Improving European competitiveness

By Diana Farrell

Reports of the New Economy's demise have been greatly exaggerated. Evidence from both the US and Europe indicates that IT was and is important to productivity growth, but that its primary role is as an enabler of innovation and competition.

Generalizations about Europe at the macroeconomic level rarely yield meaningful insights. At the sector level, however, one generalization hits the mark: where innovation flourishes, productivity rises.

The McKinsey Global Institute (MGI) has pulled together a set of high-level insights into European productivity performance. Based on studies of 7 European countries across 15 industry sectors, this perspective piece looks at the cycle by which innovations are developed, diffused, and scaled, and draws lessons for economic success and failure.

This piece includes a number of vivid examples, both negative and positive:

Innovation Development

In the 1990s, the telecommunications industry in France and Germany profited from a wide range of innovations. New operational support systems, digital technology in mobile services, and IT innovations spurred massive growth. Over the course of the decade, productivity grew at a compound annual rate of 17.7 percent in France and 19.4 percent in Germany.

Innovation Diffusion

The benefits of innovation also come when companies replicate approaches developed elsewhere. Poland, for example, has adopted the innovations that hypermarkets have introduced. Where free to develop, these new hypermarkets have achieved productivity levels already 75 percent of those in the US, three times the level of traditional domestic formats.

Scaling Innovation

To take maximum advantage of some innovations, companies must have sufficient scale. Currently, the German retail banking industry is hampered by ownership structures that restrict consolidation. Banks cannot benefit fully from IT innovations such as back office automation because the optimal gains occur at larger sizes. As a result, German productivity in the retail banking sector is 18 percent lower than in the more heavily consolidated French sector.

Myriad examples make clear that innovation is vital to productivity. In the long run, economic reform—designed specifically to remove the obstacles to innovation—will be key to improving European competitiveness.

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