From SSKE
European countries continue to pride themselves on their rich industrial heritage and strong global position in high-end manufacturing. Yet the underlying reality is that manufacturing is playing a steadily diminishing role in both employment and output. In contrast, the services sector accounts for around two-thirds of total output in the EU, and for fourfifths of growth in recent years. In terms of employment growth, the dominance of services is even more striking. With few exceptions,
manufacturing employment in the EU has contracted, total employment expansion thus being accounted for either by services or by construction.
Reflecting the emphasis on the services sector in the EU2020 strategy, this study highlights some key features of the services sector in the EU, including productivity and innovation in market services. One important observation is is that the services sector accounts for as much as threequarters of cross-country differences in economic growth across individual EU countries. Relatively fast-growing countries have also typically had above-average productivity growth. Even though productivity growth is generally lower in the services sector than in manufacturing, it nevertheless accounts for a large share of aggregate growth in output per employee because of its large size. Countries with high aggregate productivity growth also tend to have relatively higher productivity growth in services.
But the services sector consists of a very disparate group of subsectors, with varying productivity performance and very different mechanisms for enhancing output per employee. The study points to three key ingredients in services sector productivity expansion.
The first is tangible fixed investment. On average, market services have as much fixed capital per employee as manufacturing, but this capital stock is more skewed towards buildings and information and communications technology. These investments have been shown to contribute substantially to productivity growth in several key services subsectors.
A second element is intangible capital. Services industries attain higher productivity by combining investment in fixed capital, new computer software and human capital so as to create new organisational structures and business models, and sometimes entirely new service products. But cross-country differences in the EU are substantial, in terms of both tangible and intangible investment.
A third element is that services sector innovation, in contrast to that in manufacturing, draws less on in-house knowledge creation in the form of R&D. Services industries tend to innovate in interaction with customers, suppliers and competitors. There is also substantial scope for productivity improvements by adopting best practice, both within and between certain service industries. The lower level of in-house knowledge creation partially reflects smaller average firm size in services industries. This greater reliance on external sourcing of new knowledge suggests that cluster formation fostering knowledge transfers and spillovers is an important element in supporting services sector innovation.
