the responsiveness of both demand and supply (separately) to the ‘driver’, and the way in which supply and demand interact to determine the overall condition of the market. In this context, in addition demand and supply conditions, overall market conditions – referred to as the institutional framework (i.e. regulatory and other framework conditions) – will also influence the ability of supply (industry) or demand (consumers) to respond to a structural adjustment driver; i.e. the institutional framework will influence the responsiveness (in terms of size and/or speed of change) of supply and/or demand. At the same time as influencing responsiveness to structural change pressure, changes in the institutional framework can themselves be used to encourage structural change; for example, environmental regulations may increase certain input costs, or necessitate changes in production technologies, or prohibit the production and sale of certain products. Similarly R&D, ICT and other technology-related policies may be used in an effort to shift industry towards hightechnology manufacturing. These types of change in the institutional framework can be seen, therefore, to create adjustment pressures in much the same way as other adjustment drivers.

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Allowing for the inclusion of policy measures aimed at moving industry towards specific types of activities or business processes within the definition of industrial policy (i.e. measures to promote structural adjustment), adds a dimension that goes beyond typical ‘neutral’ or ‘passive’ policy measures aimed at creating benign framework conditions for enterprise development and competitiveness. It implies that industrial policy may also encompass more ‘positive’ or ‘active’ policy measures aimed at influencing and promoting the (structural) development of industry in specific directions. From the above, industrial policy in the context of structural adjustment can be seen to encompass the following elements: • ‘Market functioning measures’ aimed at shaping industrial adaptation in response to structural adjustment drivers or ‘other’ policy objectives. Typically this encompasses the use of regulatory measures that provide incentives or impose requirements on industry that reinforce structural adjustment pressures on industry (i.e. both ‘carrot’ and ‘stick’ measures may be applied). Most obviously, in the current context, this can be related to policy directed towards, for example, changing energy utilisation and environmental emissions by industry in the context of climate change and sustainable development objectives. ‘Supporting measures’ aimed at facilitating processes of industrial adaptation through support for ‘industry’ efforts to exploit new opportunities and respond in an active and positive way to threats created as a result of changing conditions. Such measures can be considered as extension of role of industrial policy to provide the right framework conditions for enterprise development and competitiveness, albeit with a potentially more sector specific dimension given that adaptation requirements can be expected to differ across sectors. ‘Mitigating measures’ to be applied to ease transition in declining industries where the negative impacts of changing conditions on business performance are beyond redress through ‘positive measures’ and where the extent of adverse effects associated with industrial decline – typically in terms of loss of employment – is sufficient to warrant temporary policy interventions. Although ‘entitlement’ to such measures may be based on general principles applicable across industry as a whole, clearly there is a sector-specific dimension in terms of the application of such measures to particular (declining) sectors.

1.7

Industrial policy and sustainable development
In the preceding sub-section, the argument was made that the ultimate aim of industrial policy is to enhance the contribution of industry to economic growth (and employment). The mechanism for achieving this aim is primarily through measures to improve the ‘framework conditions’ so as to enhance the competitiveness of industry. Industrial policy is, however, also subject to other broad policy objectives and desired outcomes beyond the contribution of industry to economic growth and that influence the way in which competitiveness is (or should be) achieved. The (re-launched) Lisbon Strategy, which set out the main policy framework for EU industrial policy, is not simply concerned with delivering growth and employment but, also, that this employment should be in the form of ‘better jobs’. This emphasis on ‘more and better jobs’ is a reflection of broader policy concerns related to social inclusion and cohesion within Europe both in a general and regional context. At the same time, the Lisbon Strategy also emphasises the coherence between the growth and employment agenda with the EU’s commitment to sustainable

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development. Essentially the shorter-run ambitions of the Lisbon Strategy are presented as being consistent with the overarching – and longer run – objectives of sustainable development:
“Making growth and jobs the immediate target goes hand in hand with promoting social or environmental objectives. The Lisbon Strategy is an essential component of the overarching objective of sustainable development set out in the Treaty: improving welfare and living conditions in a sustainable way for present and future generations. Both Lisbon and the Sustainable Development Strategy contribute to ensuring this goal. Being mutually reinforcing, they target complementary actions, use different instruments and produce their results in different time frames.”
44

“The EU SDS forms the overall framework within which the Lisbon Strategy, with its renewed focus on growth and jobs, provides the motor of a more dynamic economy. These two strategies recognise that economic, social and environmental objectives can reinforce each other and they should therefore advance together. Both strategies aim at supporting the necessary structural changes which enable the Member States´ economies to cope with the challenges of globalisation by creating a level playing field in which dynamism, innovation and creative entrepreneurship can flourish whilst ensuring social equity and a healthy environment.”
45

In this context, it is worth noting the wide definition of sustainable development incorporated within the EU Sustainable Development Strategy (SDS):
“It [sustainable development] is about safeguarding the earth's capacity to support life in all its diversity and is based on the principles of democracy, gender equality, solidarity, the rule of law and respect for fundamental rights, including freedom and equal opportunities for all. It aims at the continuous improvement of the quality of life and well-being on Earth for present and future generations. To that end it promotes a dynamic economy with full employment and a high level of education, health protection, social and territorial cohesion and environmental protection in a peaceful and secure world, respecting cultural diversity.”
46

Placing industrial policy in the broad framework of the EU’s Sustainable Development Strategy, the underlying objectives of industrial policy can be formulated not only in terms of the contributions of industry to economic welfare – the core purpose of industrial policy – but also in terms of its coherence with and contribution to social and environmental welfare, as follows: • • Economic welfare, which relates to the contribution of industry to economic growth and employment, and underpins the competitiveness dimension of industrial policy. Social welfare, which relates to the contribution of industry to social inclusion and cohesion. On the one hand, this directly concerns the level and growth of industrial employment but also takes account of the nature (‘quality’) of jobs created within industry. On the other, it embraces wider dimensions of ‘social welfare’ in the context of the role of industry in regional cohesions (e.g. regional/cohesion policy) and also industrial adaptation to structural change pressures (e.g. support for workers in declining industries). Environmental welfare, which related to the contribution of industry to achieving a (more) sustainable utilisation of resources – both within industry itself (i.e. industrial production) and

44 45

COM (2005) 24 “Working together for growth and jobs: A new start for the Lisbon Strategy” 10917/06 “Renewed EU Sustainable Development Strategy” 46 10917/06 “Renewed EU Sustainable Development Strategy”

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in other economic activities and final markets (i.e. consumption) – and to reducing negative impacts of economic activities on the environment. Following from the above, it is possible to distinguish a broad and narrow concept of sustainable industrial policy. The broad concept – aligned to the wide scope of sustainable development adopted under SDS –would integrate the full range of economic, social and environmental aims and objectives set out above. This can be contrasted with a narrower concept of sustainable industrial policy focussed more directly on the environmental aspects, such as sustainable resource utilisation and environmental protection. An issue that arises when we start to consider sustainable industrial policy is the connection between the concepts of sustainability and competitiveness. On the one hand we can consider sustainable competitiveness as simply the ability to maintain competitiveness over a long (sustained) period of time, irrespective of the basis on which this competitiveness is assured. On the other hand, we can consider sustainable competitiveness in terms of achieving competitiveness whilst at the same time contributing to the aims, and complying with the requirements, set for (broad or narrow) sustainable development. Of course, it is arguable that both of these notions of competitiveness ultimately amount to the same thing, if ‘long-run’ competitiveness is considered to be possible only if the objectives of sustainable development are achieved. However, as there is often a certain degree of ambiguity in the way that the term ‘sustainability’ is attached to ‘competitiveness’, and often with little regard to the notion of sustainable development outlined above, it is perhaps worthwhile to make a distinction between: • • Sustained (industrial) competitiveness, reflecting the ability to maintain the competitiveness of industry over a long (sustained) period of time; Sustainable (industrial) competitiveness, reflecting the ability to achieve (and maintain) the competitiveness of industry in accordance with sustainable development objectives. Narrowly defined, these objectives imply that competitiveness should be achieved while using resources in an efficient and sustainable way while minimising negative environmental impacts (i.e. enhancing environmental welfare). More broadly, competitiveness should be achieved while respecting social welfare objectives, such as social equity and cohesion.

The EU Sustainable Industrial Policy Action Plan Although achieving a sustainable growth path has very wide reaching implications for industry, EU policy actions that are explicitly labelled under the heading of ‘sustainable industrial policy’ appear rather limited. Current EU sustainable industrial policy (SIP) is amalgamated with sustainable consumption and production (SCP) in a single Action Plan (see Box 1.7). This Action Plan contains somewhat more concrete initiatives aimed at ‘smarter’ consumption and ‘better’ products, but rather vague actions in relation to industrial production 47. Concerning ‘actions’ that can be linked more directly to the international environment, these include: • promoting sectoral approaches in international climate negotiations;

47

These include: (i) boosting resource efficiency: e.g. tools to monitor, benchmark and promote resource efficiency; (ii) supporting eco-innovation: e.g. tools to monitor, benchmark and boost eco-innovation; a voluntary, partly self financing, EU wide environmental technology verification scheme; (iii) enhancing the environmental potential of industry: e.g. revision of the Community eco-management and audit scheme (EMAS); developing policy initiatives for environmental regulations (screening of regulatory barriers and market failures); helping SMEs (use of Enterprise Europe Network to disseminate know how and expertise in the field of energy and environment).

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promoting good international practices in relation to sustainable consumption and production policies; promoting international trade in environmental goods and services through trade negotiation, including efforts to support the adoption of EU environmental and energy standards as the basis for international standards.

Box 1.7

EU sustainable industrial policy Sustainable industrial policy and related measures Sustainable development - within which economic growth, social cohesion and environmental protection go hand in hand and are mutually supporting - is an overarching long term goal for the EU. In line with the EU Strategy for Sustainable Development (EU-SDS) , the EU has endeavoured over recent years to ‘mainstream’ the objective of sustainable development across a broad range of policy areas . Specifically, from an industrial policy perspective, the EU approach is built upon three basic principles of sustainable industrial policy : • Stimulating the development and commercialisation of low carbon and energy efficient technologies, products and services: ‘sustainable product policy’; • Creation of a dynamic internal market that is supportive of environmental products and services: ‘industrial policy for eco-industries’; • Creation of global markets for low carbon and energy efficient technologies, products and services: ‘global environment and climate change initiatives’. The current EU Action Plan for sustainable consumption and production (SCP) and sustainable industrial policy (SIP)
51 50 49 48

is built on a core of actions aimed at improving the energy and environmental performance of products

and foster their uptake by consumers. This includes initiatives for eco-design, for eco-labelling, and the promotion of green public procurement, while at the same time withdrawing entitlement to EU incentives for products below a certain level of energy or environmental performance. These actions are to be combined with (as yet undefined) initiatives to support eco-industries through addressing market failures and regulatory barriers. From the broader international perspective, the Action Plan offers support for (voluntary) sectoral approaches to limit emissions, for the promotion of international ‘best practices’ for sustainable consumption and production, and for the promotion through international negotiations of trade in environmentally friendly goods and services. Concerning EU policies directed towards improving the energy efficiency and environmental impact of production processes, a more regulatory approach is encapsulated in measures such as the Integrated Pollution Prevention and Control (IPPC) Directive ETS) . Recent amendments to EU-ETS renewable energy sources
56 53 54 52

and the Greenhouse Gas Emissions Trading System (EU55

and directives on carbon capture and storage (CCS)

and on

are all part of a wider package of initiatives and reforms directed towards meeting

the EU’s target of reducing its overall emissions by 20% below 1990 levels by 2020.

48 49

Council of the European Union DOC 10117/06 COM(2009)400 50 COM(2007)374 51 COM(2008)397 52 Directive 2008/1/EC 53 Directive 2003/87/EC 54 Directive 2009/29/EC 55 Directive 2009/31/EC 56 Directive 2009/28/EC

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Towards Sustainable Industrial Competitiveness policy
Issues paper to EU Ministers of Industry Part II A SMEs, Innovation and Growth

Client: Ministre de l'Economie, des PME, du Commerce extérieur et des Technologies nouvelles du Gouvernement Wallon

ECORYS Brussels NV in partnership with IDEA Consult NV

Brussels, 18th June 2010
P P

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Table of contents
Preface SMEs, innovation and growth 1.1 Background and general context 1.2 Overview of key issues 1.2.1 Constraints on SME innovation 1.2.2 Constraints on growth of innovative SMEs 1.3 Policy responses 1.3.1 Implications of a ‘paradigm shift’ for SMEs 1.3.2 Innovation in SMEs, entrepreneurship and the “Small Business Act” 1.3.3 The role of competitive innovative clusters 1.3.4 Targeted support towards sub-sets of SME population 1.3.5 Access to finance for innovation 1.3.6 Reinforcing demand-driven policies: triggering the ‘pull factors’ 1.3.7 Improving multi-level governance of innovation towards more coherence and more co-ordination 1.4 Key conclusions 3 4 4 6 6 8 9 9 10 11 13 14 15 17 18

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Preface
In the current economic climate, and with a new European Commission just starting, expectations about the EU's ability to advance in the development and implementation of coherent and coordinated economic and competitiveness policies is high. There is a clear need to revisit the key components of an integrated industrial policy for sustainable competitiveness. It is important to further define the Europe 2020 ambitions and translate them into concrete policies that will contribute to recovery and long-term competitiveness of EU industry as a whole. Within this context the EC is preparing a Communication on Sustainable Industrial Competitiveness Policy in the autumn of this year. This issues paper is being prepared on request of the Belgian Presidency. It aims to inform the preliminary conclusions of the Industry Council of the EU, based on evidence which can be confronted with the European Innovation Plan and the Commission’s Communication on Industrial Policy. The study results will be integrated in the programme of the Belgian Presidency. This Issues paper consists of the presentation of a general framework for Sustainable Industrial Competitiveness Policy (Part I), followed by two contributions where this framework is applied to specific situations: SMEs, Innovation and Growth (this Part IIA) and Transformation and Resource-intensive Industries (Part IIB).

Vincent Duchêne Paul Baker

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SMEs, innovation and growth

1.1

Background and general context
Increasing competitiveness by reducing costs and stabilising public finances, while essential, will not be sufficient to ensure that the EU reaches a higher, sustainable growth path necessary to meet the economic, social and environmental challenges it is facing. Ultimately, this requires increasing productivity, which is the key driver of long-run economic performance and sustainability. In turn, innovation – by both generating and exploiting ideas – is crucially important because it is a key driver of productivity growth. Thus, innovation policy is a critical subset of any Sustainable Industrial Competitiveness policy.

Any attempt towards Sustainable Industrial Competitiveness Policy is doomed to fail if not specifically aligned to SMEs...

Economic simulations show, for instance, that, to keep the costs of tempering and adapting to climate change within acceptable limits, we need a sufficiently broad spectrum of implemented technologies 1 . Although much can already be done with a more effective diffusion and implementation of ‘best available technologies’, new technologies (in particular ‘zero-emissions’ technologies that are also not dependent on constrained resources) also need to become available. Today, these technologies are either not yet available or far from large-scale implementation.
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Small and medium sized enterprises (SMEs) represent the overwhelming majority of European enterprises (more than 95%). In the EU-27, they also account for more than two-thirds of the non-financial business economy workforce and for almost 60% of the non-financial business economy’s value added 2 . Therefore, any attempt towards Sustainable Industrial Competitiveness Policy is potentially doomed to failure if it is not aligned to the SME population. To put it bluntly: achieving a 10% improvement of ‘sustainability’ among SMEs is likely to have a far larger impact on society than a 50% improvement among large companies. Finally, SMEs do not only adopt sustainable modes of production (demand-side), they can also generate ‘green’ innovations and are often critical in the value chain (supply-side). Accordingly, SME’s – and specifically their innovation behaviour – can play a crucial role in achieving the EU’s economic, environmental and social ambitions.
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In assessing the actual and potential importance of SMEs innovation behaviour, it is important to recognise at the outset that the vast majority of SMEs do not actively engage in research and technology development in a formal sense. For example, EURAB (2004) 3 indicates that the vast majority of SMEs, about 70%, undertake no or little formal R&D
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Aghion, Ph., Veugelers, R. and Serre, Cl., “Cold start for the green innovation machine”, Bruegel Policy Contribution 2009/12, November 2009; Bosetti, V., Carraro, C., Duval, R., Sgobbi, A. and Tavoni, M. (2009) ‘The role of R&D and technology diffusion in climate change mitigation: new perspectives using the WITCH model’, OECD, Economics Department working paper 664. 2 Eurostat, “Enterprises by size class – Overview of SMEs in the EU”, statistics in focus, 31/2008, p. 1. 3 European Research Advisory Board (EURAB), report on “SMEs and ERA), EURAB 04.028-final
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activities. At the other extreme, a very small number, less than 3%, is involved in leadingedge research. In between these extremes, some 30% of SMEs regularly develop, apply or acquire technology. An obvious implication is that one policy objective may be to move SMEs up the research “stairway” towards higher engagement with, and involvement in, technology developments. Although most SMEs do not engage in research in a formal sense, the vast majority of SMEs do innovate. Where innovation is understood as a much wider concept that goes far beyond technological development:
“Innovation entails investment aimed at producing new knowledge and using it in various applications. It results from the interaction of a range of complementary assets which include R&D, but also software, human capital, design, marketing and new organisational structures – many of which are essential for reaping the productivity gains of and efficiencies from new technologies” .
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Innovation needs to be understood in a broad sense – as most SMEs do not really engage in research in a formal sense...

From a policy perspective, therefore, it is important to recognise that SME innovation does not just concern ‘high-tech’ innovation but also encompasses production processes, business models and organisational design as well as technologies, and it is of application in both the manufacturing and the services sector. This broad understanding of innovation – and implications for competitiveness and sustainable development – can be applied to domestic as well as internationally-traded sectors, public and private sectors, manufacturing and services industries. A large part of innovation in SMEs is motivated by the almost daily struggle to survive rather than by a long-term strategic development plan. Time horizons are short, resources are lacking, and solutions have to be practical and quick 5 . Typically, SMEs improve their existing products, processes and services in small step-by-step ways (incremental innovation). More rarely, they take a major risk and introduce a new product, process or service (radical innovation). Although ‘new’ knowledge required for innovation can sometimes come from research, more frequently, it comes from listening to customers and suppliers, observing competitors, talking to potential customers, experimenting with present products, processes and services, visiting fairs etc.
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Although much of innovation in SMEs may be incremental and lacking long term strategic direction, a number of recent studies highlight the significance of highly innovative, high-growth SMEs for economic growth and industrial transformation 6 . In the US, for instance, this type of companies nowadays account for a disproportionate share of net job creation 7 . There is evidence, however, that in the EU the typical growth path of innovative SMEs lacks critical dynamism, to that extent that this explains part of the structural EU-US growth performance gap. In the US, and to an increasing extent in Asia as well, many ‘Young Innovative Companies’ (YICs) are able to grow rapidly and become key economic players worldwide. This occurs to a much lower extent in the EU.
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OECD (2009), Interim report on the OECD Innovation Strategy, Paris, 2009, p. 4. EURAB report on “SMEs and ERA”, Report and Recommendations, EURAB 04.028-final
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Cunningham, P. (2008), “Policies in support of High-Growth SMEs” – Thematic report, INNO Policy Trendchart, July 2008; Veugelers, R. (2009), “A Lifeline for Europe’s Young Radical Innovators”, Bruegel Policy Brief 2009/1, March 2009 7 “Fast-growing young firms, comprising less than 1 percent of all companies, generate roughly 10% of new jobs in any given year”, in: Stangler, D. (2010), “High-Growth Firms and the Future of the American Economy”, Kauffman Foundation Research Series: Firm Formation and Economic Growth, March 2010.
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Using a sample of the largest companies in terms of market capitalisation and research and development spending, Veugelers (2009) shows that in the US (and also other nonEuropean countries) young companies make up a much larger proportion of leading innovators than in Europe. 22% of the US companies which are now in the world top 1000 in terms of market capitalisation were created after 1975, compared with only less than 5% of their European counterparts 8 . Most of these US companies (created after 1975) are ICT companies, but similar trends can be seen in other emerging high-tech sectors, such as in the biotech sector. It seems that the US and some Asian economies have, to a larger extent than the EU, the flexibility to re-orient themselves towards new promising sectors, especially through the rapid growth of new innovative companies.
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In addition, if we focus on radically new innovations that have the potential to generate new markets, young innovative companies become even more pivotal, as incumbent companies tend to concentrate their innovative activities relatively more on incremental innovations that build on their existing competences 9 .
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A need both for young companies to develop new products and for existing SMEs to absorb new innovations...

In a nutshell, for a Sustainable Industrial Competitiveness Policy to be effective – i.e. supporting the transformation to a green(er), sustainable economy – we need to have both: − More young innovative companies able to develop new businesses up to a minimum critical mass (cumulative process); − More innovative SMEs able to absorb new (sustainable) technologies and innovations, or at least able to absorb the ‘best available technologies’.

1.2
1.2.1

Overview of key issues
Constraints on SME innovation SMEs encounter specific constraints when it comes to engaging in innovative operations or using and exploiting innovations (from others). Although available evidence is not conclusive about which types of ‘constraints’ have the most impact on SMEs 10 , the most commonly mentioned ones referred to are: • Limited access to finance for innovation; • Difficulties in appropriating the benefits from research and innovation; • Lack of innovation absorption capacity; • Regulatory and administrative burden; • Lack of effective training and education programmes.
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This figure does not include creation of companies through mergers and acquisitions, but only ex nihilo creations. Veugelers, R. (2009), “A Lifeline for Europe’s Young Radical Innovators”, Bruegel Policy Brief 2009/1, March 2009, p. 2. These results correspond also to earlier findings by Cohen, E. and Lorenzi, J.-H. (2000), « Politiques industrielles pour l’Europe », Conseil d’Analyse Économique, 2000, Paris, p. 122-126. 9 Veugelers, R. (2009), Op cit., p. 2 (based on earlier findings). 10 Notably because the SME population is very heterogeneous and some constraints are not applicable to all types of SMEs, and because there may be regional or national differences at stake here.
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Innovation is by definition riskier for SMEs, while they have less access to capital markets to fund it...

Limited Access to finance for technology development and innovation There are multiple reasons why SMEs encounter specific difficulties to access innovation funding and finance. Veugelers (2008) 11 , for instance, points to the following factors: • Innovative projects undertaken by small firms are, ceteris paribus, riskier than if done by larger firms. This is due to the fact that SMEs can be disadvantaged in terms of lacking the wide range of complementary competencies and experience – such as marketing, pure management, organisational fine-tuning, access to complementary know how – needed for reaping the full benefits of, for example, a technological improvement. • Imperfections in capital markets usually affect SMEs more than large firms for two reasons: (i) the availability of internal financing is normally less constraining for older/larger firms than for smaller/younger ones and (ii) access to global capital markets is easier/cheaper for larger firms.
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SMEs often lack the scale to take all measures necessary to capture the value of their innovations...

Difficulties to appropriate the returns from investment Beyond the issue of more difficult access to finance, one can also mention the difficulty of appropriating the benefits from innovation. For instance, even in the presence of a patent system, SMEs may find it more difficult to appropriate the returns from their innovations, notably because the cost of patenting may be too high for a SME. Moreover, appropriation requires complementary strategies to patents (e.g. trademarks, secrecy, lead time, complexity), but SMEs may lack the necessary critical scale to effectively implement these types of strategies. In addition, SMEs may be unable to appropriate the surplus created by subsequent innovations that build on the knowledge introduced by the initial innovation. Limited innovation absorption Evidence points to the need for an own absorptive capacity for SMEs that allow them to benefit from RDI cooperation. SMEs may again lack the necessary scale to develop such absorptive capacity. Moreover, compared to larger companies, SMEs have also specific constraints with regard to their ability to keep abreast of the latest developments affecting their sectors. Timely information can be crucial to the success of businesses. Inadequate knowledge or access to new technologies and know-how represents, given the limited resources at their disposal, a constraint affecting SMEs to a greater extent than for larger companies. A disproportionately high regulatory and administrative burden One of the most burdensome constraints reported by SMEs is compliance with administrative regulations. Indeed, SMEs bear a disproportionate regulatory and administrative burden in comparison to larger businesses. It has been estimated that where a big company spends one euro per employee for implementing a regulatory duty, a small business might have to spend on average up to 10 euros. 36% of SMEs report that red tape had a significant dampening effect on innovation as well as on broader

… and to develop the necessary absorptive capacity...

Implementing regulatory duties can cost SMEs up to 10 times more than large companies...

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Veugelers, R., “The case of SMEs in innovation in the EU: a case for policy intervention?”, (Memo for BEPA), March 2008.
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entrepreneurial activities over recent years 12 . SMEs also are particularly vulnerable to overly complicated patent procedures and property right laws.
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More than 60% of companies think that schools do not provide the competences required....

Lack of effective education and training programmes While it is widely accepted that effective education and training programmes are fundamental to a country’s innovative capacity, there is also a consensus that many educational systems in the EU fall short in delivering the technical and managerial skills required to develop or take advantage of new developments. More than 60% of companies consider that schools do not provide the competences needed by the entrepreneurs and their staff. SMEs suffer in particular from the lack of skilled labour in the field of new technologies 13 .
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1.2.2

Constraints on growth of innovative SMEs In addition to constraints on innovation within SMEs, as noted above, SMEs in the EU seem to suffer from a less dynamic growth profile than observed elsewhere, notably in the US. Again, the reasons that may explain this lack of dynamism are many-fold, but two explanatory factors are often mentioned: • Market fragmentation and market access barriers; • Financial market functioning, notably for venture capital. The EU remains a fragmented market Differences in market integration are usually mentioned when assessing the differences in growth path between companies at both sides of the Atlantic. An SME in the US has much more growth potential due to the economies of scale and scope that the integrated US market (including common standards, more coherent legislation with regard to public procurement rules, trade mark rights etc) offers. In the EU, SMEs are more affected by the fragmented nature of aggregated demand and institutional frameworks than large companies which have the infrastructure for trading and exporting. The evidence suggests indeed that new EU firms face higher barriers to entry, exit and growth compared to their US counterparts 14 . This implies a strong link to the Single Market policy.
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Innovative EU firms face higher barriers to entry, exit and growth than their US counterparts...

Limited interest from financial markets to support innovative SMEs There is evidence of less willingness (or ability) on the part of the EU financial markets to fund innovations or new innovative companies (e.g. venture capital) than is the case in the US 15 . In spite of some recent initiatives (such as the joint EC-Eureka ‘Eurostars’ initiative, the EC-EIB Risk-Sharing Finance Facility or the EC-EIB Jeremie Joint Initiative), a key ingredient is still missing here: an EU-wide financing solution for fastmoving European companies. This has been repeated recently by the European Commission, pointing to the fact that European venture capital markets are still functioning below their potential, reflecting a long-standing market failure in equity
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Report from the Expert Group on “Models to reduce the Disproportionate Regulatory Burden on SME”’, May 2007 (available at http://ec.europa.eu/enterprise/policies/sme/files/support_measures/regmod/regmodex_en.pdf) . 13 “Think Small First”. A “Small Business Act” for Europe, COM(2008) 394 final, p.15. 14 Philippon, T. and Véron, N. (2008), «Financing Europe’s fast movers », Bruegel Policy Brief 2008/1, March 2008. 15 EC (2007), “Key Figures 2007 on Science, Technology and Innovation. Towards a European research Area”, (EUR 22572), Brussels, p. 36-37.
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finance at both the demand and supply side of venture capital 16 . This lack of funding for innovation within SMEs is currently being aggravated by both the financial crisis and economic downturn and the associated increased risk awareness.
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An EU-wide financing solution for fast-moving European companies is still missing...

This structural lack of funding in the EU also implies that young, innovative companies looking for growth financing may be in the EU more rapidly bought up by larger companies able to finance their commercial development. This in turn has different implications in terms of growth and employment as compared to internally driven growth of SMEs. One implication is that international buy-outs are more likely to lead to international relocation of innovation activity, or to ‘technology outsourcing’, while internal-driven growth of SMEs is more likely to remain embedded in the region of origin. Therefore, beyond the structural lack of innovation funding, there is also an aggravated risk that the return on EU innovation is captured by non-European firms rather than remaining in the EU.

1.3
1.3.1

Policy responses
Implications of a ‘paradigm shift’ for SMEs The previous section elaborated some of the key issues seen as constraining the degree of innovation within SMEs and the potential growth of innovative SMEs. The types of constraints facing SMEs are not new, but they are exacerbated by the challenges facing SMEs. These go beyond the present economic situation and touch upon more fundamental changes (e.g. globalisation, energy and environment, technological change etc.) that are exerting significant adjustment pressures. The challenges facing SMEs will require significant changes to the ways in which businesses operate. The extent of the necessary adaptations required to these challenges has led some commentators to argue that a fundamental ‘paradigm shift’ is needed in the way in which businesses – and policy-makers – address competitiveness, economic growth and job creation, most notably in relation to moving the a sustainable (‘green’) long term growth path.

For SMEs, the risks of adjusting wrongly may be higher than for large companies, but the gains of adjusting correctly may be higher as well...

In terms of the capacity of firms to make the sorts of radical changes implicit in a ‘paradigm shift’, SMEs may have greater flexibility to adapt than larger firms that are ‘locked-in’ to existing business practices and production processes. However, as pointed out earlier, larger firms may be more able than SMEs to spread risks associated with shifting to a new growth path. For individual SMEs, with a smaller portfolio of activities or markets over which to effectively spread risks then the consequences making a ‘wrong’ decision could be more dramatic (e.g. in terms of business failure); although, conversely, the return on making a ‘right’ decision could also be higher. At an aggregate level, if the ‘paradigm shift’ argument is right, then on balance this has to favour shifting to new production process and ways of doing business, rather than retaining ‘old/traditional’ approaches. Overall, from a policy perspective, the aim would be to encourage existing firms to undertake the necessary adjustments to shift to a new sustainable growth path – even if this may imply a transition that could raise the number of business (particularly among SMEs) while encouraging the creation of firms based on
16 European Commission (2009), Commission Staff Working Document. “Financing Innovation and SMEs”, Brussels, Sept 2009, SEC(2009) 1196 final.
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‘sustainable’ growth practices. This would imply that higher 'churn' (more company formation and closure) could be the necessary counterpart to achieving the shift to a new (sustainable) growth pattern. From the above, it follows that there is an important connection between industrial adaptation and shifting to a new sustainable growth path, and the discussion of policy in relation to entrepreneurship and risk-taking behaviour. In particular, how can policy act to stimulate entrepreneurs and SMEs to take the (individual) decisions required to bring about the necessary changes in production processes and business behaviour (i.e. to increase the 'up-side' of making the right decision while reducing the 'downside' of making the wrong ones). 1.3.2 Innovation in SMEs, entrepreneurship and the “Small Business Act” Following from the above, there is a clear link between SME innovation policy and entrepreneurship, hence a link to the Small Business Act (SBA) 17 .
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The Small Business Act addressed most of the key issues...

The SBA and its effective implementation by Member States have the potential to make an important contribution to innovation in SMEs, because it addresses several of the constraints identified above 18 . For instance:
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Access to innovation financing: for instance, the new General Block Exemption Regulation adopted as part of the SBA consolidates and harmonises previous support rules and raises aid intensity for SMEs (i.e. 20% higher aid proportion for small enterprises and 10% higher for medium-sized enterprises). Member States have also adopted in 2008 and 2009 policy measures to enhance SMEs’ access to liquidity, especially to bank lending, through the creation and extension of loan and guarantee schemes. Within the 7th FP, an SME can now keep the benefit of SME treatment even if it exceeds the SME ceilings during the project. Despite these improvements and as pointed above, recent evidence shows that the lack of funding for innovation remains a problem 19 . Market fragmentation – access to markets – access to property rights protection: the SBA bundles and re-focuses initiatives with regard to an easier or larger access to the Single Market for SMEs. For instance, in May 2009, the EC and the Member States jointly decided to lower the fees for EU-wide trade mark rights by 40%. The SBA also invites Member States to take most of the so-called ‘European Code of Best practices’ to facilitate SMEs’ access to public procurement contracts adopted as a part of the SBA in June 2008. The EC also increased EU financial support in 2009 to improve SME information on, for instance, the use of European standards etc. Regulatory and administrative burden: the SBA re-invigorates the general trend towards administrative simplification. According to the 2009 SBA implementation report, all Member States have now adopted targets for reducing administrative
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“Think Small First”. A “Small Business Act” for Europe, COM(2008) 394 final; European Commission (2009). Ibidem; see also Report on the implementation of the SBA, COM(2009) 680. 19 European Commission (2009), Commission Staff Working Document. “Financing Innovation and SMEs”, Brussels, Sept 2009, SEC(2009) 1196 final. See also European Commission (2009), “Summary of responses to the public consultation on Community Innovation Policy”, Dec 2009 (available on http://ec.europa.eu/enterprise/policies/innovation/future-policy/consultation/results_en.htm .
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burden and have been continuing to simplify the administrative environment for SMEs. For instance this has led to a substantial reduction of the average time and cost to start-up a private limited company between 2008 and 2009. There is however still room for improvement, for instance under the form of expanding electronic onestop-shop systems like in Slovenia. Effective Education systems: the SBA promotes the exchange of best practices in enterprise education, and invites Member States to introduce entrepreneurship as a key competence in school curricula. According to the 2009 implementation report, a number of EU countries have already anchored entrepreneurship education in their curricula, while others have decided to do so in the future. In Austria, Denmark and Sweden, Entrepreneurship education is currently the object of a new national strategy or action plan. The challenge however, is to combine these curricular changes with innovative learning methods, as well as to increase the cooperation with the SME community.

Above all, the SBA increases coherence in policies towards SMEs...

Probably the major overall contribution of the SBA is to stimulate the streamlining of the large spectrum of relevant policies to reflect the specific needs and constraints of SMEs (i.e. ‘to irreversibly anchor the “think small first” principle in policy-making’ 20 ). If effectively implemented at all levels, the SBA will not only increase the coherence of policies towards SMEs, but also increase the level playing field in which SMEs operate (and can grow). The introduction in the course of 2009 of an ‘SME-test’ by the Commission and a few Member States to assess the impact on SMEs of major legislative and policy proposals indicates the willingness to re-orient the whole policy-decision approach in this regard. Moreover, while some Member States may focus on the implementation of some axes of the SBA, some others have ‘transposed’ the SBA as a whole in their national policy programmes (e.g. Italy, Ireland).
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… but its ‘innovation dimensions’ should be reinforced...

If effectively implemented, the SBA will contribute to improving the growth conditions of European SME’s. However, in view of the potential role of innovation for achieving the transformation necessary to shift towards higher, sustainable growth paths, there might be need for even more major efforts to reinforce the ‘innovation dimension’ within the SBA (or to launch a specific ‘SBA for innovation’). Certainly, it will remain very important to pay a particular attention to the articulation between the SBA and its implementation on the one hand, and the upcoming Innovation Act on the other hand 21 .
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On top of this, some elements that may play an additional role in this context are discussed under the following sections. 1.3.3 The role of competitive innovative clusters Paradoxically, globalisation increases the importance of local situations and local anchorage. Therefore it also increases the importance of the framework conditions and policies to attract economic and innovation actors and stakeholders to build powerful cooperation networks. Policies stimulating innovation networking such as innovative
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“Think Small First”, op cit., p. 3. “Research and Innovation Strategy”, Communication of the European Commission (forthcoming, expected Sept-Oct 2010).

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clusters are also critical in the context of nurturing, transferring and implementing on a large-scale new, key enabling technologies 22 . The pervasive character of these key enabling technologies (e.g. nanotechnologies, biotechnologies, bioinformatics, new materials etc) and the blurring boundaries of traditional ‘sectors’ (i.e. the traditional view that considers industrial sectors as ‘homogeneous’ and independent no longer holds as adequate basis for policy development) call for the development of multidisciplinary cooperation. It is thus all the more important that the EU stimulate fair competition and the development of the necessary framework conditions to allow for the development of highly-competitive, multidisciplinary innovative clusters. In this regard the work carried out by the EC on clusters (in terms of e.g. supporting cross-border clusters or diffusing information on international best practices) is welcome and needs to be continued.
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Clusters must have the possibility to reach a sufficient critical mass in order to be internationally competitive …

While the bottom-up approach is important to align the object and missions of a cluster with the relative strengths, weaknesses and opportunities of the regional innovation systems (following the principle of ‘smart specialisation’ 23 ), it is important to recognise that these clusters must have the possibility to reach a sufficient critical mass in order to be internationally competitive. This may imply the potential evolution from local to interregional clusters active at EU-level. Moreover, ‘smart specialisation’ also implies an improved interaction between levels of governance to ensure full complementarity between local clusters and EU developments such as European Technology Platforms or Joint Technology Initiatives.
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When it comes to SMEs, innovative clusters are an important link within European innovation systems between technology and innovation producers, small and large companies, high-tech and low-tech companies. They facilitate the transfer of technology within and towards the SME population and they contribute to the internationalisation of SMEs by linking them more effectively to large companies or other international partners. At the same time, although clusters benefit from the presence of large multinational companies, the integration of dynamic and innovative SMEs into clusters is particularly important for helping clusters achieve high levels of excellence and innovation. Clusters and cluster organisations can offer a wide range of business services – in particular to SMEs (e.g. facilitating cooperation with research institutions, managing IPR, supporting internationalisation activities) – which supplement current innovation support mechanisms towards SMEs. Recent reports show, however that there is a need to better integrate SMEs into innovative clusters 24 . Many cluster initiatives and cluster organisations, for instance, lack a critical mass and strategic orientation to fully exploit the potential of SMEs. This is partly because SMEs are not fully integrated in clusters and do not participate enough in cluster initiatives. The same holds for other initiatives such as European Technology
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Local clusters (and participating SMEs) need to be better linked to EUlevel initiatives, such as European Technology Platforms...

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“Preparing for our future: Developing a common strategy for key enabling technologies in the EU”, COM(2009) 512/3.
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Foray, D., David, P.A., and Hall, B., “Smart Specialisation – The Concept”, Knowledge Economists Policy Brief nr. 9, June 2009 (http://ec.europa.eu/invest-in-research/pdf/download_en/kfg_policy_brief_no9.pdf?11111).
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“The concept of clusters and cluster policies and their role for competitiveness and innovation: main statistical results and lessons learned”, Europe INNOVA / PRO INNO Europe Paper nr 9, Commission Staff Working Document SEC(2008) 2637, October 2008; “Towards world-class clusters in the European Union: Implementing the broad-based innovation strategy”, COM(2008), 652 Final/2, October 2008; European Commission (2009), “Summary of responses to the public consultation on Community Innovation Policy”, Dec 2009 (available on http://ec.europa.eu/enterprise/policies/innovation/future-policy/consultation/results_en.htm.
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Platforms (ETPs), Joint Technology Initiatives (JTIs), Lead Market Initiatives (LMIs), or the recently launched Knowledge and Innovation Communities (KICs) of the EIT. For example, according to a recent evaluation of the ETPs 25 , there is need to better involve SMEs (in all their variety) in the definition of the strategic research agenda, especially in sectors with a large concentration of SMEs. Limited resources and absorption capacity often prevent them to use the outcomes of platforms 26 . Better, customized services offered by cluster organizations and targeting SMEs should be tested and implemented, and these initiatives can be part of the European Cluster Alliance Initiative 27 .
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1.3.4

Targeted support towards sub-sets of SME population Policies may take the option of targeting sub-sets of the SME population, such as ‘highgrowth / high-tech’ SMEs. Arguably, the heterogeneity of SMEs as well as the relative importance of high-growth, high-innovative companies for both aggregate growth and the introduction of radical innovations call for more tailored approaches 28 . The topic of highgrowth start-ups, spin-offs and SMEs (and the need for a differentiated approach between them) do form a focus for policy discussion in many EU countries. However, few countries have policies or initiatives that explicitly target support for high-growth companies; the majority of policies that are applicable to such companies tend to be generic SME support policies 29 . Recently, new State Aid rules for innovation have identified young innovative enterprises, which can be a big step towards more targeted national level policy.
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Few countries have policies that target support to high-growth SMEs...

This of course raises the issue of the extent to which policy should, and is able, to differentiate between various segments of the SME population. Comparing SMEs with large companies, the latter are indeed far easier to identify and target (not only for innovation policy initiatives). Moreover, policies aimed at somehow supporting the emergence of high-growth companies may be something of a blunt and static instrument acting on a dynamic target. Provided that differentiating between SME sub-groups and ‘favouring’ some of them is politically accepted, one has to investigate first what can be done to better identify those types / groups of SMEs that would have the greatest 'valueadded' if their innovation capacity was enhanced (and accordingly could be targeted through innovation policy). Secondly, we should be sure that the current innovation 'themes' (e.g. eco-innovation, biotech) are actually the most relevant and with the most 'value added' for SMEs. In particular, if we are talking about sustainable innovation
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Idea Consult, “Evaluation of the European Technology Platforms (ETPs)”, final report, August 2008 (available at: http://cordis.europa.eu/technology-platforms/home_en.html) . ‘European Technology Platforms’ (ETP’s) bring together technological know-how, industry, regulators and financial institutions to develop a strategic agenda for leading technologies. They were set up as industry-led stakeholder forums with the aim of defining medium to long-term research and technological objectives and developing roadmaps to achieve them. The definition of Strategic Research Agenda’s in specific areas is key for structuring the efforts and may result into the launch of a Joint Technology Initiative (JTI) for its implementation. For a status report, please consult: European Commission (2009), “Fourth Status Report on European Technology Platforms. Harvesting the Potential”, (DG RTD), EUR 23729, June 2009.
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In this context we can note the initiative to hold a session on ‘fostering international cluster cooperation with a focus on mechanisms for SMEs’ during the upcoming 2010 European Cluster Conference (Sept-Oct 2010). See: http://www.proinnoeurope.eu/clusterconference2010/content/european-cluster-conference-2010.
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See for instance the proposal by Veugelers for “A (Green) EU Programme for Young Innovative Companies” (Veugelers, R. (2009), “A Lifeline for Europe’s Young Radical Innovators”, Bruegel Policy Brief 2009/1, March 2009, p. 7-8). 29 Cunningham, P., “Policies in support of High-Growth SMEs” – Thematic report, INNO Policy Trendchart, July 2008.
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policy / eco-innovation, are current concepts and initiatives broad enough to have a substantial impact on SMEs (and contribute to a transformation towards a new sustainable growth path)? Developing specific policy action towards high-growth / high-tech SMEs should go hand in hand with tailored action towards ‘lower-tech SMEs’. Any Sustainable Industrial Competitiveness policy and a substantial shift towards a ‘greener’ economy cannot succeed if its impact remains limited to the top 1% of the SME population. Therefore, there is need to improve the current mechanisms for knowledge diffusion, codevelopment of innovations, technology transfer etc in the EU at all levels of governance. Technology transfer tools have been developed over the past 15 years in the EU at both the EU and the national / regional levels. In general, policy intervention comes under the form of funding ‘intermediaries’ (innovation agencies, public research centres, private consultants, universities) for the co-development of innovations of benefit to SMEs. Sometimes (as in the case of the FP7 SME-specific measures), the SME itself receives funding to ‘buy in’ research services from a knowledge provider. A recent evaluation shows, however, that intermediaries may have a too dominant role in the conception and execution of the innovative project, limiting implicitly the valorisation potential afterwards by the SMEs. Projects where the original idea came from the SME are more likely to result in successful commercial outcomes. Therefore -and this holds true for all technology transfer programmes- it is crucial that SMEs are encouraged to play an active role in the project from the outset 30 .
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Green technologies need to be transferred to mainstream SMEs on a much wider scale...

1.3.5

Access to finance for innovation As pointed above, and in spite of some recent improvements, the limited access to innovation financing remains a problem, especially in the current context of credit squeeze caused by the crisis. In this respect, it is very important to keep working on building a single market for venture capital; the fact that it is one of the major actions under consideration in the current preparation of the ‘Innovation Act’ is to be welcomed 31 . The idea of raising, in partnership with the EIB, additional capital funds for start-ups, innovative SMEs and growth businesses, is also very much welcome 32 . However, while building up a Single Market for risk capital is critical, it is also desirable that other financial instruments are broadened (e.g. guarantee schemes) to widen and expand the innovation trajectory of SMEs.
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Towards a Single market for risk capital, reinforced by other financial instruments to expand the innovation trajectory of SMEs...

The most important source of external financing for innovation in SMEs is the commercial bank loan. A mid-term assessment of the joint EU-EIB ‘Risk-Sharing Finance Facility’ can be helpful to adapt the scope of this facility according to the new needs of the present situation. In particular, this may allow the EU to leverage public initiatives of regions or Member States providing guarantee, loans and other debt
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European Commission (2010), “Impact assessment of the SME-specific Measures FP5 and FP6”, EUR 24290 EN, 2010; Idea Consult, “Impact Assessment of the SME-specific measures of the Fifth and Sixth Framework Programmes for Research on their SME target groups outsourcing research. Final evaluation report”, 2010. Both documents available at http://ec.europa.eu/research/sme-techweb/index_en.cfm?pg=publications . 31 “Towards an Innovation Union. Preparation of the new EU Research and Innovation Plan. Presentation to the Enterprise Policy Group”, (EC, DG Enterprise, powerpoint presentation), May 2010. 32 Ibidem.
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financing for research and innovation to SMEs, for which these local initiatives become more easily accessible. 1.3.6 Reinforcing demand-driven policies: triggering the ‘pull factors’ Policies supporting innovation and technological development have long been focusing on the supply side (i.e. increasing innovation in SMEs, increasing absorption capacity in SMEs). The trend towards more demand-driven policy tools is important and should be reinforced, because it offers another important way of reducing risk for SMEs by stimulating and expanding aggregate demand for new sustainable/green products and services (e.g. eco-innovations). From the public side, public procurement markets (i.e. the public sector covering part of the risk associated with SMEs innovation by favouring innovative solutions) offer important leverage effects. With public procurement accounting for 16% of EU GDP, public authorities have powerful means of stimulating private investment in research and innovation, for instance by providing a 'test bed' for innovative solutions. While this may entail additional risks for public procurers (i.e. risk of projects not fulfilling expectations), it may be beneficial in terms of stimulating innovation and generating long-term gains. Initiatives from the European Commission to increase ‘Green procurement’ are in this context more than welcome and should be endorsed by Member States 33 . Current major actions under consideration in the context of the preparation of the ‘Innovation Act’ to overcome the fragmentation of procurement markets are very important in this regard 34 .
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A stronger emphasis on demand-driven policies is essential, especially when promoting new green products and services ...

A recent major initiative in this regard is the Lead Market Initiative (LMI). The LMI initiative was launched by the EC following the 2006 EU’s Broad Based innovation Strategy 35 and the 2006 Aho Report 36 . The LMI is the first comprehensive effort at EU level for a coordinated demand-side innovation policy approach. It combines a number of policy instruments (e.g. regulation, public procurement, standardisation and complementary activities such as specific CIP measures supporting networks of clusters, and FP7 calls for technology development) to facilitate the uptake of new innovative products and services in the market. Six Lead Markets have been launched up to now, among which three are clearly applicable to the field of sustainable / green markets (‘sustainable construction’, ‘recycling’, ‘renewable energy’). Even though the measure is very recent and therefore real impacts have not yet materialised, one of the major contributions of the initiative is that policy makers and stakeholders are engaged in a learning curve in the implementation and governance of this comprehensive demand-side innovation policy approach.
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Recently (July 2008), the Commission adopted its ‘Communication on public procurement for a better environment’ (COM(2008) 400 final). The Commission proposed a political target of 50% Green public procurement to be reached by the Member States by the year 2010. The target was linked to a process for setting common Green public procurement criteria, recommended for inclusion in tender documents for a series of priority product and service groups. These criteria have been finalised and Member States have been invited to formally endorse them. 34 “Towards an Innovation Union. Preparation of the new EU Research and Innovation Plan. Presentation to the Enterprise Policy Group”, (EC, DG Enterprise, powerpoint presentation), May 2010. 35 “Putting knowledge into practice: A broad-based innovation strategy for the EU”, September 2006, (COM(2006) 502 Final). 36 “Creating an Innovative Europe. Report of the Independent Expert Group on R&D and Innovation appointed following the Hampton Court Summit and chaired by Mr Esko Aho”, EU 22005, Jan 2006.
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While demand-driven initiatives should be better connected to supply-side measures…

The 2009 mid-term progress report of the LMI, however, identifies the need for better coordination and links with supply-side measures (at both Community and national/regional levels), as well a better uptake by -and coordination with- national innovation policies 37 . In particular, the following areas for improvement are detailed: − Momentum for implementation of the LMI’s action plans needs to be further increased. In particular, it is clear that for a real impact, a more active involvement of Member States and corresponding policy take-up of the LMI at national level are needed; − The challenges ahead will be to strengthen the links and coordination with national innovation policy measures, to achieve greater visibility and to establish links with supply side measures. − At Community level, a better coordination between the measures under the LMI and supply-side instruments such as the Recovery Plan, European Technology Platforms, Joint Technology Initiatives and ERANets has great potential; − The designated ‘contact groups’ could be enlisted more effectively to increase visibility and dissemination of the LMI’s activities to businesses and other actors of the innovation 'ecosystem', such as regulators, professional bodies, sectoral stakeholders and civil society. − In parallel, national and regional lead market initiatives with a strong international market potential could be encouraged and benefit from Community support through existing support mechanisms.
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Parallel to this, ‘sustainable consumption policies’ that aim at redirecting or influencing consumption behaviour towards more ‘green’ or sustainable consumption have the potential to increasing the absorption capacity of consumers, and hence to increase aggregate demand for new green products, processes or services. A major step was the European Commission’s Action Plan on Sustainable Consumption and Production (SCP) and Sustainable Industry Policy, published in summer 2008. The publication of this plan constitutes remarkable progress, but it also leaves room for further enhancement of public policies’ efforts directed towards striving for the greening of European consumption patterns. Sustainable consumption policies should indeed be differentiated according to their contribution to changing consumer behaviour. Looking at current policy developments in Europe, one can distinguish three major ways to foster sustainable consumption patterns: raising consumer awareness, making sustainable consumption easy, and greening markets. The more government policies can grasp these three dimensions, the larger their overall impact will be 38 .
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European Commission Staff Working Document, “Lead Market Initiative for Europe. Mid-term Progress Report”, SEC(2009) 1198 final, December 2009. « Promoting Sustainable Consumption. New Policy Approaches », Policy Brief, March 2009 (final report from the FP7 ASCEE (“Assessing the potential of various instruments for sustainable consumption practices and greening the market”) research project), (available at http://cordis.europa.eu/fp7/environment/home_en.html) .
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1.3.7

Improving multi-level governance of innovation towards more coherence and more coordination On top of all the issues raised above, a further critical issue is to improve the multi-level governance of innovation policies by increasing coherence and coordination between policies and policy tools. This entails two types of increased coherence: one the one hand, more ‘horizontal’ coherence (i.e. between policies, policy tools), on the other hand, more ‘vertical’ coherence (i.e. across governance levels). We discuss first the former one at the level of Community policies / policy tools. One of the recurrent reactions to the public consultation following the EC 2009 communication on Community Innovation Policy 39 was the lack of coordination and of coherence between policy domains and policy instruments, namely with regard to SMEs and innovation 40 . In this respect, the increasing focus on societal challenges can provide a joint and shared thematic reference framework based on the endorsed EU2020 Strategy. This should facilitate the integration of the missions, objectives and programming of the various programmes for research and innovation within the overarching strategy for sustainable European growth.
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A joint thematic reference framework as tool for increasing coordination and coherence between policy domains…

Coordination between priorities and objectives of the various EU programmes and policy instruments should be more effective. This is all the more important as the governance of innovation policies has become much more complex and much more intertwined (across levels) over the past ten years. With the establishment of new instruments such as ERANets, ETPs, JTIs, bottom-up Joint Programming (with or without involvement by the EC), the classical system with centralised, project-based funding at Community level and at national / regional level has evolved into a hybrid system with co-funding of initiatives by various levels of governance. This brings us to the issue of multi-level governance. The fragmentation and lack of coherence of the innovation support policy in the different Member States and in the EU is often considered as one of the main obstacles to unleash the potential on innovative SMEs 41 . Therefore, the ‘additionality’ and ‘complementarity’ of support measures at different governance levels need to be better organised and assessed for a more efficient and effective use of the scarce resources. Both EU, national and regional instruments should reinforce each other to the maximum through leverage mechanisms in a common framework for sustainable economic growth, and within which innovative SMEs are at the core. The current trend towards more (ex-ante or ex-post) impact assessments of policy initiatives should be reinforced. In the context of the Better Regulation Agenda, the EU has an important role to play to stimulate the uptake by Member States of coherent methods for assessing impacts of policies. These impact assessments, moreover, should not remain limited to a specific policy tool or governance level, but should
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« Reviewing Community Innovation policy in a changing world », COM (2009) 442 Final, Sept. 2009. European Commission (2009), “Summary of responses to the public consultation on Community Innovation Policy”, Dec 2009 (available on http://ec.europa.eu/enterprise/policies/innovation/future-policy/consultation/results_en.htm). 41 European Commission (2009), “Summary of responses to the public consultation on Community Innovation Policy”, Dec 2009 (available on http://ec.europa.eu/enterprise/policies/innovation/future-policy/consultation/results_en.htm).
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More uptake of Impact Assessment practices as tool to improve multilevel governance …

increasingly take into account the interactions (synergies) between policy tools and governance levels 42 .
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Beyond the necessity of increasing coherence between existing support mechanisms across governance levels, there is also need for more coherence when setting up the strategic agenda’s, defining the objectives of policies and designing their implementation. Recent experience indeed shows that improvements are needed here. In the case of European Technology Platforms, for instance, coordination and synergies with national stakeholders and policy-makers (via National Technology Platforms and the so-called ‘mirror groups’) vary largely between countries. For some of the Member States, there are missed opportunities in terms of coordinating strategies across levels of governance, in terms of integrating regional innovation strategies into the broader, global context 43 .
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New multi-level governance structures are needed to streamline all relevant instruments towards shared objectives…

The ideas currently under development at the European Commission for the launch of socalled “European Innovation Partnerships” (EIPs) in the context of the preparation of the 2010 ‘Innovation Act’ deserve a lot of attention in this respect 44 . Under the current stateof-thinking, EIPs would be launched around specific themes and objectives (such as ‘zero-emission cities’). Depending on the theme selected and the objectives associated, EIPs would bring together existing instruments (eg ETPs, JTIs, Era-Nets, clusters, FP7 Thematic priorities, Lead Market Initiatives, Public Procurement, Standards setting etc) and actors (researchers, companies, regulators, end-users, etc.) under a new ‘umbrella’ (the ‘partnership’). EIPs would be ambitious in scale and scope and would bring together both supply-side and demand-side instruments. It would not be another new initiative, only a framework for integrating whatever existing initiatives are relevant.
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If endorsed, the EIP concept should be followed by initiatives defining a road-map or process for bringing the relevant instruments and actors together, depending on the list of themes chosen. In the light of the unleashing the full potential of innovative SMEs, it is important to guarantee high involvement by SMEs, especially for the themes where sectors characterised by a large concentration of SMEs are expected to play a major role.

1.4

Key conclusions
Context and background 1. Small and medium sized enterprises (SMEs) represent the overwhelming majority of European enterprises (more than 95%). In the EU-27, they also account for more than two-thirds of the non-financial business economy workforce and for almost 60% of the non-financial business economy’s value added. Therefore, any attempt towards Sustainable Industrial Competitiveness Policy is potentially doomed to fail if not aligned to the SME population.
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Idea Consult is currently advising 11 EU countries on ‘Harmonising Impact Assessment practices of Research and Innovation Support’ in the context of a FP7 OMC-Net Project led by the Belgian Federal Office for Science Policy (Project acronym: CIA 4 OPM). 43 Idea Consult, “Evaluation of the European Technology Platforms (ETPs)”, final report, August 2008 (available at: http://cordis.europa.eu/technology-platforms/home_en.html) . 44 “Towards an Innovation Union. Preparation of the new EU Research and Innovation Plan. Presentation to the Enterprise Policy Group”, (EC, DG Enterprise, powerpoint presentation), May 2010; Speech by European Commissioner on Research, Innovation and Science Máire Geoghegan-Quinn at the 2010 ETP Conference, 11 May 2010.
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2. It is important to recognise that SME innovation does not just concern ‘high-tech’ innovation but also encompasses production processes, business models and organisational design as well as technologies. Although much of innovation in SMEs is incremental and lacking long term strategic direction, a number of recent studies highlight the significance of highly innovative, high-growth SMEs for economic growth and industrial transformation. 3. For a Sustainable Industrial Competitiveness Policy to be effective – i.e. supporting the transformation to a green(er), sustainable economy – there is a need both for more young innovative companies able to develop new businesses up to a minimum critical mass (cumulative process) and for more innovative SMEs able to absorb new (sustainable) technologies and innovations. 4. Specific constraints on SME innovation can be identified, when it comes to using and exploiting innovations. The most commonly mentioned constraints are: Limited access to finance for innovation; Difficulties in appropriating the benefits from research and innovation; Lack of innovation absorption capacity; Regulatory and administrative burden; and Lack of effective training and education programmes. 5. Furthermore, particular constraints on the growth of innovative SMEs can be mentioned. Indeed, EU-based SMEs seem to suffer from a less dynamic growth profile than observed elsewhere, notably in the US. The reasons that may explain this lack of dynamism are many-fold, but two explanatory factors are often mentioned: Market fragmentation and market access barriers and; Financial market functioning, notably for venture capital. 6. The extent of adjustments required to face today’s external challenges has led some commentators to argue that a fundamental ‘paradigm shift’ is needed in the way in which businesses – and policy-makers – address competitiveness, economic growth and job creation, most notably in relation to moving to a sustainable (‘green’) long term growth path. SMEs may have greater flexibility to adapt than larger firms that are ‘locked-in’ to existing business practices and production processes. Overall, from a policy perspective, the aim would be to encourage existing firms to undertake the necessary adjustments to shift to a new sustainable growth path. 7. As a starting point for a policy response, the Small Business Act (including its effective implementation by the Members States) streamlines the large spectrum of SME-relevant policies. It has the potential to make an important contribution to improving the growth conditions of European SMEs. However, there is a need to reinforce the ‘innovation dimension’ in the implementation of the Small Business Act, or to launch a specific ‘SBA for Innovation’. Moreover, it will be necessary to pay particular attention to the articulation between the SBA (and its implementation) and the upcoming, 2010 ‘Innovation Act’. 8. Paradoxically, globalisation increases the importance of local situations and local anchorage. Innovative clusters are a response: they facilitate the transfer of technology within and towards the SME population and they contribute to the internationalisation of SMEs by linking them more effectively to large companies or other international partners. At the same time, the integration of dynamic and innovative SMEs into clusters is particularly important for helping clusters achieve high levels of excellence and innovation. It is therefore important to foster the

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development of internationally competitive and innovative clusters that better integrate SMEs into their strategy and activities. Implications for industrial policy 9. Generic policies towards SMEs should be combined with more targeted instruments towards sub-sets of the SME population. Specific support towards ‘high-growth, high-innovative companies’, however, should go hand in hand with tailored measures towards ‘lower-tech SMEs’ to ensure full deployment of innovations among the industrial texture. As part of such targeted policies, it is of utmost importance to foster dialogue between policy-makers and the SME population, for instance through an exchange of good practices about the instruments to be used. 10. It is essential to address the limited access to finance for SMEs, especially in the light of the credit squeeze caused by the crisis. It is very important to keep working on the construction of a Single Market for risk capital. However, it is also desirable that other financial instruments are broadened (e.g. guarantee schemes), allowing to widen and expand the innovation trajectory of SMEs. 11. Policies supporting innovation and technological development have long been focusing on the supply side. But the trend towards more demand-driven policy tools is also important and should be reinforced, because it offers another important way of reducing risk for SMEs by stimulating and expanding aggregate demand for new products and services. From the public side, procurement markets offer important leverage effects. There is also a need to better connect and integrate demand-side instruments and supply-side instruments. 12. As part of a new framework for policies towards SMEs, innovation and growth, the multi-level governance dimension needs not be overlooked. This dimension entails two types of coherence: one the one hand, more ‘horizontal’ coherence (i.e. between policies, policy tools), on the other hand, more ‘vertical’ coherence (i.e. across governance levels). 13. To improve the multi-level governance of innovation support towards SMEs, several aspects need to be taken into account. It is important to expand the use and application of impact assessments in the Member States, including the assessment of interactions between policies and governance levels. Furthermore, it is essential to agree on joint and shared thematic reference frameworks and common goals. Finally, it is important to better align regional innovation strategies with research and innovation agenda’s set at EU level.

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Towards Sustainable Industrial Competitiveness Policy
Issues paper to EU Ministers of Industry Part II B Transformation and Resource-intensive Industries

Client: Ministre de l'Economie, des PME, du Commerce extérieur et des Technologies nouvelles du Gouvernement Wallon

ECORYS Brussels NV in partnership with IDEA Consult NV

Brussels, 18th June 2010
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Table of contents
Preface Transformation and Resource-intensive Industries 1.1 Background and general context 1.2 Recent performance of the industry 1.3 Key challenges ahead 1.4 Impact of key challenges on external competitiveness and environment 1.5 Industry responses: towards transformation strategies 1.6 Policy options 1.6.1 Short-term mitigation policies 1.6.2 Market-regulation measures 1.6.3 Coordination measures and action plans 1.6.4 Capacity building and investment measures 1.6.5 Towards integrated multi-level governance 1.7 Key conclusions 3 4 4 5 7 12 14 16 16 17 18 18 19 20

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Towards Sustainable Industrial Competitiveness Policy – Part IIB

Preface

In the current economic climate, and with a new European Commission just starting, expectations about the EU's ability to advance in the development and implementation of coherent and coordinated economic and competitiveness policies is high. There is a clear need to revisit the key components of an integrated industrial policy for sustainable competitiveness. It is important to further define the Europe 2020 ambitions and translate them into concrete policies that will contribute to recovery and long-term competitiveness of EU industry as a whole. Within this context the EC is preparing a Communication on Sustainable Industrial Policy in the autumn of this year. This issues paper is being prepared on request of the Belgian Presidency. It aims to inform the preliminary conclusions of the Industry Council of the EU, based on evidence which can be confronted with the European Innovation Plan and the Commission’s Communication on Industrial Policy. The study results will be integrated in the programme of the Belgian Presidency. This Issues paper consists of the presentation of a general framework for Sustainable Industrial Competitiveness Policy (Part I), followed by two contributions where this framework is applied to specific situations: SMEs, Innovation and Growth (Part IIA) and Transformation and Resource-intensive Industries (this Part IIB).

Brussels, 18th June 2010
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Jan Maarten de Vet Paul Baker

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Transformation and Resource-intensive Industries

1.1

Background and general context
Access to the outputs of resource-intensive industries 1 , and their cost and quality, is of crucial and strategic importance to Europe’s industrial base. 2 Resource-intensive industries are typically positioned ‘upstream’ in production value chains. The outputs that they produce provide essential inputs that are transformed during subsequent stages in the value chain. Innovations and improvements in the quality of the products of resourceintensive industries are of importance not only for the competitiveness of these industries themselves but also because they can make a significant contribution to the competitiveness of ‘downstream’ sectors.
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Access to outputs of resource-intensive industries are crucial for Europe...

Many of the EU's resource-intensive industries currently face enormous challenges, including: • • Increasing global competition and the emergence of new competitors – particularly but not only from China – operating from a lower cost base than European producers; Increasing underlying global demand for raw materials reflected in upward pressure on commodity and raw material prices, accompanied by increased short-term price volatility in international markets caused by temporary imbalances in supply and demand conditions. Additionally, concerns are not simply related to material prices but also their security of supply. Increasingly higher energy costs in Europe relative to those of international competitors. These higher costs reflect not only structural issues within EU energy markets but also other external factors such as energy pricing mechanisms used by countries outside the EU to encourage investment and support for exports of energyintensive sectors. Increasing additional costs and pressures to transform production processes that are associated with compliance to EU and national-level climate change initiatives and environmental legislation. Resource-intensive industries tend to be associated with high levels of environmental costs in proportion to the direct value of their production. Improvements in their energy and resource efficiency are, therefore, of great important in meeting the EU’s environmental objectives.

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Resource-intensive industries are not a clearly defined category of industries. We base ourselves here on the definition used by McKinsey (2010). Essentially, resource intensity relates to the proportion of ‘natural’ resources (e.g. raw materials, energy, water) in total production inputs utilised to produce a unit of output. Intrinsically, some industrial sectors are much more resource intensive than others, with the most resource-intensive ones typically positioned at the beginning of production value chains. 2 This section will draw on studies carried out by ECORYS for EC DG ENTR in the areas of steel, ceramics and glass (all completed in 2008).
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Towards Sustainable Industrial Competitiveness Policy – Part IIB

Assisting EU industry to face these challenges goes beyond 'industrial' policy

The challenges are evidently broad and diverse. From a policy perspective, assisting EU industry to face up to these challenges calls not only upon 'industrial' policy but, also, labour market policy, trade policy, energy policy, environmental policy, etcetera. Moreover, the distribution of activities of resource-intensive industries across Member States and their regions, and the diverse linkages between these industries and other industrial sectors imply a variety of national, regional and cross-sector policy dimensions. Finally, the global nature of competition and markets implies looking beyond EU level policy initiatives and towards international (global) efforts to ensure a fair and level playing field for resource-intensive industries. Overall, developing an appropriate – coherent and coordinated – policy framework for resource-intensive industries requires an integrated and multi-level approach.

1.2

Recent performance of the industry
The important challenges facing resource-intensive industries in the EU, as briefly outlined above, consist of both cyclical and more structural elements. They also impact upon the business and market environment of resource-intensive industries through a variety of channels that can influence either demand-side conditions, supply-side conditions or a combination of the two. We will use a Sustainable Industrial Competitiveness Policy framework to identify some of the main issues facing resourceintensive industries and policy-makers (see Part I of this Issues paper).

Over the years, the industry has already implemented extensive restructuring

Prior to the economic and financial crisis, labour productivity growth in most of the EU’s resource-intensive industries was below the average for manufacturing as a whole (see Table 1.1). This should be seen, however, in terms of their performance relative to other manufacturing sectors and slow productivity growth in the economy as a whole. In fact, the Chemicals 3 sector was among the highest performers in terms of productivity growth and several other manufacturing 4 (and service) sectors fell well below resource-intensive industries. Overall, by implementing extensive restructuring, the EU's resource-intensive industries were largely able to respond to the various pressures they faced, and to position themselves as reliable suppliers of high quality and specialised products to the most demanding client sectors.
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Only Electrical and optical equipment (DL) achieved a higher productivity growth rate. For example: Food products, beverages and tobacco (DA), Textiles and textile products (DB), Leather and leather products (DC), Manufacturing n.e.c. (DN).

Towards Sustainable Industrial Competitiveness Policy – Part IIB

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Table 1.1

Recent evolution in resource-intensive industries: value-added, employment and labour productivity in the EU27 (1995-2007) NACE Sector Labour productivity growth DD DE Wood products Pulp, paper and paper products, publishing and printing DG Chemicals, chemical products and man-made fibres DH DJ Rubber and plastic products Basic metals and fabricated metal products DI D Other non metallic mineral products Total – all manufacturing sectors Total – all sectors 2.9% 3.2% 1.4% 1.9% 2.7% 2.5% -1.0 -0.5% 1.0% 2.3% 2.5% 2.9% 2.7% 0.6% 0.2% 5.2% 4.2% -1.0% 2.2% 2.5% Value-added growth 1.4% 1.5% Employment growth -0.8% -0.9%

Source: European Commission, EU Industrial Structure 2009

At one point, output of basic metals contracted by 35%...

The economic crisis resulted in strong decreases in demand as downstream markets contracted rapidly and severely. As pointed out recently by the EC 5 , demand for intermediate goods such as wood, paper and paper products, chemicals, metals, and nonmetallic mineral products were all hit as final demand fell. For example, car registrations in Europe dropped by 20% in the last quarter of 2008 and by the beginning of 2009 sales of passenger cars were down by 27%, while sales of commercial vehicles were hit even harder 6 . This drop had immediate impact on the steel and other basic and fabricated metals industry, with (temporary) closure of factories as a consequence. At one point, output of basic metals contracted at some stage by 35% and chemicals by 20%. The glass and ceramics industries have also been particularly hard-hit; factories were recently closed in for example the UK, Poland and the Czech Republic, with important employment losses as a consequence. Elsewhere, firms in resource-intensive industries have responded by selective temporary factory closures and, where available, by making use of short-term unemployment schemes (e.g. Germany, Belgium). With more recent improvements in demand (e.g. European and global car sales increased again in 2010), factories have stepped up production or reopened factories; for example, both Arcelor Mittal’s steel factories in Belgium (Gent and Liège) were fully or partially reopened in the last few months.
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The following additional sector-specific comments can be made, based on the EC's initial overview of the impact of the crisis on various sectors and by distinguishing short-term and long-term trends 7 :
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The woodworking sector has overall suffered very badly from the recession, as most EU wood is used in construction.

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EC DG ENT (2010) "EU Manufacturing Industry: What are the Challenges and Opportunities for the Coming Years?" EC (2009) “Responding to the crisis in the European automotive industry”, COM (2009) 104 final. 7 EC DG ENT (2010) "EU Manufacturing Industry: What are the Challenges and Opportunities for the Coming Years?". 26th April.
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The pulp and paper industry has seen a fall in demand, followed by a fall in production, prices and exports. There is increasing competition in export markets, especially from low-cost producers including China. Employment has continued to decline, with several temporary or permanent production facilities closures, translated in lay offs and job cuts.
The chemical sector has been hit hard as well...

The chemicals sector has been one of the manufacturing sectors most affected by the economic crisis, largely due to the severe downturn in construction, automotive and machine building, but there are considerable differences between sub-sectors. In the longer term, new strong competitors, namely in the BRIC countries, shape the development of the global chemicals industry. Until now, the EU sector has been able to maintain a relatively strong position, with 29% of the world market, and the chemicals market is bound to grow throughout the foreseeable future. The Iron and Steel sector has been affected by the decline in investment and private consumption resulting in lower construction and automotive demand, with significant reductions in production and employment announced by all major steel groups. The Non-ferrous metals sector has been impacted by the crisis due to falling demand in all sub-sectors, with significant reduction of production and employment.

1.3

Key challenges ahead
Key challenge 1: Growth in demand for the industry's products will come mostly from emerging markets The longer term growth potential of demand within EU and other ‘developed’ markets, and the implications this may have for the future prospects of resource-intensive industries within the EU, is arguably of greater concern than short-run cyclical conditions. Within Europe, a transformation to more sustainable production and consumption modes will provide challenges – indeed opportunities as well as threats. For example, tighter environmental regulations have created a number of new opportunities for glass producers, e.g. by shifting demand from the construction sector to more high-end products. By the same token, the growth in demand for high-speed rolling stock and the need for lighter and more fuel-efficient passenger cars in Europe has led to an increase in the demand for aluminium. But these opportunities are likely to be off-set by threats and declining demand for more traditional products (e.g. demand for commercial aircraft). Overall underlying demand growth within EU markets for the outputs of many resourceintensive industries is therefore expected to be modest, particularly when compared to prospects elsewhere. This situation is illustrated by demand resulting from infrastructure investments, which are being squeezed both in Europe and the US. By contrast, emerging economies - notably China and Brazil - are boosting infrastructure investments. For example, in 2009 automobile sales in China had already overtaken those in the US (13 million against 10 million cars) and medium- to long-term forecasts for car sales in China. Responding to these kinds on developments implies considerable investments to improve and increase capacity of (transport) infrastructure. Chinese investments in roads, public transportation, harbours and utilities are all growing, with a strong demand for

Infrastructure investment is now propelling China's economy...

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resource-intensive industries as a consequence; in fact the World Bank states that infrastructure investment is now propelling China’s economy. Brazil, a country which has been characterised by relatively low infrastructure investments to date, is now accelerating. Against the backdrop of the 2014 World Cup and the 2016 Olympics Games, The Brazilian National Development Bank estimates that infrastructure investment could total more than $ 145 billion over the next three years to come. For EU resource-intensive industries, their ability to take advantage of global demand growth will depend not only on their cost competitiveness – particularly in the face of increased competition from global competitors able to operate from a lower cost base – but also on market access (e.g. tariffs, and non-tariff and other informal barriers). Key challenge 2: Increased competition from global suppliers Exposure to global competition, especially in price-sensitive segments, is increasing and sectors such as the glass and ceramics industry that were previously relatively sheltered are coming under growing global competition. For example, import growth of (flat and container) glass has accelerated in years – even though extra-EU trade in the glass sector is fairly limited to date. In 2007 Chinese float glass imports increased by 162%, to just less than 550,000 tonnes, which means Chinese float glass imports have increased tenfold since 2004. In the steel sector, China, Japan, India and South Korea represented more than 50% of world steel output in 2007, and combined with Russia and Ukraine represent more than 60% of world steel output.
The EU's overall share in world crude steel output was 24% in 1997, 16% in 2007 and 12% in the first months of 2010.

European steel industry has traditionally had a strong regional focus - the major destinations of exports from EU countries are other EU countries. And although Europe is increasingly becoming part of a broader set of trade relations, it is no longer the strongest player and its position is eroding. As a consequence of increasing global production, the EU’s overall share in world crude steel output fell from 24.3% in 1997 to 16% in 2007. In the first four months of 2010, its share in world crude steel output had already fallen to 12.4% 8 , while China's share of global output had increased to 45.8%.
PF FP

Most of the EU's resource-intensive industries have already undertaken significant adjustments to respond to increasing global competition. This has involved improving production efficiency, with some inevitable closure of production sites and loss of employment. More fundamentally, these industries have focussed on moving into higher value-added, ‘up-market’ product segments. This process is closely linked to technological developments and innovations that have provided the basis for EU’s competitive advantage. For the future, the challenge for EU industry will be to maintain its technological advantage while faced by improving technological sophistication and know how of global competitors. Key challenge 3: Commodity and energy prices are a rollercoaster Over the past few years, developments in commodity and energy market prices have been nothing short of a rollercoaster. After a relatively long period of stability, the Commodity Index value increased by 13% in 2007, followed by a 33% increase in 2008 and a sudden decline in 2009 (35%), again followed by an increase of 20% in the early part of 2010.
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International Iron and Steel Institute, Crude Steel Statistics 2010.

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Energy raw material prices (steam oil and crude oil) have followed a pattern which is close to that of industrial raw materials.
Table 1.2 Aggregate development of Commodity and Energy prices 2007-2010 (in US$) – annual change 1) Commodity and Energy indices 2007 2008 2009 2010 (first half) Food total Industrial raw materials Energy raw materials 25% 15% 12% 34% 6% 42% -14% -27% -38% 1% 18% 24%

Total – all commodities including energy

13%

33%

-35%

20%

1) Based on a USD/EUR exchange rate of 1.40 for 2009 and 1.50 for 2010 Source: IfW Kiel & Association of European Business Cycle Institutes (AIECE) - 2010
In 2010 so far, commodity and energy prices have recovered more than expected.

The recovery of world market prices in 2010 has been considered remarkable, and does not reflect the strength of the rebound after the global economic crisis. It is therefore suggested that additional factors related to the financial markets could play a role – and add to fluctuations and unpredictability of such prices. 9
PF FP

Energy prices are obviously an important issue for many resource-intensive industries, as energy can represent a significant proportion of total input costs. Energy costs account for up to 30% of total costs for (primary) aluminium production and, as a consequence of increases in energy prices, energy costs now account for a larger share of operating costs of resource-intensive industries than in 2004. 10 For energy-intensive EU industry sectors that have already invested heavily to raise energy efficiency, the short-term scope for further radical improvements in energy efficiency is limited as much of the technology is already mature. Consequently, increases in energy prices are likely to be directly translated in to higher production costs and higher prices of outputs. This, in turn, implies higher input costs for downstream intermediate and final goods producers; for example, the spectacular increase of steel prices in the years prior to the economic and financial crisis led to considerably higher costs for the car manufacturing industry.
PF FP

Key challenge 4: Global energy prices: no level playing field The issue of higher costs for commodities and energy is unlikely to disappear for the foreseeable future, either short-term or long-term. According to the IEA, energy prices are expected to go up in the long run and volatility will increase. Furthermore, the financial crisis has reduced drastically investments needed to meet longer term energy demands. This could lead to a new surge in oil and other energy prices, with adverse affects on global economic growth. 11
PF FP

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Views of the German Kiel Institute. McKinsey & Company/ECOFYS (2006) "EU ETS Review – Report on International Competitiveness", on behalf of EC DG ENV, December. 11 International Energy Agency (2009) "World Energy Outlook", Vienna and "World Energy Outlook 2010" - forthcoming.
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To the extent that energy and commodity input prices are determined in international markets, changes in prices should have a limited direct impact on relative competitiveness. Accordingly, any pressures to adjust production processes in response to price fluctuations should be similar for EU and other global producers. While this may broadly be the situation for many internationally traded raw-materials and commodities, it is less so the case for energy. Of key importance from the perspective of the external competitiveness of EU resourceintensive industries are the differences in energy prices between the EU and its competitors. From a historical perspective, there have long been differences in international energy prices and within the OECD, and energy prices tend to be lower in the US while higher in Japan. In particular, according to the IEA, industry electricity prices are highest in Italy, the UK, Germany and Spain, while considerably lower in the US, Canada or Russia 12 . At the same time, the difference between prices paid by EU and non-EU producers has widened considerably over the last 10 years.
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Increasing evidence of energy price subsidies in various non-OECD countries.

Of even greater concern, however, is the increasing evidence that various non-OECD countries have opted for some sort of energy price subsidies. A common practice is the use of price controls that hold retail or wholesale prices below the level that would prevail in a truly competitive market. The most recent IEA analysis on the subject indicates that fossil fuel subsidies appear to be much higher than previously thought. In 2008, such subsidies rose to an estimated $ 557 billion, a considerable increase from the 2007 level of $ 342 billion. Although most (66%) of these are related to transport, and smaller portions affecting industry (10%) and power generation (10%), the combined effect could remain significant for sectors concerned. Amongst others, energy subsidies are given in countries such as China, Russia, India and the United Arab Emirates – where global competitors in the resource-intensive industry can be found. Although most countries have policies to reform subsidies, their commitment is reviewed as being often halfhearted while timing is often vague 13 .
PF FP

Key challenge 5: Securing Access to Energy and Natural Resources In addition to the above challenges, a particular challenge relates to the continued access to both energy and natural resources. Energy-security has been receiving increased attention, 14 especially following the January 2009 gas crisis – which underlined the EU's dependency on external resources. The challenges will be here to combine the energysecurity aim with other energy objectives, as formulated in the EU's 20-20-20 strategy. Addressing energy-security will involve infrastructure and diversification of energy supplies (including new pipelines), external energy relations, oil and gas stocks and crisis response mechanisms, energy efficiency and an optimal utilisation of the EU's own energy resources. Clearly, all such measures will come at a price for industry, either directly or indirectly.
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Differences also exist for gas prices, but not to the same extent as electricity prices. Ibid. 14 EC (2009) "EU Energy Security and Solidarity Action Plan: Second Strategic Energy Review".
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Concerns about securing access expand from energy to natural resources. Access to raw materials can be particularly problematic in those situations where mining of strategic resources is concentrated in a few countries only. The price for uranium, for instance, is expected to rise from $ 40 a pound now to $ 100 a pound before the end of this year. 15 Such price fluctuations are not only caused by a strong demand, but also by the inability of supply to meet demand, not to speak of a sheer interruption of supply. Most important supplier of uranium nowadays, for example, is no longer Canada but Kazakhstan, which provides 28% of global demand. Other examples of concentrated raw materials supply come from dysprosium and terbium, both essential ingredients for making permanent magnets used in electric (and hybrid) cars. More than 90% of global output of these materials are under Chinese control.
PF FP

Access to supply becomes particularly critical when strong demand and concentrated supply give rise to strategic positioning.

Access to supply becomes particularly critical when strong demand and concentrated supply give rise to expected shortages and strategic positioning, mostly by non-OECD countries. For example China has stockpiled uranium for several years now, and its stock is expected to last until 2015. 16 In 2006, China also introduced the policy to promote high value-added products rather than materials – which is translated in reduced export quota's for both dysprosium and terbium from 2006 onwards. 17 Indeed, strategic stockpiling appears to become a widely-used practice in China, and extending to other natural resources including food commodities such as grain and soybeans: China's stocks equal 40% of annual domestic demand, allowing it to safeguard food supply and control its domestic prices. This ratio is almost double the global average, as estimated by the FAO. 18 Even when such actions may be justifiable from a purely domestic perspective, the sheer weight of the Chinese economy today makes the impact of such strategic stockpiling measures on global markets for energy and commodities enormous.
PF FP PF FP PF FP

The European Commission is aware of this key challenge, and an Ad hoc Working Group on defining critical raw materials recently concluded that, based on an analysis of 41 minerals and metals, within the next ten years not geological scarcity but changes in the geopolitical-economic framework are most likely to impact on the supply and demand of raw materials. Indeed, many emerging economies are now pursuing industrial development strategies – through trade, taxation and investment instruments - aimed at reserving their resources for their own. 19
PF FP

Key challenge 6: Longer term uncertainty about costs for compliance with future EU legislation Stricter environmental regulation within the EU adds to relative cost pressures faced by EU resource-intensive industries. The EU climate and energy package, the Integrated Pollution Prevention and Control (IPPC Directive), and REACH, as well as eco-design have the potential to significantly affect production costs in the EU.

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Bloomberg Businessweek, 30th March 2010. Bloomberg, 23rd March 2010. 17 Courrier International, 14th January 2010. 18 Bloomberg, 8th March 2010. 19 EC DG ENT (2010) "Critical raw materials for the EU", Report of the Ad-hoc Working Group on defining critical raw materials. June.
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So far, and when drawing up these policies, considerations and concerns about the competitiveness of specific EU-industries tend to have been taken into account. An important example here are the recent EU’s measures to prevent carbon leakage – a situation whereby an increase in CO2 in one (non-EU) country is a result of emission reductions by another (EU) country. The EC has prepared and agreed a list of sectors and subsectors which are considered to be exposed to a significant risk of carbon leakage 20 . The list includes many of the resource-intensive industries, including important parts of the chemicals, metals, ceramics and glass industries.
B B PF FP

What is lacking is a longer term policy framework in which the industry can transform and adapt.

However, such industry-considerations tend to be taken into account on an ad hoc basis and exemptions are often of a temporary nature, while underlying cost base differences are more of a structural nature. What is lacking is a longer term policy framework in which the future of the EU's resource-intensive industry can develop and transform. Such a framework needs to take full account of both economic and environmental objectives and considerations. Such a framework is particularly important as many of the industry's investment horizons are long and the global environment for this industry is already uncertain enough. A longer-term, strategic outlook is therefore urgently needed for better understanding the pressures faced by the EU’s resource-intensive industries.

1.4
The potential for transformation is often limited...

Impact of key challenges on external competitiveness and environment
Resource-intensive industries are faced with major adjustment pressures as a result of increasing global competition, environment-related policy measures, together with often volatile market conditions both for inputs and demand. At the same time, the potential for transformation in production processes is often limited. This combination of exposure to adjustment pressure and limited transformation potential represents a major challenge facing resource-intensive industries in Europe. Meanwhile, demand growth in Europe is expected to be modest, and it will be difficult for EU-based resource-intensive industry to benefit from stronger growth in global markets. On the one hand, this relates to their higher cost base – including regulatory compliance costs – and, on the other hand, to problems related to market access barriers. So what could be the impacts of these challenges on the (external) competitiveness of EU resource-intensive industries and the environment? Unfortunately, the existing tools for painting such a picture are only crude. Although impact assessments are increasingly advanced and informative at the EU-level, many of such assessments focus on a specific policy intervention and compare these to a baseline which is taken for granted. They rarely address a complex range of issues together – which would provide such a baseline. With regard to external competitiveness, we can only point to a number of shorter term and longer term impacts of the above trends on the EU-based resource-intensive industry. At the same time, it needs to be recognised that external competitiveness impacts would vary strongly between sectors, sub-sectors and
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EC Decision on 24/12/2009

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individual firms, and there appears no overall view on what the impacts of each of these challenges is on the EU's resource-intensive industries as a whole. Having said this, and in light of a fluctuating (short-term) and limited increase (long-term) in Europe’s demand, growth prospects for the EU’s resource-intensive industries will be strongly linked to their external competitiveness and capacity to continually increase there productivity.
Higher costs lead to lower profits and reduced ability to invest..

Faced by higher costs in the EU – e.g. for energy or as a result of environmental compliance – the ability of EU producers to pass these on to customers through higher prices will be constrained by the nature of international markets (i.e. global market price setting), particularly for standard, homogenous products. Higher prices imposed on EUbased producers will reduce their competitiveness both in the domestic and export markets. In the absence of offsetting import tariffs or compensating measures for exports, this can be expected to suck in imports and reduce exports, with a negative impact on the EU’s external trade balance. At the same time, lower profits for resource-intensive industries, which will reduce their ability to invest in new technologies or innovation that will be necessary to maintain future competitiveness, address environmental concerns and support the transformation. This situation may be further exacerbated by longer term uncertainty about costs for compliance with future EU legislation, that may hold back investments in new technology and innovation. The prospect of a weak future performance of the EU’s resource-based industries has, in turn, serious implications for other downstream EU industries in the value chain. On the one hand, these downstream industries may become increasingly reliant on imported inputs from non-EU suppliers, with possible additional risks related to security of supply. Further, by weakening the interaction between EU resource-based industries and other parts of EU industry may reduce inter-industry synergies (e.g. new product and materials development, and customisation) with negative implications for both parties. The ability of the resource-based industry to respond to specific and highly demanding requirements from manufacturers, - including the EU's automobile industry, aviation industry, shipbuilding industry or pharmaceuticals industry – has been a key factor for the competitiveness of these manufacturers, while contributing to the external competitiveness of EU resource-based industries. The expected environmental impact of such a scenario would not be favourable. On the one hand, reduced capacity of the the EU's resource-based industry to invest in new technologies and processes would hamper the achievement of energy and environmental targets within industry. On the other hand, a decline in output of EU resource-based industries – while inevitably implying lower CO2 emissions – may simply be compensated by increased imports of commodities and intermediary products, with higher transportation and related emission costs.
B B

At a global level, the environmental impacts of energy-subsidies are negative as well..

At a global level, to the extent that non-EU producers would face less restrictions on energy-use and emissions than EU-based players, there may be additional adverse environmental impacts of the above scenario (e.g. carbon leakage). Furthermore, this needs to be set against international policies that, for example, actually encourage energy use. The impact of energy-subsidies on global energy demand and environmental burden is not to be underestimated: the IEA expects that unchanged energy-subsidies could lead to a global energy demand in 2020 which is 5.8% higher than a situation where these

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would have been abolished. Even worse would be impacts on CO2 emission: cheap and subsidised electricity generated from coal would be favoured over more expensive electricity generated through more CO2-friendly modes, including natural gas and renewable sources.
Outcomes will not be favourable from the view of a Sustainable Industrial Competitiveness Policy

Although above extrapolations are necessarily general, the message to retain is that the above key challenges are unlikely to result in outcomes that can be considered favourable within the context of a Sustainable Industrial Competitiveness Policy framework. In order to address and prevent such a situation, both industry and policy-makers will need to act.

1.5

Industry responses: towards transformation strategies
How is the EU's resource-intensive industry responding to these challenges? Transformation is the key, but transformation into what, and into what direction? And what would be the options available to industry? Broadly three transformation strategies are being pursued by the EU-based resource-intensive industries: Transformation strategy 1: Process innovation and reducing resource-intensity Investing in technologies and production methods that reduce resources and energyintensity are a key transformation strategy. In the energy-intensive basic material industries such as chemicals and steel, the potential for increasing energy productivity typically relates closely to core process technologies. Replacing old, inefficient plants or production lines with newer ones is often a major opportunity for improving energy efficiency. 21
PF FP

Illustrations of the type of technology developments and innovations aimed at reducing resource and energy-use intensity are widespread. These may involve the development of specific process innovations such as the re-use of steel manufacturing gases, which at the same time reduces the impact on the environment and energy consumption. Another example is the Ultra Low CO2 Steelmaking research programme (ULCOS II) that aims to develop new technologies that can drastically reduce the steel industry’s carbon dioxide emissions; the initiative brings together around 50 partners, including steel makers, research laboratories, universities and other players in the steel supply chain. 22 At a broader level, particularly in relation to SMEs, application of systematic energy management and environmental management systems in combination with investments in BAT technologies may reduce energy consumption and the environmental footprint of production.
B B PF FP

In aluminium, recycling consumes 20 times less electricity than primary smelting…

Particular potential lies in the further promotion of recycling, which is already at high levels in various European countries but which offers still more potential. About 50% of the input (measured in value of the metric tons) to the steel industry is recovered steel and the other 50% stems from the production of pig iron. The major part of pig iron and recycled iron is produced or recovered internally in the EU. Only a minor part of the pig iron and recycled steel is imported – and some export is happening as well. 23 A high and
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McKinsey Global Institute (2008) “The Case for Investing in Energy Productivity”. February. http://www.feast.org/articles/?ID=907 23 EUROFER
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increasing degree of recycling in the EU's resource-intensive industry also reduces the EU’s dependency on imported raw materials and contributes to energy savings and the sustainable use of resources. For example, within the aluminium sector, secondary smelting (recycling) consumes 20 times less electricity than primary smelting. 24 Yet, within the EU, the steel scrap recycling process is very well organised in some countries, while this is not the case in others. When promoting further investments in recycling, it is important to recognise that the appetite to do so will depend on the development of scrap prices in relation to raw materials. A too sudden shift to recycling could therefore lead to higher scrap prices and to a reduced interest to continue such investments – at least in the short-term.
PF FP

Nevertheless, this transformation strategy provides clear advantages from a European policy perspective: it dampens the energy-intensity of the industry, reduces emissions and increases technology-intensity. However, many resource-intensive industries – particularly larger firms - have already invested substantially in process technologies and the scope for further investments from either a technological or economic (return on investment) perspective may be limited. More potential may exist for SMEs, but in terms of major investments this will depend on financial capacity, and may be further limited by uncertainty about the general business environment and the direction of future energy and environmental policy. Transformation strategy 2: Moving to 'up-market' segments EU industries have responded to globalisation pressures by specialising and differentiating their products, by moving into niche markets and by moving to 'up-market' segments. For instance the European shipbuilding industry, also characterised by fierce cost-based competition, has been quite successful in specialising in niches such as cruise ships, ferries, cable-laying ships and other service vessels 25 . Furthermore, once sustainable production and consumption become more widely spread, this could lead to new demand for specific products and services as well.
PF FP

Sustainable consumption and production can lead to new demand for specific products too.

Increased differentiation and moving to higher value-added segments can however be difficult for parts of the resource-intensive industries, if they are unable to differentiate their products or compete on technological intensity. Investment and development in 'up-market' segments will reduce the industry's exposure to consequences of supply-side sensitivity. Such a transformation strategy can also be implemented by vertical integration through acquisitions, mergers, and joint ventures/partnerships. Investment in R&D and new technologies are important as well, with a view to develop high-quality products building on the latest technology; and with a view to maintaining leadership in relation to sustainability, functionality, and product performance.

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McKinsey & Company/ECOFYS (2006) "EU ETS Review – Report on International Competitiveness", on behalf of EC DG ENV, Devember. 25 ECORYS et al. (2009) "Study on the competitiveness of the shipbuilding industry", for EC DG ENTR. See also Economist (2010), May 1st, p.63.
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Transformation strategy 3: Increase presence in growth markets and relocate to lowcost countries Relocation of production to improve access to growth markets and take advantage of lower costs is an alternative strategy. Either through direct investment in new production or acquisitions or mergers, strong EU firms can increase their presence in high-demand and fast growing emerging markets (e.g. China, India, and Brazil). This strategy, however presumes both the capacity of EU firms to undertake such investments and the absence of foreign investments restrictions. It would also allow these EU companies to take advantage of the lower cost base in these markets. From such low-cost countries, products could be shipped back to Europe or elsewhere. Within the EU, there is still potential in this respect for New Member States. Outside the EU, Russia or the United Arab Emirates are frequently mentioned as low-cost locations, e.g. for aluminium production.
Despite clear advantages for industry, this strategy can hardly be called favourable from a European or global perspective

Although this transformation strategy could provide clear advantages for EU-based companies, they would almost certainly lead to less favourable outcomes from a European policy perspective: European output and employment would be reduced, and while environmental impacts could be favourable from an EU policy-perspective, this would not be the case at a global level. Clearly, any choice between the above transformation strategies is not to be made for the resource-intensive industry as a whole. There is no ‘one size fits all’ and the ability to apply such strategies will vary depending on the sector and sub-sector, the location, size and strength of companies, etcetera.

1.6

Policy options
The role for policy makers will be to provide the long-term framework conditions – providing more incentives for those transformation strategies that will contribute to a Sustainable Industrial Competitiveness Policy. Basically, four types of policy strands can be distinguished: 1) Short-term mitigation policies; 2) Market regulation measures; 3) Coordination measures and action plans; 4) Capacity building and investment policies.

1.6.1

Short-term mitigation policies Many of the measures to increase industry’s flexibility to respond to temporary shocks act to decrease the intensity of external shocks and alleviate or dampen adjustment pressure on the industry. An example is short time work arrangements, that many European governments have taken forward as a response to the current economic crisis. These arrangements allowed employers access to temporary state assistance to top up the wages of workers with reduced working hours due to the crisis. Such schemes have for instance been implemented in Belgium and Germany in 2008 and 2009, also in the resource-intensive industries. These schemes appear to have been a success in the steel industry, allowing

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factories to respond more flexibly and resume operation without irreversible problems. They imply however a strong link to overall labour market policies. Another example is the Automobile scrapping scheme, as introduced in various Member States in the course of 2008 and 2009 to limit the drop in automobile sales, by providing a subsidy on old cars. 26 The scheme has helped to stabilise the market, but more so for passenger cars than for commercial vehicles.
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Short-term measures are unlikely to contribute to long-term transformation

However, despite their short-term effectiveness, such measures alleviate adjustment pressure, and they are therefore unlikely to contribute to transformation from a longer term perspective. They provide few incentives to adjust firm strategies and business models, input factor utilisation, production process development, etcetera. Therefore, when implemented on a long-term basis, these measures appear to contribute to maintaining the status quo of industry rather than to an increase in productivity and competitiveness. The objective of mitigation measures therefore needs to be clearly defined, namely either (i) short-term to ‘shelter’ industries from temporary shocks that do not necessarily imply a long term loss of competitiveness or (ii) part of measures that ease the transformation/social costs of structural adjustment. Market-regulation measures Concerning EU policies directed towards improving the energy efficiency and environmental impact of production processes, a generally regulatory approach is encapsulated in measures such as the Integrated Pollution Prevention and Control (IPPC) Directive 27 and the Greenhouse Gas Emissions Trading System (EU-ETS) 28 . Recent amendments to EU-ETS 29 and directives on carbon capture and storage (CCS) 30 and on renewable energy sources 31 are all part of a wider package of initiatives and reforms directed towards meeting the EU’s target of reducing its overall emissions by 20% below 1990 levels by 2020.
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1.6.2

Other sectoral policies play a key role as well.

Other Community policies play a key role as well, especially when addressing the external competitiveness dimension. EU Trade policy can help to influence the development of the EU's resource-intensive industry – by contributing to level playing fields. Various elements play a role here. Access to raw materials is increasingly vital for the sector, as concerns over long-term security are growing. However, such concerns are not necessarily addressed yet in the current policy framework. Access to markets is another concern; the EU's resource-intensive industry requires ‘fair’ access to new global and emerging markets where this is not yet the case. When negotiating Free Trade Agreements, either bilateral or within the WTO context, access to markets for these industries should be taken into account. Thirdly, EU Trade policy should put more emphasis on and leverage trade agreements to try to achieve more uniform international
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This instrument was subsequently approved by EU, however as part of a more integral package. See EC (2009) “Responding to the crisis in the European automotive industry”, COM (2009) 104 final. 27 Directive 2008/1/EC 28 Directive 2003/87/EC 29 Directive 2009/29/EC 30 Directive 2009/31/EC 31 Directive 2009/28/EC
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policy approaches (e.g. energy and environmental policies) towards resource-intensive products. 1.6.3 Coordination measures and action plans An industry-policy dialogue is of utmost importance. Both industry and policy-makers have their own responsibilities, but transformation strategies and responses need to be aligned. Such dialogues can result in joint Action plans. For example, the current EU Action Plan for Sustainable Consumption and Production (SCP) and Sustainable Industrial Policy (SIP) is built on a core of actions aimed at improving the energy and environmental performance of products and foster their uptake by consumers. This includes initiatives for eco-design, for eco-labelling, and the promotion of green public procurement, while at the same time withdrawing entitlement to EU incentives for products below a certain level of energy or environmental performance. From the broader international perspective, the Action Plan offers support for (voluntary) sectoral approaches to limit emissions, for the promotion of international ‘best practices’ for sustainable consumption and production, and for the promotion through international negotiations of trade in environmentally friendly goods and services. The economic and financial crisis has led to an increased importance of global governance. After all, many of today’s economic, financial, energy-related and environmental challenges are of a global nature and need thereto be addressed at that level. In the context of the EU’s resource-intensive industries, and when approaching from a Sustainable Industrial Competitiveness Policy perspective, particular attention is called for addressing the subsidisation of energy prices, which have perverse economic and environmental consequences.
The key is to convince other global players to adopt measures already tested in the EU.

The key here is to convince other global players to adopt similar measures as already tested within the EU. In this respect, the G20 can play some role as well. This forum has also been instrumental in highlighting that increasing the availability and transparency of energy subsidy data is an essential step in building momentum for global fossil fuel subsidy reform. The EU, in its turn, could make better use of the G20 and the WTO to address this issue. An alternative approach would be to promote industry leadership in this area (i.e. industry-based approaches). Capacity building and investment measures Supporting measures or capacity-building policies are aimed at ‘industry’ efforts to exploit new opportunities and respond in an active and positive way to threats created as a result of changing conditions. Such measures can provide the right framework conditions for enterprise development and competitiveness, albeit with a potentially more sector specific dimension given that adaptation requirements can be expected to differ across sectors. Investing in Technology development and innovation is vital. Most investments in this sector are made by larger companies. For example in 2009, Arcelor Mittal invested $ 235

1.6.4

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million in R&D, across 15 major R&D centres. 32 In order to promote process innovation, it is important to provide the right frameworks and incentives to not only develop but also support the diffusion of technologies and innovations so that value chains can be optimised. Equally, further support and encouragement can be provided for resourceintensive industries to develop and commercialise new products that contribute to sustainable consumption.
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Beyond research, technology and innovation policies, other supporting measures may include education and training policies (particularly to address specific skills shortages) and infrastructure investments can be important too, particularly in less developed Member States and regions, where accessibility is difficult and transport costs high. EU Cohesion Funds and Trans European Networks (TENs) can thereto be used as well.
Cluster policies can be powerful as they are area-based and specific.

There is merit in integrating such measures through cluster-specific strategies and action plans – all aiming to increase the ability of industry to respond to the various challenges. Cluster policies have proven to be powerful complementary strategies, based on areaspecific hubs of economic activity. 33 Cluster policies have proven to be strong in supporting industry in an integral way, while taking into account all specificities of companies on the ground. They focus on value chains, and are able to link larger to medium-sized and smaller companies together. They can also be effective in addressing localised bottlenecks in the investment climate, including skills and labour market needs. 34
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1.6.5

Towards integrated multi-level governance A key element of any new Sustainable Industrial Competitiveness Policy is that it needs to be developed and implemented by a range of governments, requiring both vertical and horizontal coordination, and in cooperation with industry. Both vertical (across sectors) and horizontal coordination (between global, EU, national and regional levels) is crucial. For example, the EU’s research and innovation agenda focuses on the development of increased resource-efficiency and flexibility in production. But these programmes are only likely to be effective if the right industries take part and if public research in this area is closely linked to private research and aligned with firm strategies.

Table 1.3

Overview of policy options by governance level Governance level Short-term mitigation policies 1. 2. Short-term workers schemes Scrapping schemes x (b) x (b) X X Global EU National Regional

Market regulation measures 1. 2. Energy and environment Trade policy x X X x x

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Arcelor Mittal (2010) “Corporate Social Responsibilty Report: Our Progress towards Safe, Sustainable Steel. See for example ECORYS/ECOTEC (2005) “Evaluation of clusters and industries in Scotland” 34 See for example P. Mans, T. van der Valk and M.P. Hekkert (2007) “Is cluster policy useful for the energy sector? Assessing self-declred hydrogen clusters in the Netherlands”
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Governance level

Global

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Regional

Coordination and Action plans 1. 2. Industry-policy dialogue and action plans Global coordination x X X X X

Capacity building and investment 1. 2. 3. 4. Technology and innovation policy Education policy Infrastructure investment Cluster policy x (c) x X X X X x x x X X

Notes: (a) (b) (c) Competences between National and Regional level may vary between Member Stats EU competence relates to the State Aid/Competition policy aspects EU competence relates to Cohesion Fund and TENs

Although competences vary strongly between Member States, the intention of the above overview table is to point to the complexity of policy coordination. Building a long-term and reliable framework for the EU's resource-intensive industries requires coordination not only between short-term mitigation measures and longer-term market regulation measures, but also with capacity building and investment programmes – which are mainly the competence of national and regional governments. The challenge for policy-makers will be to make further steps towards the development of such a framework, which will allow the EU's resource-intensive industry to transform and respond to its current and future challenges.

1.7

Key conclusions
Context and background 1. Until recently, by implementing extensive restructuring, the EU's resource-intensive industries were largely able to respond to the various pressures they faced, and to position themselves as reliable suppliers of high quality and specialised products to the most demanding client sectors. They have implemented extensive restructuring measures and positioned themselves as reliable suppliers of high quality and specialised products to the most demanding client sectors. The economic crisis resulted however in strong decreases in demand, as downstream markets contracted rapidly and severely. Demand for intermediate goods such as wood, paper and paper products, chemicals, metals, and non-metallic mineral products were all hit as final demand fell. Growth in demand for the industry's products will come mostly from emerging markets. Countries such as China and Brazil are boosting infrastructure investments, and such investments are now propelling China's economy. It will be crucial for the

2.

3.

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future growth prospects of the EU’s resource-industries to benefit from these developments, which will depend not only on cost-competitiveness but also on market acces (e.g. tariffs, non-tariffs and other informal barriers). 4. Exposure to global competition, especially in price-sensitive segments, is increasing and sectors such as the glass and ceramics industry that were previously relatively sheltered are coming under growing global competition. Most of the EU's resourceintensive industries have already undertaken significant adjustments to respond to increasing global competition. This has involved improving production efficiency, with some inevitable closure of production sites and loss of employment. Over the years, developments in commodity and energy prices have been nothing short of a rollercoaster, and the unpredictability of such prices is likely to remain or increase. Fluctuations can only be partially explained by supply and demand, and additional factors related to financial markets could play a role. The issue of higher costs for commodities and energy is unlikely to disappear for the foreseeable future, either short-term or long-term. Of even greater concern, however, is the increasing evidence that various non-OECD countries have opted for some sort of energy price subsidies. Overall energy subsidies are estimated to be at $ 557 billion in 2008, a considerable increase from the previous year ($ 342 billion). A particular challenge relates to the securing continued access to both energy and natural resources. Access to supply becomes particularly critical when strong demand and concentrated supply give rise to expected shortages and strategic positioning, mostly by non-OECD countries. Even when such actions may be justifiable from a purely domestic perspective, the sheer weight of the Chinese economy today makes the impact of such strategic stockpiling measures on global markets for energy and commodities enormous. Within the Community, when drawing up energy- and environmental regulation, considerations and concerns about the competitiveness of specific EU-industries tend to have been taken into account. However, this tends to be done on an ad hoc basis and exemptions are often of a temporary nature, while underlying cost base differences are more of a structural nature. What is lacking is a longer term policy framework in which the future of the EU's resource-intensive industry can develop and transform. Faced by higher costs in the EU – e.g. for energy or as a result of environmental compliance – the ability of EU producers to pass these on to customers through higher prices will be constrained by the nature of international markets (i.e. global market price setting), particularly for standard, homogenous products. Higher prices imposed on EU-based producers will reduce competitiveness both in domestic and export markets. In the absence of offsetting import tariffs or compensating measures for exports, this can be expected to draw in imports and reduce exports, with a negative impact on the EU’s external trade balance.

5.

6.

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10. The prospect of a weak future performance of the EU’s resource-based industries has, in turn, serious implications for other downstream EU industries in the value chain. On the one hand, these downstream industries may become increasingly reliant on imported inputs from non-EU suppliers, with possible additional risks related to security of supply. Further, by weakening the interaction between EU resource-based industries and other parts of EU industry may reduce inter-industry synergies (e.g. new product and materials development, and customisation) with negative implications for both parties. 11. Failure to address the challenge facing resource-intensive industries will not only have adverse effects on the industries themselves, but can also be expected to have adverse global environmental impacts: global energy-needs and negative environmental impacts will be increased by shifts from EU to non-EU based production. 12. Broadly three transformation strategies can be pursued by the EU-based resourceintensive industry. Transformation strategy 1: Process innovation and reducing resource-intensity. Investing in technologies and production methods that reduce resources and energy-intensity are a key transformation strategy. In the energyintensive basic material industries such as chemicals and steel, the potential for increasing energy productivity typically relates closely to core process technologies. 13. Transformation strategy 2: Moving to 'up-market' segments. EU industries have responded to globalisation pressures by specialising and differentiating their products, by moving into niche markets and by moving to 'up-market' segments. Increased differentiation and moving to higher value-added segments can however be difficult for parts of the resource-intensive industries, if they are unable to differentiate their products or compete on technological intensity. However, investment and development in 'up-market' segments will reduce the industry's exposure to consequences of supply-side sensitivity. 14. Transformation strategy 3: Increase presence in growth markets and relocate to low-cost countries This strategy presumes both the capacity of EU firms to undertake such investments and the absence of foreign investments restrictions. It would also allow these EU companies to take advantage of the lower cost base in these markets. Despite clear advantages for industry, this strategy can hardly be called favourable from a European or global perspective. 15. Clearly, any choice between the above transformation strategies is not to be made for the resource-intensive industry as a whole. There is no ‘one size fits all’ and the ability to apply such strategies will vary depending on the sector and sub-sector, the location, size and strength of companies, etcetera. Implications for industrial policy 16. The role for policy makers is to provide the long-term framework conditions – with appropriate incentives to facilitate transformation strategies that will contribute to a Sustainable Industrial Competitiveness Policy. Basically, four types of policy

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strands can thereto be distinguished: 1) Short-term mitigation policies; 2) Market regulation measures; 3) Coordination measures and action plans; 4) Capacity building and investment policies. Competences between governance levels vary considerably. 17. Short-term mitigation policies allow to increase industry’s flexibility to respond to temporary shocks and decrease the intensity of external shocks and alleviate or dampen adjustment pressure on the industry. Examples are the short time work arrangements and the automobile scrapping schemes that have recently been implemented in various Member States. Despite their short-term effectiveness, such measures alleviate adjustment pressure, and they are therefore unlikely to contribute to transformation from a longer term perspective. 18. Market-regulation measures (often at EU-level) are directed towards improving the energy efficiency and environmental impact of production processes. A generally regulatory approach is encapsulated in measures such as the Integrated Pollution Prevention and Control (IPPC) Directive and the Greenhouse Gas Emissions Trading System (EU-ETS). Other Community policies such as Trade policy play a key role as well, especially when addressing the external competitiveness dimension. 19. Coordination measures and action plans are also important. An industry-policy dialogue is of utmost importance. Both industry and policy-makers have their own responsibilities, but transformation strategies and responses need to be aligned. The economic and financial crisis has also led to an increased importance of global governance. Particular attention is called for addressing the subsidisation of energy prices, which have perverse economic and environmental consequences. In this respect, the G20 can play some role as well. 20. Capacity building and investment measures aimed at ‘industry’ efforts to exploit new opportunities and respond in an active and positive way to threats created as a result of changing conditions. Investing in Technology development and innovation is vital. Other supporting measures may include education and training policies and infrastructure investments, particularly in less developed Member States and regions. Cluster policies can be powerful as they are area-based and specific. They have proven to be powerful complementary strategies, based on area-specific hubs of economic activity. 21. A key element of any new Sustainable Industrial Competitiveness Policy is that it needs to be developed and implemented through multi-level governance. Building a long-term and reliable framework for the EU's resource-intensive industries requires coordination not only between short-term mitigation measures and longer-term market regulation measures, but also with capacity building and investment programmes – which are mainly the competence of national and regional governments. The challenge for policy-makers will be to make further steps towards the development of such a framework, which will allow the EU's resource-intensive industry to transform and respond to its current and future challenges.

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