Regulations and technology diffusion in Europe: the role of industry dynamics

• Author: Sara Amoroso, Joint Research Centre, European Commission Roberto Martino, Directorate-General for Research and Innovation, European Commission
• Pages: 710-731

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1. The issue at stake

Subdued productivity performance has

emerged as one of the main challenges

facing Europe, and signif‌icantly so in the

aermath of the last economic crisis. While

the slowdown in productivity growth can be

traced back to the second half of the nineties,

its severity has worsened in the last decade

with zero or negative growth across Europe.

European countries have reversed the trend

only recently, and with unequal success across

their regions, revealing dif‌ferent paths and

high heterogeneity also within Member States

(Iammarino et al., 2018).

When science and technology are considered to

be the engines of growth, how can we rationalise

the recent productivity growth slowdown and the

concomitant boom in exciting new technologies?

Dif‌ferent hypotheses have been put forward.

They range from techno-pessimistic views à

la Gordon (Gordon, 2012) – claiming that such

slowdown is a permanent feature of modern

economies that are ‘physiologically’ unable to

bring productivity performance back to previous

heights – to more optimistic views, which argue

that the low growth countries are experiencing

is due to the delay in the yet-to-unfold benef‌its

from the digital revolution, caused by the slow

transition from a production-oriented towards

an intangible-based economy (Brynjolfsson

and McAfee, 2011).

Analyses of productivity dynamics at company

level provide further insights. Indeed, while

productivity growth has generally slowed down,

leading technological f‌irms are still able to keep

Summary

This chapter focuses on the dynamics of

innovation dif‌fusion by analysing the impact

of the regulatory framework on the gap

between top f‌irms and the followers. It

expands on the existing literature by explicitly

investigating the relationship between the

regulatory frameworks in the labour, goods

and capital markets and innovation dif‌fusion,

both directly and indirectly through the

intermediate ef‌fect of business dynamism.

This is particularly relevant for small f‌irms

engaging in risky activities, such as innovation,

for which barriers to access to f‌inance are

tighter than for incumbent companies.

The authors developed an original index

of potential technology dif‌fusion following

a consolidated approach that uses the

total factor productivity distance to the

technological frontier as proxy, which accounts

for the potential transfer of knowledge and

technology embodied in trade. The new

proposed methodological approach informs

on both the mediating and moderating role

of business dynamism in the relationship

between regulation in product, labour and

capital markets and technology dif‌fusion

and thereby enriches existing literature on

framework conditions and productivity.

This chapter produces evidence to inform

reform ef‌forts targeted at product, labour and

capital markets while also providing insights

on the impact of regulatory frameworks

on technology dif‌fusion, the latter being

acknowledged recently as a key factor behind

productivity dynamics.

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CHAPTER 13

up and continue to grow. A plausible implication

of this trend can be the increasing concentration

of knowledge and innovation creation among

a few actors and places and their lack of dif‌fusion

(Andrews et al., 2015; Andrews et al., 2016).

More specif‌ically, innovation benef‌its are

increasingly concentrated among frontier

f‌irms, a mechanism continually reinforced by

the process of globalisation, which contributes

to increasing the productivity gap between

the best-performing companies and the rest.

Markets tend to be highly concentrated and

dominated by a few superstar companies.

At the same time, the process of technology

dif‌fusion has stalled, reducing the scope of

lagging companies to catch up with the frontier

leaders. On the one hand, this is driven by the

greater complexity of technology, demanding

higher absorption capacity in the form of prior

accumulated knowledge and an adequate

skills endowment, in order to be able to reap

the benef‌its of technological change. On the

other hand, adverse framework conditions may

prevent a broader dif‌fusion of innovation across

f‌irms, as they can hinder their capacity to invest

and create barriers that af‌fect the market

entry of new innovative companies (Andrews

et al., 2015; Brynjolfsson and McAfee, 2011).

Therefore, the innovation gap between frontier

f‌irms and the rest grows wider, contributing to

divergences in productivity performance.

Against this backdrop, the existing literature has

analysed the impact of framework conditions

on total factor productivity (TFP) dynamics,

focusing mainly on the ef‌f‌iciency of labour,

product and capital markets. The standard

argument claims that excessive regulation in

the product market is constraining productivity

growth, as the excessive burden on companies

discourages investment (Scarpetta and Tressel,

2002; Scarpetta et al., 2002). Similarly, stringent

restrictions regulating hiring and f‌iring may

slow down the reallocation of the labour force

from less- to more-productive f‌irms, creating

a negative ef‌fect on aggregate performance

while also af‌fecting hiring decisions, especially in

downturn periods (Martin and Scarpetta, 2012;

McGowan and Andrews, 2015; Thum-Thysen and

Raciborski, 2017). Therefore, greater f‌lexibility in

the labour market is usually found to be linked

to better productivity performance. However,

a dif‌ferent perspective suggests that excessive

deregulation may reduce f‌irms’ incentives

to invest in human capital accumulation and

training, with negative impacts in the medium

and long term (Lucidi, 2012; Egért, 2016).

Finally, barriers to access to f‌inance are singled

out as a deterrent to companies' investments, in

particular for young f‌irms engaging in innovation

activities (Hall and Lerner, 2010; Agénor and

Canuto, 2017; European Commission, 2018).

This chapter focuses on the dynamics of

innovation dif‌fusion by analysing the impact of

the regulatory framework on the gap between

top f‌irms and the followers. It expands on the

existing literature by explicitly investigating the

relationship between the regulatory frameworks

in the labour, goods and capital markets and

innovation dif‌fusion, both directly and indirectly

through the intermediate ef‌fect of business

dynamism. The latter is def‌ined as the sum of

shares of f‌irms leaving and entering the market

(churn rate) on the total number of active

companies. Excessive burdens and bureaucratic

barriers tend to discourage new companies from

entering the market due to higher entry costs. This

is particularly relevant for small f‌irms engaging

in risky activities, such as innovation, for which

barriers to access to f‌inance are tighter than for

incumbent companies (Scarpetta et al., 2002;

Acs et al., 2009; Agénor and Canuto, 2017).

The emphasis on the role of f‌irm dynamics (entry

and exit) as the main channel through which

regulatory reforms may increase productivity

growth (European Commission, 2018; de Haan

and Parlevliet, 2018), via a greater dif‌fusion of

knowledge, is not suf‌f‌iciently ref‌lected in the