“You can see the computer age everywhere but in the productivity statistics” – This famous quote from Robert Solow dates back from 1987, but remains very pertinent up to date. Indeed, productivity growth has markedly slowed throughout the high-income world in recent years, from countries as diverse as the United Kingdom to Japan. While the average productivity growth exceeded 2% in high-income OECD countries over the 1980-98 period, if dropped below 1% for the 2007-18 period.

This phenomenon is puzzling and sits uncomfortably with the notion that we are living in an age of rapid technological expansion and digitalisation. Looking into the causes of this slowdown is not merely an academic exercise, as productivity is the driving force behind future improvements in living standards over the long term.

Several factors have been put forward that could explain the coincidence of (perceived) rapid technological developments and a slowdown in productivity. A first possibility, pioneered by the so-called technology pessimists, suggests that technological progress in recent decades is just not as impactful as developments in the 1870-1970 period. Big data, machine learning algorithms, robotisation and the likes do not have the potential to change our lives as mass electrification or internal combustion engines had, according to this theory. A different explanation relates to the idea that traditional indicators to keep track of economic progress, such as GDP or productivity, are increasingly detached from reality because of digitalisation. These metrics do not sufficiently pick up the use of digital goods and services, often available free of charge (such as Skype or Wikipedia, and an array of smartphone apps). While we are almost certainly mismeasuring the digital economy, it is not, however, evident that this represents the main driver of the productivity slowdown.

Innovation diffusion

A seminal paper by Dan Andrews and colleagues at the OECD, published in 2015, makes a compelling case that the issue is linked with a decline in innovation diffusion. Their number-crunching (replicated by others since then) reveals that productivity growth for companies at the technological and productivity frontier has been as robust as ever. At the same time, they observe a widening gap between these enterprises and laggards. In different words, innovation is continuing apace, and driving forward productivity, but these productivity gains have become more concentrated in a smaller group of firms than in the past. Different still, innovation does not disseminate through the economy as it used to be the case.

This observation leads to a wide number of policy implications. These range from the need to improve foreclosure and bankruptcy procedures to enable faster exit of so-called “zombie firms” at the bottom of the productivity distribution, to competition policy to allow innovate start-ups a fair level playing field to challenge incumbents. A key take-away for the EFIS Centre is that STI policies should not only focus only on leading, high-tech firms, but should also aim to narrow the innovation gap between leading firms and the rest of the economy. More concretely, STI policies should take the following considerations into account:

  1. First, capital investments in intangible assets are heavily concentrated in a small minority of companies, even though these investments are a strong predictor of firms’ productivity. Interestingly, while this phenomenon is global, it appears to be more pronounced in European countries, where investments in intangible assets lag behind peers in Japan, South Korea or the United States. To bridge this gap, many governments could do more to support firms to invest in these assets. As one example, while countries like China, Singapore and the United Kingdom are taking initiatives to leverage intangible assets to obtain finance, for example by specific guarantees or financial support to appraise the value of these assets, such schemes appear largely absent in EU countries. As another case in point, efforts to encourage small firms to invest in digital tools and technologies have had mixed results, indicating ample scope for improvements. In Italy, for instance, the digitalisation of SMEs remains low compared to most other EU countries, despite sizeable public interventions in this area in recent years.
  2. Second, there is increasing recognition that spillover effects from leading firms to laggard firms do not materialise automatically. As one example, the empirical evidence of such effects from multinational companies, which tend to have above average productivity and investments in R&D, to indigenous enterprises is mixed. More generally, spillover effects from R&D activities are smaller in practice than what is reported in narrative reviews, and depend heavily on the absorptive capacity of potential beneficiaries. Policy makers across the globe thus have an important role to play to provide incentives and boost capabilities for companies that are lagging behind to adopt new technologies and innovative practices, not just for their own sake, but for the broader economy as well.
  3. Third, the role of innovation intermediaries is crucial in this respect. These are organisations that facilitate the transfer of innovation, such as chambers of commerce and business associations, public business development providers, digital hubs, (regional) innovation offices, technology transfer offices and accelerators, incubators and technology parks and so on. Again, these institutions should not only help already innovative firms to stay ahead of their competitors, but also to help laggard firms to catch up.

Now is an opportune moment to act. In the aftermath of the COVID-19 pandemic, four in five employers plan to accelerate the adoption of advanced technologies and one in two to automate the production process, according to a survey from the World Economic Forum. This is part of the reason why EFIS Centre puts the notion of the innovation system at its forefront, i.e. emphasising the flow of technology, information and knowledge across the economy and the role of innovation intermediaries. Our work, for example, in support of the Digital Europe report of the World Bank, underlines the significant differences across European regions in the take up and adoption of advanced technologies. Such insights help policy makers take the necessary decisions required to support firms to realise these ambitions.

 

Written by Kris Boschmans, Senior Researcher at the EFIS Centre. Kris joined the Centre in February 2022 bringing extensive experience in economic analysis and policy advice, having worked in the past for the OECD, Belgian Government, non-profit organisations and academia.