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1 63((&+ 3HGUR6ROEHV Member of the European Commission Economic and Monetary Affairs 7KH LQWHUQHW HFRQRP\ LPSDFW RQ (8 SURGXFWLYLW\DQGJURZWK European government Business Relations Council meeting %UXVVHOV0DUFK

2 ,QWURGXFWLRQDQGGHILQLWLRQRIWKH,QWHUQHW(FRQRP\ I am delighted to have this opportunity to speak today about the impact of Internet economy on productivity and growth in Europe. As Commissioner for Economic and Financial Affairs, my perspective on the Internet, and the concepts that I associate with this technology, revolve around the structural implications that the spread of Internet has both at the microeconomic and the macroeconomic level. The interesting question to me is whether the technologies that increasingly pervade the way we do business and the way we communicate, produce any particular changes in the functioning of the economy.,&7lpsdfwrqexvlqhvv The real breakthrough came when firms started hooking up computers to each other; first, internally, in networks that permitted staff to access common data sources; then, externally, extending access to outside business partners. With the advent of the Internet, the network capabilities of computers were taken to a higher level, as the Internet essentially created a global network with equal access for anyone connected. The most recent addition to the network are mobile phones, carrying with them the promise to, effectively, sever the physical tie with the connection point, extending Internet access to everyone while on the road. All of this has become possible only through massive investments in communication devices and transmission infrastructure. These Information and Communication Technologies, or ICT as they are popularly called, are affecting the internal workings of the firms as well as their external dealings with suppliers, customers, and other stakeholders. In the longer term, technologies are projected to enhance the economy by enabling new business models to be created, and by making interaction and matching easier and faster. In that respect, aided by the Internet, Europe may be able to stitch together national markets the last bit that the Internal Market and the common currency have not yet accomplished. *URZWKSDWWHUQVLQ86DQG(8 The changes I have talked about so far are all microeconomic in nature, which means that the key question from a macroeconomic perspective is whether the benign characteristics of ICT prevail in the aggregate. If that were the case, as many have argued, ICT could help raise the economy s speed limit and produce faster economic growth. The debate has, of course, been stirred by the long-lasting expansion in the US, which coincided with a tremendous accumulation of ICT capital. Although recovering moderately in the second half of the decade, Europe never reached the levels of growth experienced in the US. Basically, ICT can affect economic growth through three channels. First, investment in ICT equipment raises labour productivity by expanding the capital stock available to firms. Secondly, any technological progress that arises in ICT-producing industries will translate into aggregate output growth. Thirdly, there may be spillover effects in the economy from widespread diffusion and usage of ICT. 2

3 The combined effect of the investment effect and technological progress in ICT industries added about 0.7 percentage point to annual output growth in Europe in the latter half of the 1990s. By comparison, the contribution from these two channels was twice as large in the US a total of 1.4 percentage point. The impact on European growth was constrained in part by lower spending on ICT and a limited presence in the semiconductor industry where productivity has soared. Views remain divided, however, on whether there has been any ICT impact over and above these two channels; and this goes for both Europe and the US. The question sounds simple is ICT just like any other type of capital equipment or can it in fact uncover latent productivity gains by improving work organization, for instance? In the US, estimates of this spillover effect of ICT have ranged from zero or even below up to about 1% point of total output growth. By comparison, Commission studies find that up to now the spillover effect is likely to be small. Going back to what I said a while ago about business process reengineering, it is tempting to attribute what appears to be weaker spillover effects in Europe to a deficit in organizational change. Indeed, European firms do, however, show signs of sluggishness in their attitude toward organizational change. For external commercial activities, 30% of European firms profess to have e-business capabilities but only 6% have engaged in any re-organization of their business processes. SMEs seem to be particularly slow-moving on e-business. Surveys also tell us that only 45% of the European working population use a PC at work, although the concentration is higher in the services sector. Equally, many firms seem to have ignored the abundance of opportunities, as relatively few workplaces are introducing more flexible organization of work through, for instance, teleworking. On the basis of these findings, I have to admit that from a macroeconomic perspective, the signs of an Internet economy developing in Europe are if any very limited. But let us have a look at what the future might bring. 7KHRXWORRN European growth patterns in the latter half of the 90s resembled those of the first half of the decade in the US, we ventured the idea last Autumn that Europe was lagging the US by a few years. Subsequently, we could expect, anytime soon, for the ICT build-up in Europe to start paying off like in the US. Potential growth in Europe could increase by an additional 0.3 to 0.4 percentage point per year, and persist at that higher rate of growth over the coming years. Now, in light of the downturn in the US economy, this speculative forecast of imminent ICT gains in Europe may sound like wishful thinking. While ICT probably will continue to generate strong productivity gains; during the slowdown, this impact will be counterbalanced in the aggregate by demand factors. For Europe, two important achievements make me believe that our region stands a fair chance of riding it out, should gloomy winds start to cross the Atlantic. First of all, the establishment of EMU with its attendant focus on stability-oriented fiscal policy has provided us with a robust, macroeconomic framework for managing the impact of external shocks. This means that when the external component starts sliding, a measured upswing in the domestic European components of aggregate demand should produce the resilience we are looking for. 3

4 Secondly, Europe is making progress in the area of structural reforms. Continued reforms in product, labour, and capital markets can contribute to fostering the supply of labour and capital as well as smooth the changeover to the Internet economy. Generally speaking, we must persevere in the area of structural reform. That way we are even better equipped to cope with the peaks and the troughs of economic cycles. Hence, plans for further encouraging the development and use of ICT will continue. For all the uncertainty about the impact, what seems to emerge from the debate is the perception that ICT sustain a positive net effect on the economy, but that the impact is magnified if the allocation of resources is efficient and markets are wellfunctioning. 3ROLF\$FWLRQ In terms of the policy response to the opportunities and challenges that are served up by the new technologies, what matters is that governments focus on building framework conditions that are conducive to dynamism and growth. Investments have to be made, by public as well as private players, in raising education levels and upgrading skills. Innovation and R&D efforts need nurturing too, as do markets for venture capital, which are pivotal in the creation of new businesses. The regulatory framework requires further streamlining in order to weed out unnecessary obstacles to business activities. Tax measures can be used proactively too, to stimulate change. As stressed in the Lisbon Summit last year, Member States should not ignore the benefits of joining forces as they nurture home-grown competencies. To illustrate this point, I would like to briefly mention some of the recent policy initiatives that have been taken at the Community level. The eeurope Action Plan is a prime example of action taken at the Community level in order to increase digital literacy and promote e-business. As part of the plan, the e-commerce Directive was adopted last year to provide a legal framework for e- commerce services in Europe. Another key element in the eeurope Action Plan aims at creating the HX top level domain on the Internet, stressing the pan- European dimension as e-business markets and practices evolve. In the area of education and training, a concrete policy measure has been launched in the form of a Strategy for Jobs in the Information Society. This contains a series of initiatives designed to improve the match between demand and supply for ICT skills. Efforts are also made to create a dynamic market in Europe for risk capital. The tool for accomplishing this is the Risk Capital Action Plan, according to which Governments should take steps to increase the supply of risk capital and mitigate current market fragmentation. Finally, the Commission and the Council are right now preparing the %URDG (FRQRPLF 3ROLF\ *XLGHOLQHV for 2001, and this year, the guidelines, will contain recommendations on policies that facilitate the transition to the Knowledge-based Society. 4

5 &RQFOXGLQJUHPDUNVDQGRXWORRNIRUWKHIXWXUH To sum up, there is a fair amount of empirical research to suggest that ICT plays a crucial role in the economy and will continue to do so. In the latter half of the 90s, the US experience in particular has demonstrated the capacity of these technologies to act as an engine of growth. By comparison, the signs of ICT-led growth in Europe have been more modest. That might be changing though, as Europe looks poised to become the fastest growing market for ICT. For the first time, demand for ICT in Europe is expected to grow faster than in the US this year, thus although European producers will feel the pinch of slowing demand from across Atlantic, buoyant domestic markets should provide compensation. Let me say, however, that, contrary to what some commentators were claiming a while ago, recent developments confirm that the business cycle is not dead. This, in turn, underlines the need for a stability-oriented macroeconomic policy that paves the way for maximizing structural reform benefits. Against that background, we might therefore expect for the Internet economy to continue expanding for the next 25 years, taking in millions of new users, giving rise to many new business models, and pushing efficiency gains higher. But such an outcome cannot be accomplished by the spread of technologies alone. This evolution will need the support of sound, targeted structural reform policies. In this context, the current favourable macroeconomic conditions in Europe should be seen as a unique window of opportunity to reinforce economic reforms and make good on the Lisbon goal of creating the world s most competitive economy. 5