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An economic assesment of ICT-related industrial policy

Interim report - summary
(final report expected for November 2009)

Download the executive summary of interim report (pdf, 170 KB)

About this study

This is an interim report of a Sectoral e-Business Watch study that provides an eco-nomic assessment of ICT-related industrial policy. The study objectives are to describe current practices and trends in such policy, to analyse selected policy measures and to draw conclusions for developing industrial policy measures in the future.
The preliminary analysis in this report is based on an initial theoretical analysis, expert interviews and literature evaluation. The final report will include a refined theoretical analysis as well as further findings from expert interviews, from an online survey among ICT policy makers in Europe and from case studies.

ICT-related industrial policy: definitions and current trends

ICT-related industrial policy is defined in this report as measures to promote the production, adoption and knowledgeable use of ICT in particular industries. The objectives of such policy are to foster competitiveness, growth and employment in the industries concerned. This report focuses on ICT-producing industries as well as ICT-using manufacturing industries.
Possible instruments of ICT-related industrial policy include, as industrial policy in general, market regulation, infrastructure enhancement, financial incentives, and involvement in entrepreneurial decisions. Several approaches to industrial policy can be distinguished, from complete market conformity to strong state intervention.
The EC’s industrial policy combines horizontal and industryspecific approaches. Its objective is to “create the right framework for industry to thrive” without protectionism and subsidies. It is currently challenged to find appropriate answers not only to increasing global competition and climate change but also to the economic crisis.

ICT-related industrial policy of the European Commission

While there is a defined “industrial policy of the EU” there is no such definition for ICT-related industrial policy. The term has been introduced for this study. Within DG Enterprise and Industry, the following activities are related to ICT and e-business and can thus be considered as ICT-related industrial policy measures:

  • support to ICT research, development and innovation,
  • the e-Business Support Network for SMEs (eBSN) that brings together European decision-makers from business and policy for discussion,
  • support for ICT standardisation and ICT standards adoption,
    initiatives to improve e-skills,
  • activities to create a favourable legal environment for e-business.

The strategic priorities of the EC’s ICT-related industrial policy has changed over the years, from cofinancing ICT investments towards stimulating SMEs to explore the innovation potential of ICT and, more recently, supporting SMEs to develop their e-business strategy in cooperation with their business partners. A next shift may focus on research, development and innovation of key ICT and their adoption in companies of all sizes.

Study focus on ICT-producing and ICT-using industries

This report focuses on ICT-producing industries and on ICT-using manufacturing industries. The competitive position of European hardware and software producers is ambiguous. In some segments European firms are strong, for example in mobile phones and business software. But in others Europe is weak, for example in semiconductors and packaged software. A strategic challenge for the European software industry and policy makers is to strengthen Europe’s competitive position in the course of a shift towards new paradigms such as the “internet of things” and the “internet of services”.

As regards ICT-using industries, energy-intensive industries are of particular interest. These comprise chemicals, pulp and paper, basic metals and glass-ceramics-cement. The European Commission has a special interest in promoting competitiveness of these industries also with regard to their importance for climate change policies.

These four industries represent different stages of electronic value system development. The chemicals industry represents an advanced, market-driven e-value system with an established transaction standard (Chem eStandards) and an “interoperability hub” service company (Elemica). The pulp and paper industry has a medium-high developed e-value system with an established e-business standard (PapiNet). The iron and steel industry has developed an e-business standard (ESIDEL) but it is not yet sufficiently sophisticated and not widely used. The glass-ceramic-cement industry apparently has no specific e-business standard at all.

Concept of the theoretical analysis

A theoretical analysis of selected ICT-related industrial policy measures is a key part of this report. The overall objective of the theoretical analysis is to produce insights about strategies and behaviour of companies, Member States and the European Commission when interacting about funding of ICT research, development, innovation and adoption as well as about the design of related policies.

Two analyses are conducted, one related to ICT-producing industries and one related to ICT-using industries:

(1) Policies to foster ICT RDI in order to promote commercialisation of enabling ICT: The term “enabling” refers to the opportunity to use ICT for continued innovation in the ICT industry itself as well as in other industries. The first part of the analysis targets co-operative international RDI. The issue is to develop economies of scale and scope in European RDI in the field of key enabling ICT.

(2) Policies to enhance electronic value systems in ICT using manufacturing industries: The enhancement of electronic value systems is important for the competitiveness of European industries. Enhancing e-value systems is much about fostering the adoption of advanced information and communication technology (ICT) which can often be considered as key enabling high technology. Therefore, e-value system enhancement may be part of an overarching industrial policy approach to foster high-tech adoption in Europe. The policy focus in this report is on sectoral initiatives seeking to support e-business relationships between companies. This includes small and medium-sized enterprises (SMEs) as well as large companies.

As e-business standards are indispensable for effective e-value systems, standards adoption issues will also be touched. While e-skills are indispensable for the knowledgeable use of ICT and e-business, e-skills issues will not be included in the analysis because this would require a different theoretical approach.

Concept of the theoretical analysis

The theoretical analysis is based on game theory, applying theories of industrial organisation, market failure and state failure.

Game theory is the theory of strategic interactions (“games”) between interdependent actors (“players”). The aim is to predict behaviour of players by looking at strategies which lead to outcomes no player seeks to change (“equilibrium”).

Industrial organisation theory deals with strategic behaviour and interactions of firms and the structure of markets.

Market failure theory deals with situations in which free markets produce inefficient results. Market failures with respect to ICT investments can be traced back to three factors: (1) Difficulties in appropriating the returns from knowledge due to external effects. (2) Imperfect competition and strategic behaviour distort firms’ investment incentives. (3) Imperfect information related to network effects can lead to coordination failures.

State failure theory deals with possible failures in governmental decisions, i.e. inefficient policies. This report assumes that companies seek to maximise their individual utility; governments seek to maximise social welfare. Imperfect information is a principal source of state failure.

First theoretical considerations about co-operative ICT RDI

The importance of ICT for growth and employ-ment in Europe is undisputed. However, the EC sees a critical need for European ICT RDI to be better co-ordinated, concentrated and special-ised. Policies to tackle this problem involve intense cooperation between the European Commission, Member States and companies.

As regards industrial organisation, ICT RDI has some special features, which include short in-novations cycles and relatively small invest-ments for R&D but relatively high in-vestments for commercialisation. Further aspects include standardisation or compatibility issues between existing and new products or technologies as well the cost of imitating innovations of successful competitors. The analysis shows that these characteristics of ICT RDI put large firms at a competitive advantage.

There are three types of market failures related to ICT RDI: The first ones are related to ICT adoption and demand, in particular the innovating firms’ incomplete information about potential demand. The second issue is that, while interoperability and common standards are desirable from an industrial point of view, powerful innovating firms may use incompatibilities for strengthening their market position. Third, while RDI joint ventures may increase economies of scale, they may also lead to prevention of market entry of competitors and to slowing down innovation.

Potential state failure related to ICT RDI funding can be due to at least three reasons:

  • The mechanisms to allocate grants can lead to inefficient allocation of ICT RDI grants.
  • The companies involved in RDI joint ventures may use the results of the cooperation to restrict competition. Subsidising RDI joint ventures without restricting the scope of the firms’ coordination may thus lead to less competitive markets.
  • The interplay between firms, national governments and the EU may induce inefficiencies caused by strategic actions of the different players.

First considerations about ICT adoption for e-value systems

Initial theoretical considerations question whether policies to promote companies’ participation in electronic value systems necessarily enhance efficiency:

  • As long as companies find it profitable to invest in new ICT solutions any policy measure would simply lead to windfall gains for the investing firms.
  • Companies themselves may tackle potential problems of holding up e-business investment by using relational contracts or side payments.
  • The observation that only a number of companies invest in ICT and that markets become more concentrated over time may reflect the fact that the efficient number of companies decreases due to sunk investments. Thus, policy measures may imply that an inefficiently high number of companies remains active.
  • As regards policies to standards adoption, policy makers need to be aware that the companies involved have strategic incentives to hide relevant information in order to reduce their costs of implementing a new standard or to receive direct subsidies.

First empirical findings

While the main thrust of this report is a theoretical analysis, empirical findings help to illustrate theoretical arguments. A case study about the initiative “Cluster Automotive Region Stuttgart (CARS)” illustrates the practical importance of e-business adoption in order to remain part of the supply chains to large automotive manufacturers. It also highlights that the prevalence of proprietary e-business standards can be an important barrier to enhancing e-value systems.

Findings from an online expert survey with 48 responses confirm that ICT RDI as well as e-business adoption in European industries need to be improved in order to enhance their competitiveness. The respondents saw a clear need for public policy to support ICT RDI and adoption. In fact, the majority of respondents find that the European Commission is focusing on the right issues but does too little to actually help improve industries’ competitiveness. The findings also suggest that there is a need for closer co-operation between the European Commission and the Member States in related policies and for clustering activities.

Initial general implications

In this interim report it is too early to draw detailed conclusions on policy implications. The final report will include a concept for the development of future ICT-related industrial policies, based on the theoretical analysis and the empirical findings of the study. A few general issues can already be indicated:

Usefulness of economic theory for policy design: Economic theory may have much to tell to ICT-related industrial policy designers. A theoretically-based and well-structured approach to industrial policy helps to analyse political activities, to identify particular strengths and weaknesses of them and also possible directions for the future.

Economically rational behaviour calls for policy evaluation: The existence of economically rational behaviour of company managers may call for adequate evaluation of publicly funded policy initiatives. Ideally, evaluation should take place ex ante, ongoing and ex post.

Ensure public benefits despite rent-seeking: According to game theory and the assumption of economically rational behaviour, companies participating in publicly funded projects can be assumed to seek public funds for investments they would do anyway. Policy makers should thus seek to establish mechanisms to reduce such behaviour and to ensure public benefits as returns from public funding. The participating companies may be obliged to document the results of the project, and the documentation should be made publicly available.

Importance of market structures: The theory of industrial organisation suggests a close relationship between market structure, companies’ conduct of and their performance. Thus, ICT-related industrial policy should carefully consider market structures. In particular, they should make an intentional decision about the level of industry specificity in activities to enhance value systems.

Importance of e-business standards: The adoption of widely used e-business standards is crucially important for e-value systems. Policy instruments for standards adoption should reduce the benefits of hidden intentions on the part of companies, for example by fostering institutions like standardisation committees that do not rely on direct payments.