The Services Revolution: Industrial Policy for a Modern Economy

A ”manufacturing-first” attitude has taken hold in the European economic policy discussion. New strategies and industrial policies are designed with the ambition of boosting development and output in traditional industrial sectors. These policies often build on the assumption that industrial development and jobs are “better” than new growth and employment in the services sector – that industry is a stronger source for innovation and higher productivity growth.

This view is outdated. It is also misguided and will make Europe less competitive. A growing services sector is featured in all economies that that have matured and expanded prosperity. Over time, the services sector has grown and professionalized – and is increasingly a sector of innovation and growth in productivity. Technological change has provided new opportunities for services to fuel the entire economy with business dynamism and, of course, to improve the performance of industrial companies. Some of the most R&D intensive sectors in the economy are services: global R&D spending has certainly moved towards services. As a result, the services share of value added in modern economies is rapidly increasing.

Equally important, the “manufacturing-first” attitude prevents Europe for pursuing reforms that are necessary for the EU services sector to develop. It has been pointed out in several high-level reports – including Mario Draghi’s report on The Future of European Competitiveness – that Europe trails the US in services sector performance. Because of high and restrictive regulations, innovative services sectors have grown a lot slower in the EU than in the US. Europe’s industrial performance is better than in the US: for instance, EU industrial sector R&D is higher than in the US, when measured as share of Gross Domestic Product. Europe’s big economic challenge is to boost the services sector.

For Europe to close the gap with the US, it needs to release the competitive energy of the services sector and incentivize more R&D, innovation, and business dynamism in high value-added services sectors like ICT and scientific research. In the paper, we model a scenario in which the EU would be more like the US as far as the services sector is concerned. It would include a remarkable growth in R&D spending. For example, R&D spending on computer programming would rise from EUR 15 to 66 billion – and in services like scientific and research development it would boost R&D by eight times.

If the services sector would be thriving more, the European economy would get a serious boost. Different scenarios for a better-performing services sector are modelled in this study. Using cautious assumptions for a new development of the services sector, we find that the EU could add another 280 billion EUR to its Gross Domestic Product over five years – which equals a 1.6 percent growth. 

There are several reasons why the European services sector trails the US. Digitalization and technological change are part of the explanation. Generally, US services companies have faced fewer regulations and restrictions when developing new technologies and services that fuse with “older” services and help industries to improve their performance. Boosting the European services sector requires more business and market dynamism – and a regulatory environment that primes service companies for faster growth.