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@ Ê Objectives
2 Ê @ Introduction
3 Ê 2 The competitive environment
4 Ê 2 @ Globalization
5 Ê 2 2 Deindustrialization and structural change
6 Ê 3 Industrial structure in a European context
7 Ê 3 @ Trade, specialization, and integration
8 Ê 3 2 Trade, investment flows, and multinational activity
9 Ê
preading R&D costs
@ Ê 4 EU mergers, concentration, and size of firm
@@ Ê 4 @ Mergers and acquisitions
@2 Ê 4 2 Concentration
@3 Ê 4 3
ize of firm
@4 Ê 5
tructural change, competition, and efficiency
@5 Ê 5 @ Competition and price-cost margins
@6 Ê 5 2 Competition and price convergence
@7 Ê 6
tructure and competition in the pharmaceutical industry: a case study
@8 Ê 7
tructural challenges and outlook
@9 Ê 7 @ Macroeconomic dimension
2 Ê utomated hotels in a country with @2% unemployment
2@ Ê 7 2 Corporate dimension
22 Ê 8
ummary
23 Ê urther reading
24 Ê Discussion questions


 Customers, Markets, and Marketing 



The objectives of this chapter are:

@ Êto show that the changing nature of competition in Europe can be appereciated only in the context of the forces of
globalization and deindustrialization;
2 Êto provide a guide to the important factors that partly determine such structural change;
3 Êto provide an understanding of the nature of EU trade and the effect of the introduction of The single market
programme (
MP) on such Trade flows;
4 Êto provide an insight into the dynamics of EU industry and services by discussing the forces that affect industrial
structure;
5 Êto show, by investigating the effect of carious trade and structural forces on price margins and price convergence
across the EU, how competitiveness is affected by the changes noted above;
6 Êto explain and clarify the more immediate macro- and corporate-level factors that will determine the EU's future
competitiveness

@  
OR many marketing managers economists are an irritant whose main value is to be the source of old and
rather weak jokes about their unwillingness to make definitive predictions However, many marketing
managers recognize the value of economics and indeed would agree that Ɲthe use of economics and economic
measurement techniques is being increasingly recognized as an important element in marketing and other
areas of business analysis Economic analysis and quantitative techniques allow the major factors affecting
market growth and other business issues to be related to each other in a coherent and consistent way and in a
form which can be used for the evaluation of marketing plansƞ (Greenway @999: 58)
ection 2 shows how
economic factors determine the nature of the competitive environment within which individual firms have to
operate as they market their products The following sections will consider what determines these economic
factors and the pharmaceutical industry will be used as an example
’c



 

Two major influences on the development of I the modern competitive environment have been globalization
and deindustrialization These two influences are considered in the following sections

’ @ 

Over the last two decades of the twentieth century most of the world's nations experienced an acceleration in
the pace of economic change The period saw a convergence of forces that led to a rapid growth of
interdependence between countries, while at the same time causing important structural shifts to occur within
those same nations These interrelated changes resulted in a business environment where the only constant
factor is change itself or a fuller understanding of the general trends in the world economy and the way that
such underlying factors facilitated economic change in Europe, we need to look more closely at the concepts of
globalization and structural changeƜthat is, the international and intranational aspects of economic behaviour

rom a macroeconomic perspective, globalization involves the growing interdependence of countries

worldwide, which results in an acceleration in the volume of goods and services trans acted internationally

uch movements of goods and services are also accompanied by increased flows of international capital and
the rapid diffusion of technology across national boundaries Therefore, the process of globalization can be
seen as a continuous adaptation by firms to the changing global environment
ome firms that serve mainly
the domestic market come under pressure from foreign competitors, while other firms react by aiming at
worldwide intra-firm division of labourƜthat is, they become multinational in their production and distribution
strategies In this context it is interesting to note that, if multinational companies aim at worldwide intra-firm
operations, this will tend to increase worldwide trade, whilst, if such activity is established within a
geographically concentrated area (i e within trading blocs such as the EU, NT, or PEC), sometimes known
as Ɲglobal localizationƞ, then this could lead to a fall in international trade It is the dynamic interaction between
macro and microeconomic forces noted above that often decides the changing pattern of world trade and
production

The pace of globalization trends has been determined to a great extent by the interaction of technological,
organizational, and policy changes irst, the progress in computer/communications technology has meant that
companies are able to coordinate production activities across international borders in search of low-cost
locations t the same time, the costs of transportation have fallen, making it possible for companies to
operate competitively in many areas of the world These changes have spilled over to financial markets, where
the diffusion of telematics and communication technologies have allowed markets to overcomerthe barriers of
space and time, thus affecting the volume of capital transactions
econdly, there have been significant
changes in the organization and operation of many firms n increasing number of domestic and international
companies have become less hierarchical in structure, with decision-making being delegated downwards to
often semi-autonomous subunits that are closer to the actual market Organizational changes such as these,
together with communications technology, have also made it possible for companies to distribute R&D and
marketing facilities worldwide Thirdly, no major movement towards globalization can occur without
political/policy changes In this context, the liberalization of flows of trade and services by such organizations
as the WTO (GTT), IM, and OECD has accelerated since the @97s

What have been the symptoms of rapid globalization? irst, the ratio of world exports to world GDP had
reached 24 per cent by @996, having doubled since @95, and increased by as much as a quarter over the
period @986ƛ96
imilarly, the average daily turnover in the world's main foreign exchange markets grew from
$@,88 billion in @986 to $@ 4 trillion by @996 The amounts of foreign direct investment (DI) outflows have
increased fivefold over the same period Obviously, the degree of globalization does differ across the
continents or example, the ratio of exports to GDP for North merica in @996 was @2 per cent, while the
figures for Europe (including intra European trade) was 3 per cent, and for Developing sia (China and the
NICs) the figure rose to 4 per cent

In the European context, we can look at the process of globalization in two ways: first, at increased trade
between the countries of the EUƜ i e intra-EU tradeƜand, secondly, at increased trade between all EU
countries and the outside world-i e extra-EU trade We have seen above that, on the basis of intra-European
trade, the whole area has been Ɲinternationalizedƞ for many years This is also reflected in the share of EU
merchandise exports (extra-EU trade) to world exports, which stood at 24 per cent in @996Ɯindicating the
importance of the EU as a major trading bloc

Growing interdependence between nations and trading blocs is seen as being beneficial for many reasons It is
argued that the integration of global markets via trade and DI flows will create growth and employment, will
act as a vital mechanism for the transmission of new ideas and new production and marketing techniques, and
will improve management practices worldwide In this way, improved benefits are expected for consumers,
since goods and services can be produced in the least cost locations while simultaneously giving more choice
to consumers lso, financial benefits accrue from the growth of a world market for capital, in that countries
and firms can raise money on different world financial centres using a greater range of sophisticated financial
instruments On a microeconomic level, globalization will bring competition to the doorstep of domestic
companies, forcing them to compete or die This will significantly increase competition, which, in turn, will
increase efficiency in the allocation of resources

The trend towards the globalization of the economy is, therefore, multidimensional Despite the trends noted
above, it must be remembered that three-quarters of the world's production of goods and services are still
consumed within national economies and that world-outward DI of the advanced countries is only 7 per cent
of their domestic fixed investment, which indicates how important domestic savings are in the investment
process
imilarly, globalization to date has not involved large international movements in labour, since
residents born abroad comprise only between 5 and @ per cent of the workforce of large industrialized
countries However, to say that these figures prove that integration of global markets is not a real
phenomenon is to ignore the important changes that have already occurred over the last decade in particular

The integration of global markets will heighten competition in markets worldwide Ironically, it will tend to
increase competition between nations in some markets while at the same time making nations cooperate
through pooling of knowledge and joint venturing in other markets Globalization based on the increasing
activity of multinational companies will also alter the concept of what national production means
ome writers,
such as K Ohmae (@99), have pointed to the fact that national governments will have to attract investment
for the development of their economies independently of the origin of that capital
imilarly, Reich (@99@) has
pointed to the increasing conceptual problems that arise when trying to distinguish between the
competitiveness of nations and that of international companies or example, the competitiveness of the EU-
owned corporations is not the same as EU competitiveness, since foreign companies that undertake
production, research, and marketing in the EU may be more competitive than EU companies operating abroad
The factors noted above mean that the future of global competitiveness will have critical repercussions on
domestic/regional interests, as national governments organize themselves on a more regional basis to achieve
global influence t the same time, governments have to cope with the increasingly complex task of providing
modern economic and industrial policies to provide a suitable domestic economic environment in which both
domestic and foreign multinationals can operate chieving the correct blend of independence and
interdependence will be at the core of national policies for the foreseeable future

’ ’
     


The increasing integration of the world economy noted above has coincided with a longer-term phenomenon
that can also help to shine light on the nature of the competitiveness of nations This revolves around the
continuing structural changes that affect economies as they mature  brief analysis of this concept will help
place competitiveness and structural change in the EU in their proper perspective Basically, as an economy
matures, there is a shift in the sectoral composition of its total output (value added), and employment from the
agriculture sector shifts towards manufacturing and then services or the more advanced countries, the most
significant change over the last forty years of the twentieth century involved the continuing shift in the share of
output and employment from manufacturing to services as per capita income rose

When we look at the value added by the manufacturing sector as a percentage of GDP (current prices), we
find that there was a fall in the ratio in all major economies after @96 or example, taking the main industrial
countries together, we find that manufacturing comprised 3 per cent of their combined GDP in @96 but only
2 per cent by @995, while the share of the service sector rose from 53 to 66 per cent over the same period
or the EU, the share of manufacturing fell from 33 to 23 per cent, and the share of services rose from 47 to
68 per cent in the same period The greatest change occurred in the U
, where the share of manufacturing
fell from 28 to @9 per cent, and the share of services rose from 57 to 72 per cent

These statistics seem to indicate that the shift from manufacturing to service reflects a shift in the pattern of
domestic spending away from manufacturing and towards services This conclusion seems to be confirmed by
sectoral changes in employment, as shown in igs 5 @ and 5 2 Here we see that the share of manufacturing
employment in total civilian employment fell significantly from @97, while, conversely, the share of
employment in services rose strongly at the same time These trends seem to follow the pattern for the share
of output (value added) discussed above,and appear to confirm the hypothesis that such shifts probably reflect
the changing pattern of domestic spending, as per capita income rises as the more income-elastic services are
substituted for manufacturing

However, this analysis is not wholly correct, as the current value of a given output is composed of the price of
each unit of output multiplied by the number of units produced Therefore, the current value of total output
can change from year to year, not only because more units are produced but because the price of each unit
has changed To get a clearer picture of the real changesƜthat is, whether the number (volume) of units of
output has increasedƜwe need to adjust the value figures for changes in pricesƜthat is, calculate output at
constant prices This has been done in ig 5 3 This shows us that after @97 the value added in
manufacturing as a share of GDP at constant prices (i e volume) did not fall significantly in the industrial
countries or in the EU, while there was a some what sharper fall in the U
, and even a rise in the ratio for
Japan until the early @99s

The above analysis indicates that, in volume (i e constant prices) terms, there has not been a very significant
shift in real expenditure from manufacturing to services either in the major industrial countries or in the EU
The question that naturally arises is why should the shares of manufacturing in money GDP fall (and in services
rise), while the shares of manufacturing and services at constant prices do not show the same extreme shifts
The answer is to be found in the changes in the relative movements in the prices of manufacturing and
services over the period In the major industrial countries, the average growth of productivity in services
between @96 and @996 was only @ 6 per cent per year (EU @ 5 per cent), while that of manufacturing was 3 5
per cent (EU 3 @ per cent) These productivity differences resulted in a relatively high cost/price structure in
the less tradeable service sector, while the influence of new technology and global competition was more
severe on more tradeable manufacturing, thus bringing costs and prices down relative to those of services
These price changes tended to exaggerate the real structural shifts in value added

What we can conclude at this stage is, first, that deindustrialization (as measured by value added at constant
prices) is a phenomenon that is occurring at a slower rate in the major economies, including the EU, than
shown by the money figures alone However, trends since @97 do still show a slow decline in the share of real
value added in manufacturing In other words, real expenditure on services has not risen consistently faster
than real expenditure on manufacturing
econdly, that productivity in manufacturing has increased at a rate
that is twice that of services Thirdly, that the significant shifts in employment from manufacturing to services
must therefore be due to the difference in productivity between the two sectors Research by Rowthorn and
Ramswamy (@997) indicates that, of the 9 6 per cent drop in the share of manufacturing employment in OECD
countries between @97 and @994, some 6 3 per cent (i e 65 per cent of the drop) was due to higher
productivity in manufacturing industry than services

Despite the picture presented above, it is also true that the pace and timing of the deindustrialization process
can differ across the globe, as seen in ig 5 3 or example, the share of manufacturing in real value added
actually rose in Japan until the early @99s and fell more rapidly in the U
 The EU experienced only a slow
decline These factors seem to reflect the fact that domestic expenditure seems to have been shifting from
services to manufacturing in Japan, while in the U
 the shift of expenditure has been the reverse, with the
EU's experience showing a more constant pattern However, the reason for these trends may come from
another source or example, Japan has had a healthy trade surplus in manufactured goods since the @97s,
while the U
 has experienced a growing trade deficit in manufactures This tends to indicate that the pace of
deindustrialization may be determined not only by shifts in domestic expenditure within nations but also by the
nature and success of manufactures in export markets, which can slow down the deindustrialization process, as
in Japan, or accelerate it, as in the U
 gain, the EU has had a relatively steady surplus on trade in
manufactured goods, which has helped keep the manufacturing sector's real value added relatively constant

We can, therefore, see that deindustrialization is not necessarily a symptom of the failure of a nation's or a
trading bloc's manufacturing sector, but is a natural outcome of a long-term process of economic development,
where productivity in manufacturing rises more rapidly than services, thus leading to a shift of labour to the
service sector The pace of deindustrialization can vary in different countries or blocs for reasons linked to both
expenditure and trade patterns In each country, the weight of various sectors in the economy partly reflects
this trend, as seen in Table 5 @ Here, figures for the sectoral share of GDP and employment are shown for the
EU, the U
, and Japan
ome countries, such as Belgium, UK, rance,
weden, or Luxembourg, have tended
to shift resources towards the services sector some what earlier than countries such as
pain, Italy, Portugal,
or inland The reasons behind the speed of transition are complex and related to a country's stage of
development and to specific country-based factors What is obvious is the fact that the EU is a heterogeneous
group of economies bound together within a trading bloc The convergence of such economies is, by definition,
a complex and difficult process

Comparing the EU with the U
, we find that there are still more resource shifts to be experienced in the EU if
it is to follow the U
trend, while the discussions on how to manage future deindustrialization or Ɲhollowing-outƞ
is also a worry for Japan
uch shifts inevitably occur not only in the major industrial countries but also in the
newly industrialized economies of East sia, where the share of labour in total employment began to shift from
manufacturing to services in the late @98s nother factor revolves around the role of the fast growing market
services (i e non-government) sectors, such as distribution services, finance and business services, etc , which
will probably be the area of growth if the EU follows the U
/Japanese pattern

It should be noted here that, when we discuss the concept of deindustrialization with its shifts of resources
from industry to services, it is necessary to remember that we should not underestimate the interlinkages
between the sectors or example, the faster-growing transport, communication, finance, insurance, and
business services all benefit from the purchase of technologically sophisticated intermediate investment goods
from manufacturing It has been calculated that some 25 per cent of the service industry depends directly on
manufacturing or example, the production of goods places increasing demand on services such as R&D,
design, marketing, and distribution Therefore, there is a more sophisticated interlinkage between
manufacturing and services than is often imagined

© 
 

  

THE impact of the processes of globalization and deindustrialization described above has had an important
overall effect on the structure of European industries and hence on the nature of industrial competition in the
region To investigate the matter further, it is necessary to examine the different elements that make up the
industrial structure of the region t this stage it is worth pointing out that the EU is by no means a
homogeneous entity, as we have already seen in Table 5 @, but for this study we need to concentrate on the
common elements that define the region as a whole in order to try to compare its performance with other main
players such as the U
 and Japan The most obvious place to begin to understand the dynamics of EU
competitiveness would be to investigate the relationship between trade and the degree of production
specialization within the EU

© @c
!
 !  
 

In terms of intra-EU trade, we see can see from Table 5 2 that some members of the EU tend to be more
geared to trading within the EU than others or example, the trade intensity of economies such as the UK and
Germany tend to be less EU centred, while countries such as
pain, the Netherlands, and Portugal tend to be
more Euro-centric in their trading habits Given these differences, an examination of the EU as one bloc shows
that exports from EU countries to other members of the Union as a proportion of their total exports of goods
and servicesƜthat is, total intra-EU exportsƜincreased over the period @986ƛ93 lthough not shown in this
table, intra-EU trade in manufacturing rose strongly from 58 to 68 per cent, and services from 45 to 5 per
cent over the period) The U
share of exports to the EU has remained the same, while an increasing
proportion of Japan's total exports has been geared towards the EU On the import side, we see that imports
into EU countries from other EU countries as a proportion of all EU imports have remained steady, as has the
proportion of total U
and Japanese imports that came from the EU It might be useful at this stage to enquire
whether these figures give us any clue as to whether the single market programme (
MP) has led to a net
trade creation for the EU

Trade creation is the situation where the removal of trade barriers within the EU replaces a country's local
production with more efficient imports from within the EU, leading to an increase in overall welfare Trade
diversion occurs when the barriers to trade that still exist between the EU and outside countries lead EU
countries to switch their imports from more efficient outside countries to countries within the EU, thus
decreasing overall welfare The idea here is that the lowering of trade barriers within the EU can make the
goods of EU countries more attractive to each other, thus resulting in increased trade flows between them
However, the remaining trade barriers between the EU and countries outside might result in some of the trade
previously done with countries outside the EU (extra-EU trade) being diverted to countries within the EU 
cursory glance at Table 5 2 shows that between @986 and @992 the share of EU imports in total imports did
not change within the triad (EU, U
, and Japan) that is, trade diversion was minimum t the same time, the
figures show that the EU had become more open as a destination for both EU and triad exportsƜthat is, trade
creation had taken place These tentative conclusions are based on the period @986ƛ92, since the change in
statistical reporting after @993 created difficulties in comparing pre- and post-@993 figures However, the table
seems to indicate that net trade creation appears to have taken place as a result of the
MP

lthough the above analysis has given us an insight into trade flows in general, it has not provided a sectoral
analysis of competitive conditions in the EU To provide this type of information, it is necessary to take the
discussion down to the level of the industry concerned Inter-industry trade refers to the situation where some
countries within the EU tend to specialize in the production and export of products of industries where they
have a comparative advantage (that is, those in which they are relatively more efficient), while importing from
other countries the products of different industries in which these countries have a comparative advantage In
simple terms, this type of trade involves an exchange of products from different industries On the other hand,
intra-industry trade is based on the exchange, between countries, of products that are classified as being in
the same industry; that is, it involves trade in similar products

Inter-industry trade carries efficiency gains, because each country can specialize in commodities in which it is
relatively more efficientƜso lowering prices and benefiting consumers However, this sort of trade may entail
redistributive effects, since production may have to close down in less efficient industries, leading to a fall in
incomes or unemployment in those sectors The cost of adjustment is also high for companies, since it may not
be easy to shift resources from one industry to another

Intra-industry trade also carries benefits in that consumers of various countries have a greater variety of
products from within a given industry to choose from, as countries continue to exchange a large range of
products from within the confines of the same industry In this case, the redistribution and adjustment costs
are less, because resource shifts are not so large, since it is less likely that the whole of an industry will
disappear as a result of competition lso, adjustment costs are lower, since companies are involved in shifting
resources to similar products within the industry rather than closing down altogether  study of the nature of
inter/intra-EU trade will, therefore, give a clearer view of the structure and nature of competition in the EU

Before analysing these trends, it would be beneficial to discuss the forces that determine the nature of EU
trade flows and hence the nature of inter- and intra-EU trade irst, as was intimated earlier, trade flows are
partly determined by comparative advantage, in that countries with different relative endowments of resources
can specialize in certain commodities and then exchange these internationally
econdly, trade flows are also
sensitive to changes in transport costs, since, as transport costs fall, the volume of trade will expand, often
affecting the location of such trade or example, before transport costs fall significantly, production may tend
to be located somewhere near the centre of the EU, where the main market lies, but, as costs fall, locating
production on the periphery of the EU becomes more feasible Thirdly, the potential benefits derived from
internal economies of scale can stimulate trade flows in those companies whose domestic market may have
previously been too small to sustain the outputs necessary to enjoy such economies
ourthly, the volume and nature of trade patterns are also determined by technological factors Countries that
tend to have firms that are technology/R&D intensive may become more internationally specialized and thus
increase their ability to engage in profitable worldwide exports  fifth, and increasingly important factor that
has a powerful effect on trade is the trend towards product differentiation s average incomes rise, there is a
well-known tendency for consumers to demand a greater range of goods t the same time, technological
progress and increased R&D expenditure mean that firms discover new product specifications that are different
from other products even in the same industry

ome products may be differentiated because of their clearly perceived quality differences, while others may
be very similar in quality/price but be differentiated by some other characteristicsƜfor example, colour range,
and so onƜall designed to meet the increasing demand for variety inally, the role of national governments in
trade creation should not be forgotten or example, the opening-up of the EU through the
MP has meant
that governments have had to dismantle trade control and decrease other regulatory constraints that
previously inhibited trade The influences of the above factors on the relative growth of interand intra-industry
trade varies or example, any growth in the importance of comparative advantage would tend to enhance
inter-industry trade, while, the greater the influence of technology/R&D as incomes rise, the more likely it is
that intra-industry trade will be stimulated

With the above theoretical framework in place, we can now trace the pattern of trade within the EU over the
@99s in order to clarify the competitive forces at work Table 5 3 shows the shares of inter- and intra-industry
trade in different trade categories in @994 and the change in the shares between @987 and @994 In @994
inter-industry trade accounted for 38 5 per cent of total trade within the EU, while the share of intra-industry
trade in similar or homogeneous products was @9 2 per cent and trade in differentiated products stood at 42 3
per cent

Table 5 3 indicates that EU inter-industry trade (that is, trade between countries in products of different
industries) declined significantly over the @987ƛ94 period, while intra-industry trade (that is, trade between
countries in the products of the same industries) rose The intra-trade category has been divided into twoƜ
homogeneous and differentiated products The former category includes products of the same industry that
are very similar in price and quality, while the latter includes products that are quite different in terms of price
and quality Over the period, both increased their share of EU trade, but particularly the differentiated
category On average, inter-industry trade accounted for more than half the trade mainly, but not exclusively,
in economies with lower levels of economic developmentƜfor example, Greece, Ireland, and PortugalƜwhile
intra-industry trade, both in similar and particularly in differentiated products, was higher in the more
developed economies of the EU lthough not shown on Table 5 3, it should be noted that inter-EU-industry
trade is located mostly in sectors such as food and beverages, mining, non-metallic minerals, and textiles,
which account for one-third of manufacturing value added On the other hand, intra-trade is located mostly in
sectors such as electrical and non-electrical machinery, motor vehicles, chemicals, scientific instruments,
televisions, video recorders, and so on, and accounts for two-thirds of manufacturing value added

While the analysis above has pinpointed the importance of inter- and intra-industry trade across the EU, we
need to take a closer look at the nature of the products being traded in order to provide us with a clue as to
the specialization process in terms of quality products Table 5 4 shows that in @993ƛ4 high-price/quality goods
represented more than 4 per cent of exports in countries such as Ireland, Germany, Denmark, the UK, and
rance, while low-price/quality products represented more than 25 per cent of total exports in Portugal,
Greece,
pain, and Italy The influence of multinational investment in assembly and technology industries in
Ireland has been important in placing the country in the high-quality category If we want to look at which
types of products are being traded between nations, rather than what each nation produces, then we should
investigate the trade balance in different types of products The countries with the strongest trade balance in
high price/quality goods are Ireland, Germany, and rance, whereas the UK, the Netherlands, Benelux, and
Denmark tend to have the strongest trade balance in medium price/quality goods
pain, Greece, Italy, and
Portugal appear to have positive trade balances in the low price/quality range

EU countries also show a tendency to have particular strengths/specializations in the products of certain
industries or example, trade balances tend to show that the UK has strengths in the electrical machinery
industry, particularly in the medium- to high-quality range Portugal has particular strengths in textiles, wood,
and paper, especially the medium -and low-quality range Germany is the only EU country that does not show
strong industrial specialization in any one area Its major strengths are to be found in the products of many
industries, most of which are in the high-quality category

 final point of interest is to investigate whether the development of the
MP has affected the structure of
production (value added) in the different countries In other words, has the structure of manufacturing
production and exports tended to converge across EU countries as a result of the freeing of trade from various
restrictions? Comparisons of @985 and @994 figures tend to show that the structure of value added and exports
has become more similar across EU countries, a conclusion that seems to contradict the analysis of Krugman
(@995) that the elimination of barriers would lead to more specialization and an increasing dissimilarity in the
structures of output and exports However, it is possible that, after an initial convergence, there might be a
move to greater country specialization once more

© ’c
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 "!   

The trade flows described above are inextricably bound up with international flows of capital between nations
One of the most important forms of capital flow that involves industry and services directly is that designated
as foreign direct investment (DI) DI is a long-term investment relationship involving significant control by a
parent company investor in one country over another enterprise located in another country Technically
speaking, DI has three components: equity capital, reinvested earnings, and other capital igures for DI
include the value of shares held by a home-based Ɲparentƞ company in an affiliated foreign enterprise, provided
that the value of such shares exceeds @ per cent of the total value of the voting capital of the affiliate
enterprise DI also includes any retained profits earned by the affiliated company together with any long or
short-term borrowing between parent and affiliated company In effect, the direction and character of DI
flows are intimately bound up with the operation and strategies of multinational enterprises (MNEs)

In more practical terms, DI usually takes the form of a parent company in one country setting up a brand
new subsidiary company abroadƜthat is, a Ɲgreenfield investmentƞƜor a company acquiring, or merging with,
a company based in another country Whichever way the DI takes place, it results in substantial changes to
the location and strategy of companies and hence the flows of goods and services in a global environment
Historically speaking, the relationship between trade and DI in the manufacturing sector has been simple, in
that companies have usually supplied home markets first, and then, through exports, licensing, and other
methods, begun to sell their products abroad When a firm finds it can extend its market and improve its
profits by producing abroad, it will begin to engage in DI In this way, DI becomes a substitute for trade
However, if domestic manufacturing firms are searching for low-cost inputsƜfor example, labourƜthey may
engage in international production immediately via DI and thus create new trade

In both these situations, trade and DI can be viewed as options for the manufacturing sector However, it has
been more difficult for services to follow the manufacturing patternƜthat is, from domestic production to
trade, and then on to overseas production This is because services often need to be delivered to the customer
in the locality where it is demanded in the first instance In other words, services have traditionally been less
Ɲtradeableƞ across boundaries than goods This may account for the shift in world DI stock towards services
over the last fifteen years of the twentieth century, as affiliate service companies were set up abroad or
through international takeovers and mergers in the service sector However, it should be noted that the rapid
development of information-intensive services in recent years has begun to make some of these services more
tradeable or example, telecommunications and information-technology (IT) developments can mean that
service companies in one country can export their services overseas via these links without setting up
subsidiary companies abroad through DI

The importance of DI may be gauged by realizing that in @995 the total outward stock of DI in the world
economy stood at $2,73 billion (Table 5 5) The additions to such a stockƜthat is, the flows of DIƜgrew at a
phenomenal rate of 24 7 per cent per annum in @984ƛ9, before falling to @2 7 per cent per annum in @99ƛ5
as a result of the slowdown of the world economy in the early @99s These growth rates of DI outstripped
the growth of trade in goods and services, which showed yearly growth rates of @4 3 and 3 8 per cent over the
same periods In @995 the value of the total stock of DI was equivalent to 48 per cent of the world's gross
fixed capital formation (GC) and @@ per cent of world GDP for that year

Table 5 5 also helps to show that the bulk of the world's stock of DI (92 per cent) is concentrated in the
developed countries, and also that, over the period @984ƛ95, some 9@ per cent of the total annual average
outflows, and 66 per cent of the total annual average inflows, of the world's DI came from, or went to,
developed countries In other words, the bulk of the flows involved the developed countries investing in each
other rom the context of the EU, we can calculate from the table that this region accounted for 44 per cent
of the total world outward stock of DI in @995 Between @984 and @995 the EU accounted for 32 per cent of
the world's average annual inflows, and 5@ per cent of the world's average annual outflows, of DI

igures for @996 show that the total inflow of DI into the EU was 66,822 million ecus, of which 4,947 million
ecus, or 6@ per cent came from within the EU and 39 per cent from outside the EU (3 per cent from the U
)
These figures help to show the extent of the intra-investment activity in the EU Of the cumulative DI inflows
between @984 and @996, some 65 per cent were in the service sectors, whilst about 3 per cent went to
manufacturing This follows from the dominance of the service sectors in most economies and the fact that,
since services are less tradeable, it is not surprising that DI and multinational activity have often been the
only way to supply foreign markets or example, the impact of the
MP on German outward DI between
@987 and @992 was to increase it by ($@3 7 billion) or @7 5 per cent Of this amount, the contribution of
distribution ($2 9 billion) and finance and other services ($8 9 billion) have dominated, indicating the
importance of such services in intra-EU investment (Pain and Lansbury @997)

The rationale behind such DI flows (that is, that firms prefer to produce abroad rather than export) is
complex, although the groundwork for such rationale was laid down in the work of Dunning (@995) He
indicates that such decisions often depend on three conditions irst, ownership-specific advantages: i e a firm
may possess assets that are internal to the firm that provide a cost advantage over a local rival in a foreign
country (for example, it may have a better processing technique or capital resources)
econdly, locational
advantages: a firm may locate a subsidiary overseas in order to overcome trade barriers or to take advantage
of cheaper foreign factors of production or foreign markets Thirdly, internationalization advantages: a firm
may prefer to set up a subsidiary abroad to ensure stability of supplies or to protect the quality of service

These basic ideas have been modified through the @99s as the nature of economies has changed or
example, ownership-specific advantages have tended to be seen less in terms of traditional assets such as
capital and more in terms of Ɲknowledge based assetsƞ This idea revolves around firm specific activity such as
production processes, product innovation, and other activities that involve Ɲintangibleƞ assets such as
marketing, management skills, and R&D These types of assets are easily transferred back and forth between
different locations at little cost and can, therefore, give firms significant advantages or example, a multiplant
MNE firm need make only a single investment in R&D, which it can spread over many overseas plants, whilst
independent firms must make their own R&D investment (see Insert)
uch MNEs can enjoy joint input shared
across various plants, which gives economies of scale to the firm rather than at the specific plant level Two
other examples of the idea of a knowledge-based firm specific asset can be seen in a situation where a single
multi-plant firm can locate production near a market and, using knowledge-based assets, customize the
product to that market with the help of its specific knowledge of computer techniques, brand imaging, etc

imilarly, knowledge-based assets also encourage firms to engage in DI rather than licensing foreign locals to
produce the product or service This is partly because licensing has the risk that quality may not be maintained
or that technical secrets may be lost Interestingly, the level of DI and its industrial pattern seem to be
determined partly by knowledge-based factors such as expenditures on R&D and patents

The work of Krugman (@995) has pointed out that theories that try to explain the location of DI and MNE
activities in terms of the classical comparative advantage lines need to realize the fact that modern competition
occurs within imperfect markets and is based to a great extent on product differentiation This means that DI
and MNE activities may be more strongly related to the interaction between, on the one hand, the advantages
of knowledge-based firm-specific assets that facilitate product differentiation, and the structure of barriers to
trade between large blocs such as the EU and NT, on the other It is interesting that the integration of the
EU market has not necessarily led to rapid concentration of production in a smaller number of plants, as has
happened in large markets such as the U
 This may be partly due to the activity of knowledge-based MNEs
operating in an area such as the EU with its diverse national markets and consumer preferences

We can see some of the complexity of motives for DI if we investigate the trends in EU DI or example, the
location of outward DI flows from German firms tends to have been influenced by the development of the

MP German firms have tended to divert DI towards the EU as a result of the
MP Within the EU, their
location decisions have been more sensitive to cost factorsƜfor example, labour costs and tax burdens
However, investment outside the EU has been determined more by market pull and the existence of specialized
products

Meanwhile, the motivations for Japanese DI in the EU has been largely due to the existence of EU barriers to
outside trade and the strength of its legislation-for example, dumping regulations Once inside the single
market, the Japanese have located according to cost conditions, such as labour flexibility and labour costs s
far as the UK is concerned, it has been successful in attracting labour intensive DI because of its lower labour
costsƜespecially in the non-manufacturing industryƜbut poor in attracting capital intensive investment,
especially from high-tech, producers for whom labour costs are not as important This is disappointing,
especially when one of the major sources of UK technical progress is DI

inally, it is interesting to note that, despite labour flexibility and low labour costs in the UK, there has been no
tendency to exploit economies of scale at home and then increase exports to the EU, instead of investing in
other members of the EU This tends to substantiate the fact that outward investment has an important role to
help open up markets, thus allowing the UK to exploit whatever knowledge-based firm-specific benefits it has
over local firms abroad n idea of the major EU companies who engage in multinational activity can be seen
by scrutinizing the top twenty EU companies by capitalization, as shown in Table 5 6 lthough they are
dominated by goods industries, a quarter of the companies shown are in the fast-growing banking and
insurance-sectors lt would be beneficial at this stage to realize that one important feature of international
production through DI is that of intra-firm trade across international boundaries In other words, the flows of
goods and services between parent firms and their affiliates and vice versa, as well as the export and import
between the affiliates themselves, are an important part of a nation's trade flows and determine the structure
and competitiveness of their economies

n idea of such MNE activity can be gauged from the latest figures available for the numbers of parent firms
and their affiliates worldwide, as seen on Table 5 7 In total there were in @995 some 38,747 parent companies
operating abroad with 265,55@ affiliates The sales of foreign affiliates in @995 were $6,22 billion which was
greater than the world's export of goods and non-factor services at $4,77 billion The @ largest MNEs
ranked by foreign assets abroad accounted for 33 per cent of global DI stock and in @995 employed @2 million
or @6 per cent of the 73 million people employed by all MNEs worldwide n overwhelming 88 per cent of
parents originated in the developed regions, while the affiliates were more spread out among the regions of
the world Table 5 7 provides a further breakdown of the DI/MNE situation in the EU Here we see the main
location of foreign affiliates and the share of total DI inflows in EU countries The activity of these
multinationals and their effects on different EU economies can be striking or example, intra firm exports by
MNE's can make up quite a high proportion of total exports of some countries We can measure this proportion
by adding the value of the exports of parent MNE firms based in a country to the exports of any foreign
company affiliates also resident in that country If we compare this figure to the country's total exports then
we can have an idea of the role of intra-MNE trade in total trade The figures for exports are as follows: U

36%,
weden 38%, rance 34%, and Japan 25% The figures for imports are 43%, 9%, @8%, and @4%
respectively The main conclusion here is that DI investment has helped to create powerful trade flows
between various sectors of the same company, which has implications for a country's total trade and the
competitiveness of its industries and services

Together with the growth of intra-firm exports, we find that the relationship between different parts of the firm
has also changed or example, the flows between parent and affiliates and vice versa have become less
important and the flows between affiliate and affiliate have increased In other words, the affiliates of large
MNEs are forming closer links with each other in certain regions of the world The most complete insight into
this process may be seen by investigating the global trade flows between U
parent companies and their
affiliates t the world level we see that the share of affiliate to affiliate trade as a percentage of all intra-firm
trade (i e parent to affiliates + affiliates to parent + affiliate to affiliate) for U
MNEs between @977 and @993
rose from 3 to 44 per cent If we look at U
MNEs in the EU, we find that the figures rose slightly from 68 to
7@ per cent over the same period These figures show that the intrafirm trade of U
MNEs has been relatively
high in Europe, even before the
MP The intra-firm integration already apparent in the EU is spreading to
developing sia, where the figures in @977 and @993 for U
MNEs were 23 and 35 per cent respectively Using
the U
 as an example, we can see that the general trend will be for more intraaffiliate integration across the
MNEs of most major countries

Interestingly, the above analysis included MNEs in all sectors The case of intra-firm exporting in manufacturing
is more well known, as parts and intermediate products are sent from one affiliate to another for processing or
assemblingƜthat is, tradeable flows are created On the other hand, the parts of the service sector that are
relatively tradeable are normally produced abroad by setting up identical Ɲclonesƞ in the other country and the
amount of intra-firm division of labour is quite underdeveloped (with the exception of financial services)
However, the rapid technological developments in telecommunications and computers may make some
services more tradeable-for example, financial services, professional services, consulting and engineering R&D,
and information-intensive industries as a whole This means that, instead of having to engage in BI to set up
affiliates abroad, some of these services can be exported from their home baseƜthat is, become more
tradeable This may create a new set of international flows in services without necessitating any movement of
capital or labour


 #$

One of the reasons why BMW bought the Rover Car Company was so that it could spread the costs of R&D
over a bigger market These costs have been escalating in recent years and sales of the BMW models were no
longer large enough to generate enough income to cover these costs (It was also, of course, a quick way of
obtaining an established brand name )

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! 
 ! 
  
To understand the linkages between DI and MNE activity in both a world and an EU context, it is necessary to
understand that mergers and acquisitions (M&s) are a popular way for firms to restructure in order to
improve their international competitiveness By selling off divisions/subsidiaries they do not need, and
acquiring other subsidiaries, they can often enhance their effectiveness
uch reorganizations are a quick way
of acquiring established brand names, supplier networks, and technical expertise lthough the value of DI
and M&s is not identical, they tend to follow each other, since they have one important common element
They both include foreign equity investment, a feature that was discussed above when we defined the term
DI While much of the investment flow is designed to set up new production sites abroad, a significant
amount is also used to take over foreign companies or merge with them, creating an Ɲinstantƞ MNE

% @&

 ' 

M& activity can be defined in two ways  merger is usually defined as a situation where two companies
agree to join to become one entity However, the definition of an acquisition is a little more complicated
ƝMajorityƞ cross-border acquisitions refer to business combinations where the investor acquires at least 5 per
cent of the voting securities of the resulting business, and, in general, this means that the deal has involved a
change of ownership ƝMinorityƞ cross-border acquisitions refer to the situation where less than 5 per cent of
the voting shares are acquired The latter often occurs when companies forge links with the aim of diversifying,
engaging in loose cooperative activities, or forming joint ventures The total value of world cross-border
(majority plus minority) M&s doubled between @988 and @995 By the latter year, the EU accounted for 48
per cent of the world's M&s as compared to 35 per cent for Japan and 3 per cent for the U


In @995, if we take mergers plus majority acquisitions only, the sectoral distribution of the world's M&s were
as follows: primary sector (9 per cent), secondary sector (4@ per cent), and tertiary sector (5 per cent)
Within the secondary sector, the greatest share of world M& activity was to be found in food, drink, and
tobacco (@ per cent) and in chemicals and pharmaceuticals (@3 per cent) In the tertiary industries the
dominant area for M& was banking and finance (@3 per cent) Between @988 and @995 the growth of majority
M&s was particularly active in chemical, pharmaceutical, and finance sectors If we also include figures for
minority control in the M& figures, then sectors such as electrical engineering in the secondary sector, and
the utilities and the media in the tertiary sector, become important, reflecting the increasing cooperative
activity between enterprises in such sectors

The share of EU M& in the worldwide total more than doubled between the mid-@98s (2 per cent) and
@995 (48 per cent), so that many of the world trends shown above are also relevant to the EU case Of the EU
total share of world M&s in @995 of 48 per cent, 32 per cent were basically intra-EU mergers and @6 per cent
extra-EU During the @99s, mergers and majority acquisitions accounted for around 6 per cent of total M&
activity in the EU This figure decreased over the decade, reflecting the growth of minority ownership as the
relationship between firms becomes more complex

Table 5 8 shows the breakdown of M&s across the EU and the nationality of the partners It also shows those
countries whose companies were active acquisitors (bidders) and those countries whose companies were
vulnerable to mergers and takeovers (targets) What becomes obvious from this table is that over the period
@986ƛ95 some 7 per cent of all EU M&s were purely domestic occurrences, with such M&s being
particularly important in the restructuring in the largest economies such as Germany, rance, and the UK

econdly, the smaller countries on average tended to have a greater proportion of EU-based M&s Thirdly,
the countries most active in M& activity with firms outside the EU were the UK, Ireland, ustria, and
weden,
while the larger economies of Germany, rance, and Italy were much less involved in such activity inally, it is
interesting to note that the most aggressive bidders in EU cross country mergers were the UK, rance, and the
Netherlands, while the target countries were pre-dominantly Germany, Italy, and
pain

The sectoral breakdown of M&s shows that up to the late @98s most restructuring through M&s occurred in
the manufacturing sector, while during the first half of the @99s the service sectors became increasingly more
important In @995 for example, the total number of M& operations in services ( 2,6) exceeded the
number in manufacturing ( 2,3), as the effects of the
MP began to filter down to the less tradeable service
sector Within this sector, the M& activity in banking and finance comprised some @8 per cent of both national
and EU cross-border M&s, while the distribution/hotels section accounted for 8 percent of all national M&s
and a more impressive @7 per cent of EU cross-border M&s However, some 7 per cent of M& activity in
the service sector was primarily domestic as compared to 6 per cent for manufacturing, which may reflect the
fact that the
MP changes have been slower to be implemented in services than manufacture However,
buoyant M& activity in the banking and finance sector tends to show that national and international mergers
in services may grow together in the future or example, since @989 large national mergers in banking
(T
B/Lloyds Bank (UK @995) and Midland Bank/H
BC Holdings (UK @992)) and insurance (UP/xa (rance
@996)) have also been followed by increasing interest in international mergers, as evidenced by the @997
activities shown between BT/Zurich and Generalli ssicurazioni/ssurances Générales de rance in insurance,
and Merita/Nordbanken in banking

The rapid change in the market environment brought about by deregulation led to an increasingly more
efficient European capital market, with more companies being quoted on the exchanges and more capital
available for investment t the same time, there was a more effective market for corporate control as
institutional investors such as pension funds and insurance companies became more dominant These features
allowed companies that wanted to diversify and restructure to take advantage of the more efficient market for
corporate restructuring One such mode of restructuring is external to the firm-that is, through mergers,
acquisitions, joint ventures, or equity participation This activity grew rapidly in the @99s and the pattern is set
to continue in the future

The natural question that remains is the extent to which the growth of M&s in the EU has gone hand in hand
with changes in the structure of various sectors To investigate this a little further, it would be beneficial to
look briefly at the trends in concentration ratios and firm size across the EU and to ask whether these have
affected EU competitive environment This latter proposition will be investigated after we have discussed
concentration and firm size

% ’ 
 
Concentration ratios are normally defined in terms of a four- or five-firm ratio In other words, it measures the
combined production of either the four (C4EU) or the five (C5EU) largest producers in a specific industry as a
share of total EU production of that industry
tatistical tests have shown that the difference in the predictive
results obtained from using either of the ratios is small, so that they can be used as alternatives rom an
international perspective, comparable data for the manufacturing sector for @995 show that the C4EU
measurement for the EU (2@ 8) was lower than for the U
 (35 7) and Japan (55 4) Given that the U
(and to
a lesser extent the Japanese) manufacturing sector is roughly comparable to that of the EU, then one might
expect EU concentration levels to rise as the EU market becomes more integrated under the
MP movement
Obviously, concentration will differ between different industries, and to measure this it may be beneficial to
divide the manufacturing industry into two main categories The first type of industry (type @) is where the
products are relatively homogeneous and where the influence of scale economies is important This means that
the predominant form of competition is through price (as in shipbuilding, cement, cotton, wood products, etc )
The second type of industry (type 2) is not restricted to the use of price competition as the only competitive
weapon Instead, this type depends more on advertising and/or R&D and uses these as their main competitive
weapon This type may be predominantly advertising intensive (type 2) (food, confectionery, beer, tobacco,
etc ), or predominantly R&D intensive (type 2R) (chemicals, telecommunications equipment, office machinery,
electrical machinery, aerospace, etc ), or a mixture of both (type 2R) (pharmaceuticals, soaps, detergents,
radio and television, motor vehicle) s far as EU manufacturing industry is concerned, in @995 type I covered
52 per cent of manufacturing industry, type 2@3 per cent, type 2R 25 per cent, and type 2R@4 per cent of
EU manufacturing

Research on concentration ratios across EU industry has shown that sixteen out of the twenty most
concentrated industries (C5EU > 33 3%) are in type 2 industries, indicating the high advertising and R&D-
related costs of product differentiation This trend is shown when the concentration ratios of the EU are
compared with those in the U
 (i e U
C4/EU C4) We find that U
/EU concentration ratios are relatively
higher for both type @ (2 8) and types 2 (@ 36), but, as can be seen, the gap is smaller for the latter type In
particular, the EU's R&D-intensive industries (type 2R) are the most concentrated/integrated (@ @5) as
compared to those in the U
, followed by type 2R (@ 27) and type 2 (@ 67) However, if, in the future, the
EU moves towards the U
industrial pattern, the pressure for increases in concentration may come from type @
and type 2 industries

bsolute levels of concentration and the growth of concentration in the different types of industries within the
EU between @987 and @993 are shown in Table 5 9 Here we see that the C4EU ratio was much lower in the
type @ industries than in type 2, with R&D-intensive industries (2R) and advertising and R&D industries (2R)
being more concentrated The growth in concentration was positive for all types, but particularly so in the
R&D-driven (2R) sector These trends show that, in the industrial sector, the sectors that depend mostly on
economies of scaleƜthat is, plant-based economiesƜare not the most concentrated across Europe, since, as
the market grows, the minimum efficient scale becomes smaller relative to the size of the market and so the
degree of concentration remains small However, those sectors that are based on advertising and R&D tend to
be more concentrated, partly because their success depends on creating greater product differentiationƜthat
is, either perceived or actual changes in quality This means that they invest more heavily in advertising and
R&D expenditures, which then become strategic weapons in such industries to enable them to improve their
market share The need for large firm-based outlays in such industries tends to contribute to higher levels of
concentration in type 2 sectors in the EU (Davies and Lyons @996)

In terms of services, increased concentration has been experienced in distribution and road freight transport as
a result of the
MP, although the highly regulated services such as telecommunications, airlines, or retail
banking have experienced less European-wide concentrations although more national concentration The
industrial restructuring shown by the level and change in industrial concentration shown above is, to some
extent, related to the evolution of firm size across the EU The argument here is that the increase in
concentration and size of firms may signify efficiency gains as reflected by the growth in the size of plants
(production economies) and/or growth of assets shared by the whole firm (research, financial, or advertising
economies) The opening of the EU market will exaggerate these features, as firms are able to benefit from
access to specialized knowledge available from other countries of the EU irms in the manufacturing sector, as
we have seen, where the goods are more tradeable, may grow relatively more as a result of plant-based
economies, while firms in the service industry may be more likely to grow as a result of setting up foreign
establishments to spread their knowledge and skills abroad

% ©
  

On an absolute level, the distribution of firms by size according to turnover/persons per enterprise varies
across the EU, as seen in ig 5 4 Countries can be grouped into three categories The southern countries,
Greece,
pain, Italy, and Portugal, have the smallest average enterprise size in the EU, especially in the retail
trade and craft sectors Germany, Luxembourg, the Netherlands, and ustria have the highest average size of
enterprise, twice the size of the southern countries Belgium, Denmark, rance, Ireland, inland,
weden, and
the UK are in a middle position

If we look at the sectoral distribution of enterprises in the EU (Table 5 @), we find that the larger firms are
located in the traditional capital intensive industries (energy and extraction industries) and also in the
manufacturing sectors (chemical and metal manufacturing) and the Ɲother servicesƞ (air transport, banks, and
insurance) The smaller size of company is clearly located in the construction sector, and in services such as
the trade, hotel, restaurant, and catering sectors

Within this pattern, there are great differences or example, in Luxembourg the importance of larger firms in
the financial sector exceeds the EU average, while the importance of larger manufacturing firms in German
industry exceeds the EU average In manufacturing, the most significant cross-country difference can be seen
by taking the gross value-added (GV) figures for the average company In Germany in @992 the figure was
7 4 million ecus per company, while in rance (4 9 million ecus), UK (4 8 million ecus), and Italy (3 3 million
ecus) the figure was much less Over the period @985ƛ92 the growth in size of German GV was @5 4 per cent,
similar to Italy (@5 4 per cent) but above rance (7 7 per cent) and the UK (- 2 per cent) The difference in
the average size of firms has, therefore, remained largely unchanged The relatively larger size of German
firms ranged across the motor-vehicle, chemicals, and engineering industries as well as in the more traditional
food, textiles, and clothing The impact of the
MP has not been great in this area, as those sectors that were
more sensitive to the
MP have not registered higher growth of firm size This means that the changes in the
size of firms have been due more to the nature of competition within each sector or example, the size of firm
has increased in the advertising-intensive industries (type 2) across the main EU countries, as firms hope to
gain economies of advertising and product development

rom the above account, one would expect some relationship between concentration data and the evolution of
firm size across member states of the EU Basically speaking, at the EU level, the more concentrated the
industry within individual member states and/or the higher the intra-EU multinationality, then the higher the
concentration In other words, if individual member countries are experiencing an increase in concentration, it
is not surprising that the overall EU concentration levels will increase However, the overall EU concentration
level could also increase if more companies operated as multinationals across the EU, since their activity would
begin to dominate the EU industry as a whole t the level of the member state, the concentration level would
rise if the mean size of business grew more rapidly than industry size

Let us now put these ideas into practice We can see from Table 5 9 that, for the member states, the
conventional industries (type @) and also the technologically intensive industries (type 2R) seemed to
experience slower growth in the size of firms than in the size of the industry between @987 and @993, since the
national concentration ratios tended to fall in these sectors However, in the advertising-intensive sector (type
2) we find that the growth of firm size was faster than industry growth, thus leading to an increase in
national concentration ratios However, what is interesting is that, if we look at the European concentration
levels (C4EU), we find that the concentration ratios rose slowly for most sectors but very rapidly for the
technologically intensive industry

These facts tend to indicate two things irst, that between @985 and @993, the growth of EU concentration
ratios in all sectors was generally above the growth of national concentration ratios, indicating a general shift
towards concentration on the EU level This movement was much more pronounced for the technologically
intensive sectors, which moved strongly towards concentrative activity at the EU level, probably reflecting cross
border multinational activity in this sector, as suggested in the above analysis

econdly, there was a strong growth in the size of firms in the advertising-intensive sectors, with concentration
ratios growing positively on both national and EU levels gain, this relates to a situation where those
companies in the advertising -and R&D-intensive sectors seem to be the ones that are sensitive to growth and
concentration, possibly reflecting the fact that these sectors have high fixed costs of R&D (spending on new
products and processes) and advertising (spending on reputation and brand development) With the increasing
openness of the EU market, the main benefits may be for these types of sectors, where competition is very
much in terms of product differentiation They will then invest even more in R&D and advertising across the
whole firm in order to gain an increased EU market share This, in turn, leads to a larger size of company and
increased concentration at the EU level

ƝƦ for many years strong brands have been the focus of major takeover bids by international companies or
example, in @988 the
wiss company Nestlé acquired the British company Rowntree-Mackintosh in order to
gain a strong foothold in the European confectionery market It was recognized that there were significant
financial advantages in buying brands such as Kitkat, Rolo, and Quality
treet ƞ (Chapter 2, p 484)

Ɲllied to the drive for geographic expansion, whether global or regional, is the increasing incidence of strategic
alliances ƞ (Chapter @8, p 448)

J  
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 ! 



THERE seems little doubt that the development of the
MP has provided the platform for an increase in
concentrative activity both at the national and the EU levels However, it can be argued that the growth of
companies and the concentrative power that often accompany such power can have two possible effects irst,
the
MP may result in the rationalization of firms by allowing them to benefit from plant/firm economies

econdly, it also opens up the possibility for the abuse of monopoly power as a result of mergers, acquisitions,
and concentrative power in general

There are two main ways of assessing whether the development of the
MP and the structural features noted
above have been beneficial in terms of improved efficiency and increased competitiveness irst, we can assess
whether the company price-cost margin has changed as a result of the
MP Price-cost margins are defined as
value added minus labour costs divided by value added (or sales)  second way of confirming improved
efficiency and increased competitiveness would be if, other things being equal, there were evidence that prices
were converging across the EU
uch evidence would suggest that the implementation of the
MP has helped
to create a pan European market with increased competition

J @
  
( 

Evidence of the effect of the
MP on price-cost margins tends to show that EU countries can be placed into
three categories: those with high margins (Italy, Belgium), medium margins (rance, Netherlands, the UK, and
Ireland), and low margins (Germany, Luxembourg, Denmark, and Greece) The cross-country dispersion in
margins was not systematic up to @987, but after that period the dispersion fell, indicating inter-country
convergence of margins In terms of the trends in the margins themselves, the evidence tends to show that,
after @987, there was an average reduction of  25 per cent per year in margins Those manufacturing sectors
where the margins fell were in vehicles, consumer electronics, textiles, and clothingƜsectors where there were
relatively moderate tariff barriers before the
MP However, other sectors, such as pharmaceutical products
and electrical equipment, which also had some degree of barriers before the
MP, did not show clear margin
decreases Interestingly, advertising and R&D-intensive industries (types 2 and 2R) did not experience a fall
in price-cost margins This may be because such markets are, as noted previously, in the branded/quality
consumer goods sector, where advertising and R&D costs are naturally high, making it necessary for margins
and prices to be higher Interestingly, we noticed earlier that such markets tended to exhibit elements of
concentration, and this may also help to explain the tendency for price-cost margins to be higherƜa symptom
of excess market power
The experience of services tends to follow that of manufacturing but to a lesser degree, as the
MP has not
been as fully effective in services as is the case with manufacture There have been particular decreases in
prices in telecommunications, banking, and airlines, largely because of competition at the national level or
example, the margins in retail banking have fallen with the lower prices of credit cards, etc
imilarly, margins
have fallen in the road freight industry, leading to an average of 6 per cent fall in real transportation costs over
the @985ƛ94 period This change has allowed firms to search across the EU for lower costs of inputs
ome 42
per cent of businesses reported that the decrease in inter-country barriers had been important in accelerating
purchases of raw material from other EU markets

The change in the level of competition, and therefore in price-cost margins as a result of the
MP, can be
gauged from Table 5 @@ Here we see that firms in manufacturing have been confronted by more competitive
pressures than those in the service sectors Manufacturing tends to have more competition (in terms of
number of competitors as well as price and quality competition) from other EU countries than service industry,
where the main thrust of competition is predominantly domestic Nevertheless it should be remembered that
the service sector is not homogeneous and that, in areas such as financial intermediation, there seems to have
been much more active price competition from non-EU enterprises, as the global financial competition
intensifies

J ’
  
 




It was noted above that, if prices across the EU tended to converge over time in Europe, then this could be
taken as an indicator that the EU market had become more open to competition Despite the fact that price
convergence can occur at relatively high levels because of collusive behaviour (when oligopolistic firms come
together to agree prices), it is nevertheless true that, on average, the general convergence of prices across
national borders can give some general idea as to whether the EU market is becoming more competitive 
study by the DRI (DRI Europe Ltd @997) attempts to answer this question by calculating price dispersion
coefficients (standard deviation of prices divided by the average) over time for the manufacturing and service
sectors and then assessing whether the price movement is converging towards the EU average price

The conclusions of the survey show, first, that the levels of price dispersion increased as more member states
joined the EU (i e EU6, EU9, EU@2, and EU@5)
econdly, if we take figures for the EU@2 between @98 and
@993, we find that there was a general trend towards price convergence, with price dispersal being lowest
among the more tradeable products or services In general, the consumer and equipment goods industries
experienced more convergence than did energy, services, and construction inally, of the eighty-six
products/services categories for which there was a clear change in price dispersion, some seventy eight cases
showed price convergence, while there were only eight cases where prices diverged These seventy-eight
cases accounted for 6 per cent of total private consumption in the EU

The pace of such trends depends on the nature of individual economies and their industrial structure, the
nature of competition within such industries, and the effect of government policies or example, it is not
surprising that price dispersion increased as more countries joined the EU, since the smaller Ɲcoreƞ EU6/EU9
had more similar economies to begin with, and had had more time to become more integrated lso, the
greater convergence of prices in the consumer and equipment-goods manufacture is mainly due to the fact
that they became more tradeable as time progressed On the other hand, the energy sector did not experience
such a decrease in price dispersion, mainly because energy markets are not fully liberalized and they are
affected by different levels of taxation in different countries In the service sector, price dispersion was higher
than for more traded goods and decreased more slowly over time This is partly due to the fact that price
levels in services are strongly related to GDP per capita, so that the convergence of service prices is likely to
have been slower because of the disparities of per capita GDP levels across the EU

Price convergence in services is particularly important, given that it has been slower than the goods sector
The price dispersal measure for the EU@2 was 33 7 for @985 and had decreased to 28 6 by @993 The fact that
the figures for durable goods over the same period was 2 8 and @6 4 shows clearly that price disparity and
the degree of price convergence partly depend on whether the output of the sector is tradeable or not
Nevertheless, within the service sector, there was stronger price convergence in postal services, banking and
insurance, and telephone, telegraph, and telex services, while price convergence was slow in household
services, medical services, and pharmaceutical products, for example The former set of services were more
open to internationalization and competition, as seen in the liberalization of telecommunications and the entry
of new suppliers The latter group still have particular factors inhibiting price convergence-for example,
national regulations on pharmaceutical standards and medical health care

 final question to ask would be what general factors tend to affect the movement towards a more competitive
situation in the EU with a law of one price' We can divide the explanatory variables into three groups irst,
there are structural and policy factors These include price disparities based on differences in both consumer
demand and fiscal policy (e g VT incidence) across the EU The existence of non-tariff barriers (NTBs) is
another structural factor
econdly, there are the competitive variables in each marketƜthat is, the importance
of economies of scale, advertising, and quality factors These variables often indicate the presence of either
homogeneous (type @ industry) products or vertically differentiated (type 2 in dustry) products, whose
attraction is based on both price and quality Thirdly, there is the degree of competition in European markets
over time, as illustrated by figures such as intra/extra-EU import penetration, the concentration levels in
product markets, and the degree of multinationalization that was discussed earlier in the chapter

Econometric analysis (DRI Europe Ltd @997) has shown that about 3 per cent of the variance in prices across
the EU is due to structural and policy factors, with consumer preferences being the dominant reason for price
dispersion under this heading Under the second heading, which covers those products where competition
depends mainly on prices (homogeneous products, such as flour, bread, rice, etc ), or on both price and
diversity (horizontally differentiated products, such as clothing, footwear, glassware, etc ), the development of
the
MP has generally led to increased price convergence On the other hand, those products that are from
markets that are advertising and R&D intensive (vertically differentiated products, such as televisions,
electronic equipment, optical instruments, etc ) tend to have high and stable price disparitiesƜthat is, no
recognizable price convergence This tends to substantiate the idea suggested previously that firms use these
high costs of R&D and advertising as a strategic barrier to entry, thus enabling them to maintain price
disparities and prevent convergence Interestingly, imports in these sectors do not tend to create more
competition and hence lower price disparity, because they are in markets where imports are generally of the
intra-firm type, a feature that was discussed in
ection 3 2

 final set of conclusions from the econometric analysis shows that product markets that are intensive mainly
in R&D onlyƜproducts such as computers, replacement parts for vehicles, etc show a low average price
disparity, which tends to suggest that when the large investments needed in such areas are not coupled with
high advertising investments, the firms are compelled to adopt pan-European strategies On the other hand,
products that are differentiated primarily because of high advertising costs, which reflect companies' strategy
to raise the consumer willingness to payƜproducts such as food, confectionery, tea, and alcoholƜtend to have
high price disparities, since these companies use advertising to raise barriers to entry and tend to keep prices
high

Under the third heading, the rate of import penetration and the extent of multinational activity tended to
decrease price dispersion, while the degree of concentration exerted a significant positive impact on price
disparity These conclusions provide some information on the effect of these variables (see
ection 5 @) on
price variables

What we see from the above analysis is that the competition environment in Europe is sensitive to a range of
different factors and that price convergence has, in general, occurred, but the pace of convergence has
depended on the sector, the type of product or service within each sector, and the degree of national
government regulations However, even when we allow for further inevitable future decreases in various types
of trade barriers and the probable price convergence that such a trend will bring, we may still be left with
relative price differentials that are based on the nature and structure of the sector that firms inhabit, as
discussed in
ection 5


 
  
 
 


IN @994 total sales of medicines within the EU were 5@,85 ecus, which accounted for nearly 25 per cent of
world output
ome @5 per cent of the medicines were prescribed within hospitals, 74 per cent were prescribed
mainly by general practitioners (GPs), and @@ per cent were bought for self-medication by individuals

On the production side, economies of scale and scope are present in the industry, although, unlike the heavy
chemical sector, pharmaceutical output is relatively small and often general-purpose rather then dedicated
plant can be used Research economies are linked to size, since only firms whose annual sales are over @,
million ecus are capable of developing new active products Economies of scope are present in the discovery
phase, since research in one area can often give rise to many different products The sector is marketing
intensive, in that patented products sold under brand names are promoted directly to physicians or in the
medical press, while only products permitted for self-medication can be advertised to the final consumer
inally, because the pharmaceutical sector is fragmented, manufacturers distribute their products through
specialist wholesalers who sell to retailers, although hospital medicines and self-medication products often
bypass the wholesaler ll in all in @997, production accounted for some 3ƛ4 per cent of the turnover, R&D
@ƛ@5 per cent, and sales and marketing some @5ƛ2 per cent, and the sector is one that is both advertising
and R&D intensive

There were some 2,662 pharmaceutical companies in the EU in @997, compared to 775 in the U
 and @,556
in Japan, with some half of them located in Germany However, the forty-eight largest worldwide firms
dominated the industry; they produced some 65 per cent of the world market by value, and also accounted for
85 per cent of the world's R&D in the industry In the EU the pharmaceutical industry was still dominated by
some fifteen companies, which had sales of more than @, million ecus, representing a third of the world's
total of such firms ive of the twenty lagest EU companies can be seen in Table 5 6, and if we had included
the
wiss companies Roche Holdings and
andoz in this group, then they would have taken second and sixth
positions respectively The market is relatively fragmented, in that no one individual company had more than 7
per cent of sales within any individual state On average, the top ten had between 25 and 3 per cent of the
retail market and the top twenty-five had between 4 and 5 per cent of the market of member countries If
we take the EU as a whole, no firm had as much as 5 per cent of the market

In terms of market share by product, the best selling medicine in any country normally has less than 5 per cent
of the market, with the top fifty having 25ƛ35 per cent and the top @ having 4ƛ5 per cent by value The
major market concentration by products was greatest in the UK in @994 and least in Germany, although figures
for concentration did fall between @984 and @994, indicating the entry of generic products lthough the
overall level of concentration is low for medicines, it is still possible to have one or two therapeutic areas
dominated by a few medicines accounting for a large proportion of salesƜas, for example, happened with
Zantac/Tagamet for stomach ulcers, before their patents ran out To summarize, the pharmaceutical industry
has been dominated by a few large companies for many years, and, although the national concentration ratios
have increased, it has been mainly by the growth of the top seventy-five firms rather than at the top-ten level

However, despite the lack of a large change in concentration ratios, there has been a degree of M& activity in
recent years Between @989 and @994 some 3@2 M&s occurred in the EU pharmaceutical sector, with nearly
4 per cent of them between firms of the same country (i e national), with Germany, Italy, and the UK
undergoing the largest internal rationalization
ome 27 per cent of the M&s were intra-EU mergers, with
rench, Italian, and German companies being the most frequently targeted inally, about 33 per cent of EU
M&s involved companies from outside the EU, and here again the main target countries in over 8 per cent of
the cases were rance, Germany, Italy, and the UK part from the massive
mithKline-Beecham merger, the
majority of the acquisitions were below 6 million ecus, which is too small to support genuine innovation This
fits into the growth of concentration but only at the middle to lower end of the size scale and may reflect the
fact that many family-controlled firms may be disappearing Between @983 and @993 employment in the
pharmaceutical sector rose by only @ per cent, while labour productivity rose by 54 per cent, partly as a result
of rationalization activities through mergers The rationalization through mergers still continued through to
@997, with the Hoffman-La Roche/Corange, Nycomed/mersham International deals, together with the
possibility of new relationships between such companies as Zeneca, stra, Novo Nordisk, Rhone Poulenc, and
Pharma
The role of DI and of multinational activity in the pharmaceutical industry has been important since before the

econd World War as multinational companies have attempted to overcome import barriers by producing
locally The number of companies with plants in the EU but outside their own country of origin remained quite
steady between 2 (@984) and 27 (@994) Of the total of 27, some seventy originated from rance,
Germany, and the UK, and seventy-eight from the U

ince @994 the rationale behind the location of
pharmaceutical DI in Europe has varied, and a @997 study of U
companies operating in the EU found that
nearness to the size of the local market, the quality of its specific skills, and government incentives, together
with past experience, were the main considerations If we take these criteria, then rance, Germany, and the
UK appear to be very attractive locations for U
multinationals in terms of both production and research
However, it is unlikely that many new Ɲgreenfieldƞ facilities will be built, as growth is more likely to occur
through M&s This strategy is designed to gain some economies of scale and scope, not only in production,
but also in marketing and sales Where R&D is concerned, the great benefit of mergers is to cut out costly
duplication of overlap ping research

While the above account has delineated the structure of the pharmaceutical industry, it is also necessary to
assess the nature of competition within the sector To understand this we need to study the components of
competitive strength in this sector and then the nature of competition in the different markets We can assess
the first of these aspects by looking at the three main world marketsƜthe EU, the U
, and JapanƜand
enquiring as to whether there has been a change in the shares of each one in the other's marketƜthat is, a
shift in competitive strength Basically, the distribution of competitive strength has been stable or example,
over the period @982ƛ93, EU based companies' share of the EU market fell only slightly from 65 6 to 6@ 4 per
cent However, EU-based companies' share of the U
market increased from @ @ to 2@ 9 per cent in the same
period, much of this due to the growth of UK companies (their share of the U
market rose from 9 4 to @5 @
per cent) EU penetration of the Japanese market is small, as over 8 per cent of that market is served by local
producers

Basically speaking, EU companies have maintained their strength at home and penetrated more of the U

market The lifeblood of the pharmaceutical industry revolves around new innovations and new products In
this respect, 4 per cent of most original and innovative products discovered in the pharmaceutical sector
between @975 and @994 originated in the EU, with over half of the EU number originating in Germany and the
UK The U
 accounted for 26 per cent If we take the top fifty pharmaceutical products in @994 worldwide,
twenty-four originated in the U
 and seventeen in the EU (eleven from the UK)

We have looked at the competitive strength of the sector; it is now relevant to look at the nature of
competition in this area To do this it is necessary to understand that nearly all medicines start off life by being
prescription-only medicines and are protected by patents and brand names These are prescribed by doctors
within and outside hospitals, and the cost of such drugs was not always of great consideration However, once
the patent for a successful product has expired, generic copies appear and are often offered at a lower price to
overcome the attraction of the originally branded product This often leads to fierce price warfare On the other
hand, self-medication products can be bought directly by the customer, who pays the full cost, so that such
products will be more price sensitive Despite the growth of generic drugs, there is still intensive advertising
undertaken by the owners of branded drugs that moderates the degree of competition

or those medicines that are still under patent, the competition depends on the ability of companies to
innovate rather than on price This is because the barrier to entry in this area is high, as heavy R&D is needed,
which is beyond most of the middle-to-small companies Competition in the out-of-patent market between
originators and generic producers has undoubtedly increased in countries where there is official action, such as
pressure on physicians to control their spending on medicines inally, competition between self medication
and prescription drugs depends on the range of drugs that can be sold without prescription In general there
was a more lenient attitude towards self-medication in the late @99s, so that this market will become more
important as time progresses EU legislation in the @99s effectively allowing patents to be extended through

upplementary Protection Certificates helped the research-orientated companies to the detriment of generic
companies lso the Classification Directive (92/26/EEC), by classifying prescription and non-prescription
medicines, may lead to an increase in the market for self-medication products, although the degree of change
depends on how each country administers the directive
Given these aspects of competitive strength and competition, how have prices been determined in the EU and
are there any signs of convergence in this sector? Basically, prices of medicines vary widely between EU
member countries and are often determined by variations in the national income of countries and the policies
of national governments towards expenditure on medicines by their public health-care systems Manufacturers'
prices for medicines that are reimbursed under public health-care systems (i e that have been officially
approved and reimbursed by the government) are fixed at launch in most EU member countries, and official
permission is required for any price rises Distributors' margins are also controlled in all member countries by
setting maximum levels Discounts to retailers are allowed, although the numbers of such outlets are often
regulated ll of this means that, despite EU Transparency Directive (89/@5/EEC) to make the situation
clearer, the pricing of medicines is still complicated and linked to national government health policies

The final price of medicines in EU member countries is related to absolute income levels, national government
policy, the degree of generic competition, and the degree of parallel imports ll in all, the introduction of new
EU directives has not significantly reduced the spread of prices in the EU Prices in Denmark, Germany, Ireland,
the Netherlands, and the UK were consistently above the EU mean in @997, while prices in rance, Italy,
Portugal, and
pain tended to be below average

rom a strategic point of view, the pharmaceutical industry is one where the threat of new entrants comes
mainly from the generic companies, and the bargaining power is generally with the buyersƜthe public health-
care systems of member states However, the emergence of generic companies and the parallel trade provided
increased power for the suppliers in the late @99s Rivalry within the main companies producing new products
is still through R&D spending and product differentiation, while, even when their patents have lapsed, they
may still aggressively market and promote their products The generic companies compete in the sector where
the barriers to entry are much less than the larger firms, and they compete primarily in terms of cost
leadership, although they cannot wholly forget some element of branding, which consumers find is still
important

rom the above account it is possible to see that merger and concentration activity, together with the influence
of DI, have all been important in moulding the development of this industry t the same time, the influence
of national standards, government policies, and the per capita income of member states have affected the way
in which price and output strategies have been formulated across the EU The pharmaceutical industry is a
particularly important competitor on world markets whose development has and is being influenced by many
interacting factors We will now discuss how these factors influence not just the pharmaceutical industry but
the whole EU economy

ƝNew products fail at a disconcerting rate and companies can incur huge losses, not only in immediate
monetary terms when they fail to recover their development and marketing costs, but also in terms of future
potential when a new-product failure negatively impacts on the reputation or image of the firm ƞ (Chapter 24,
p 55@)

ƝMergers and acquisitions have proved to be an effective means for a company to expand its product mix ƞ
(Chapter @4, p 326)

½ 

 )

THI
chapter first stressed the importance of globalization and technological change We saw how such forces
affected flows of trade and investment, which, in turn, influenced the pace of structural change in both a world
and an EU context It then discussed the structural components of EU industry such as concentration, mergers,
and the size of firm, together with the effects of the opening of the EU market through the
MP on strategic
competitive variables such as price, cost margins, and price convergence This final section will attempt to
place the debate in both a macroeconomic and organizational context by investigating the concept of
competitiveness in the context of EU manufacturing and services

½ @&
 
 

In terms of macroeconomic policy, there are three main indicators of the competitiveness of a given nation or
trading bloc irst, there should be a relatively buoyant export performance and favourable movements in
international cost competitiveness
econdly, domestic productivity should increase at a steady rate that is
similar or higher than that of its rivals Thirdly, productivity improvements should occur hand in hand with a
high level of employment The underlying factors affecting the Ɲcompetitiveness pyramidƞ and therefore the
standard of living of a nation or group of nations is shown in ig 5 5 Here we see that, if a nation or a bloc of
nations such as the EU is to improve its competitiveness in manufacturing and services, there is a need to
address a number of factors that underlay the two main pillars of employment and productivity On the
employment side, the task is to create a labour market that stimulates employment creation while also making
labour more skilled and flexible On the productivity side, it means creating an environment that stimulates
R&D and other innovative activity while encouraging business investment and sympathetic government
involvement

To achieve such benefits for one country is difficult enough, but for a whole trading bloc to improve its
performance is more problematic The aim of the
MP and the EU structural policies has been to create some
degree of uniformity or convergence across the bloc Given this aim, the main question to ask at this stage is
whether the EU as a whole is showing signs of improved competitiveness vis-a-vis other advanced countries In
relation to the first criteria for sustained competitiveness given above, it is clear that the EU has lost export
market share since the early @98s at an average rate of- @3 per cent per year, with Japan's export market
share also declining by an average of-3 3 per cent On the other hand, the U
 has seen its export market
share rise by an average of ( 4 per cent per year, while, until their @997 currency crises, the sian economies
experienced a growth of 3 per cent per year in their market share of world exports over the same period

In terms of the Ɲcompetitiveness pyramidƞ, the performance of the EU on employment and productivity has
varied The employment rate (i e the proportion of working population that is employed) has fallen in the EU,
while, at the same time, it has increased in Japan and the U
 By @995 the EU's employment rate was around
6 per cent as compared to rates of 73 per cent and over in the U
 and Japan This underutilization of labour
is also to be seen in the unemployment rates, which, since the early @97s, have been, on average, 35 per
cent higher in the EU than the U
 and 23 per cent higher than in Japan

rom the productivity side, the EU performance can be measured in terms of the productivity of labour fter
the oil shock of the early @97s there was a deceleration of labour productivity in all industrial countries, but
since that time the EU has experienced a steady growth rate of labour productivity of around 2 per cent per
year, some three times as fast as the U
rate but well under the Japanese rates However, since the @99s EU
labour productivity rates have been higher than those of both its main industrial competitors This steady
growth of labour productivity over the last two decades of the twentieth century allowed the EU virtually to
catch up with the absolute levels of productivity of its competitors In @96 the level of GDP per person
employed in the EU was only 45 per cent of the U
level, but by @996 this had risen to 83 per cent The
relatively high rate of growth of productivity in the EU has helped to narrow the gap

rom the two aspects of the competitiveness pyramid we can see that the EU has done relatively well on the
labour productivity side but that its employment performance has been poor in comparison This weakness on
the employment front is largely due to the interaction between labour productivity and the substitution of
capital for labour, on the one hand, and the growth of the economies, on the other or example, the growth
of labour productivity (GDP per person employed) has two determinants One determinant is technological
progress in the form of new innovations, improved labour skills, and more organizational efficiency within
firms This is often called total factor productivity (TP) nother determinant of labour productivity is the rate
at which capital is substituted for labour This means that GDP per employed can rise because new efficient
machinery is capable of producing more output with less labour (see Insert) Table 5 @2 provides an insight
into the determinants of both labour productivity and GDP in the EU as compared with the U
 and Japan
Here we see that the growth of labour productivity was more rapid in the EU than the U
 both before and
after the oil shock, with its immediate post-oil-shock period experience being equivalent to that of Japan In
the more recent period between @986 and @995 the EU's performance on labour productivity was better than
that in the U
 and equivalent to Japan's
When we investigate the reasons for this labour productivity performance, we find that some 4 per cent of
the EU's growth of productivity over the whole period was due to the substitution of capital for labourƜa figure
similar to that of Japan's but much higher than that of the U
 at @6 per cent lthough the substitution of
capital for labour does, of course, help increase economic growth and the standard of living, it does not
address another important problemƜthat of unemployment or example, the unemployment rate for the EU
during the first half of the @99s was @@ per cent, while those of the U
 (5 4 per cent) and Japan (3 3 per
cent) were significantly smaller In other words, the substitution of capital for labour in the EU is superimposed
on an already high level of unused labour resources, while the same is much less true for the U
 or Japan

Two other factors are worth mentioning in this context irst, the rate of economic growth has not been high
enough in the EU to create sufficient growth in the number of jobs This can be seen in row 4 of Table 5 @2
which is the difference between the actual growth of GDP (row 5) and the labour productivity (row 3) Here we
see that the growth of GDP in the EU was not rapid enough to generate enough overall employment to
compensate for job losses resulting from the relatively healthy growth of labour productivity in the EU as
compared to that in the U
 or Japan
econdly, this relatively rapid rate of substitution of capital for labour in
the EU reflects some inflexibility in the EU labour market in relation to the U
 and Japan

The above analysis means that the dilemma for the EU is to maintain the growth of labour productivity while,
at the same time, trying to slow down the rate of substitution of capital for labour so as not to increase the
already high level of unemployed The growth of employment obviously depends in part on keeping average
wage cost undercontrol, which the' EU has managed to achieve quite successfully Its growth of wage costs
per head and unit labour costs has been slower than inflation, thus allowing industry to increase investment
and create more jobs However, this process has been slow, and the signs from the U
 are that not only do
average wage costs need to be controlled, but the dispersion of wagesƜthat is, the wage level between the
highest and lowest-may need to be wider This revolves around the finding that the widening of the wage
scales tends to increase employment This argument stems from the fact that, as the forces of globalization
and technical change widen labour-productivity differentials between different sectors, there is a need also to
widen the wage dispersion to enable more employment to be created at the relatively low productivity end of
the economy

The solutions to the EU labour-market problems cannot be Ɲimportedƞ from the U
, since the U
reliance on
market forces with low minimum wages and social benefits would not suit the European model with its
relatively high non-wage cost (social-security contributions) in its total wage bill However, the strategy is
aimed at the twin goals of increased growth and employment intensity To do this, the labour market has to be
more flexible through measures to improve education and other labour-skill formation programmes, while at
the same time increasing the flexibility of work arrangements within companies and firms

While the issues above have tended to concentrate on productivity/employment aspects of the competitiveness
pyramid, one should not neglect the role of investment, innovation, and investment in public infrastructure,
which lies at the base of the productivity pyramid To maintain employment growth as well as productivity, the
EU has to create the capacity for future growth and development This involves resources being channelled
into intangible investments such as R&D and innovation The EU's total R&D spending is smaller than that in
the U
 or Japan, with less being generated from the business sector in terms of both financial involvement
and research personnel
imilarly, as Table 5 @3 shows, the fact that of all the patents taken out in the EU
about a half were from within the EU, while the U
 and Japan together accounted for a half, indicates that an
increase in the innovation rate might also be needed The striving for improved competitiveness calls for a
more effective development of Ɲimmaterialƞ investment in generalƜsuch investments include effort to improve
after-sales service, design, reputation, image, etc Ɯthe so-called soft aspects of competitiveness inally, the
market/financial performance underlying productivity has to include suitable government policies to stimulate
growth and technical change

The outlook for EU industry and services depends very much on the nature of the sector concerned Table 5 @4
shows a sectoral breakdown of the annual productivity change over the @99ƛ9 period, together with the
absolute change in numbers employed We see that labour productivity in manufacturing and energy rose
rapidly in this period as a result of the reorganization and con centration of production in fewer plants, and the
reallocation of labour-intensive processes to areas outside the EU The growth in labour productivity in services
was at half the rate of manufacturing, but was still at a favourable level in relation to past performances in this
sector, mainly because of relatively rapid growth of productivity in the transport, distribution, financial, and
business sectors Employment trends during this period show the shake-out of labour from manufacturing and
construction as a result of both productivity improvements and the recession of the early @99s The growth of
employment in market services rose during the period by over 2 millions, with sectors such as distribution,
hotels, and restaurants, and Ɲother marketƞ services such as business services, social services, cultural and
recreational service, and personal services, accounting for the bulk of the employment gain

Labour productivity slowed down overall during the @995ƛ9 period, as the corporate restructuring and
relocation mentioned above decelerates In terms of employment, there will be a small addition to employment
in manufacturing and building, while market services will continue to provide the bulk of employment gains, led
by the growth of business services such as market research, advertising, accountancy services, computing, and
software services lso the growth of communication technologies will enable small companies to succeed in
markets where previously only large companies dominated These shifts will mean a change in relationship
between the demand for skilled/unskilled workers, as can be seen in Table 5 @5

Here the high-skill sectors are defined as the first three occupation categories, with the other occupations
defined as the relatively lower-skilled occupations t the end of the @99s the demand for labour was of the
skilled kind, whose growth was particularly active in the service industry In the absence of policies to remedy
the skill problems, the EU will find it increasingly difficult to remain competitive and to maintain the desired
type and level of employment

è
 
  " @’




Why haven't automated hotels sprung up like robotic mushrooms in Canada and the U
? It's not because of
lack of technology It's because, on the whole, employing humans is cheaper there In rance, with @2%
unemployment, the rationale for automating hotels is not lack of workers However, the minimum wage is
much higher than North merica and payroll taxes are twice the Canadian rate In addition there are many
complex labour laws

ource: McGugan (@997)

½ ’

 

ection 7 @ discussed the macroeconomic adjustments that will be needed for the EU to maintain its
competitiveness However, the key to such improved macro-competitiveness in the future will also be
dependent on organizational change at the micro or corporate level in both manufacturing and services The
reason for the increasing stress on the corporate level comes from an understanding that competition between
individual nations or between blocs of nations such as the EU and NT is different from competition between
companies or example, if companies are unsuccessful, then they can go bankrupt, but nations cannot Put
another way, we should remember that it is companies who compete with one another, not nations or trading
blocs (Krugman @994) Countries or blocs of countries compete only in the sense that some do better than
others at delivering rising standards of living to their citizens within an open competitive environment In order
to provide this increase in the standard of living, it is the task of governments to help to nurture the
competitive performance of their companies across both manufacturing and services

The competitiveness debate at the corporate level has also shifted somewhat from the Ɲhardƞ factors (corporate
planning, financial control, scale economies, R&D, etc ) towards the Ɲsoftƞ factors (organizational innovation,
speed to market, reputation, service, and the management of people, etc )
uccessful companies have focused
on new flatter decentralized structures, better supplier-customer relationships, improved quality, increased
training, multi-skilling, and flexible employment systems Examples of such improvements in the manufacturing
sector can be seen in the cases of the Baxi Partnership (UK, heating appliances) and Brabantia (Netherlands,
household consumer goods), and in the service sector in the cases of Karolinska Hospital (
weden, medical)
and Nationale Nederland (Netherlands, insurance) (Eurostat @997b)
Therefore the winners in the twenty-first century will be those companies that can shift their focus more
towards the customer This will involve companies changing their organizational structures, the location of
decision-making, and their concepts of what makes up a competitive enterprise or example, a Coopers &
Lybrand survey (Coopers & Lybrand @996a) showed that only 4@ per cent of EU firms had centralized
organization, while the figures for the mericas and sia-Pacific companies were 56 and 53 per cent
respectively This tends to indicate the EU firms in the latter half of the @99s had a more responsive structure,
in that decision-making was closer to the relevant market However, merican and sia-Pacific companies
indicated that they planned to decentralize rapidly in the twenty-first century, so that less than 4 per cent of
their organizations would be centralized, while EU managers did not anticipate any further move to
decentralization The cost of staying still could be large

 survey of @, business leaders in Germany, rance, Italy, and the UK in @996 by Coopers & Lybrand
(@996a) showed that these leaders felt that they had an advantage over other nations in Ɲindustry experienceƞ
and Ɲleading-edge productsƞ, while they perceived their rivals' competitive advantage to be in areas such as
Ɲpriceƞ and Ɲscale economiesƞ In global markets such relative complacency about pricing strategies can be
problematic Other companies can always buy in know-how and create elements of non-price competitiveness,
whilst also maintaining their pricing Ɲedgeƞ  further study by the accountancy company of 5 companies in
@995 (Coopers & Lybrand @996b) identified a small number of Ɲhypergrowthƞ companies, whose success was
very closely related to the level of education of senior executives, team skills training, and the willingness to
hire management from bigger companies in different industries These factors illustrate the importance of
companies as Ɲlearningƞ organizations

It should be noted that a certain degree of restructuring has occurred in EU manufacturing and services, but
the degree of restructuring depends on the dynamics of competition in the specific EU industry concerned and
the stage of organizational development of the individual companies concerned n attempt on a European
level to raise awareness of the need to change organizational attitudes to competitiveness was seen in the
second half of the @99s in the Ɲbenchmarking initiativeƞ t the enterprise level, this is aimed at identifying the
manufacturing and managerial processes that a company needs to improve It then studies a company that is
known to perform outstandingly in its sector, and measures how this performance is achieved, and then tries
to emulate it The Commission (Com (96) 4@3) suggests that common rules and a European information
network would be set up to gather the vital competitive data that would provide the core of the improvement
needed to increase the standard of living of people in the EU

ë
THI
chapter has shown that the structure and operation of the EU's industry and services have been affected
by many forces irst, the chapter explained the overriding effect of globalization forces coupled with the trend
towards Ɲdeindustrializationƞ on maturing economies such as the EU
econdly, the changing nature of inter-
and intra EU trade flows provided an insight into future trends in product demand and the EU's performance in
this field vis-a-vis other competitors Thirdly, the nature of competition in different sectors of EU manufacturing
and services was explained through a discussion of the effects of the
MP coupled with structural changes, as
evidenced by trends in mergers, concentration ratios, and firm size ourthly, the effect of sectoral changes on
competition variables such as markups and price convergence were investigated in an attempt to understand
the degree of competition in different markets inally, the chapter concluded with assessments of the relative
macroeconomic performance of EU manufacturing and services in relation to competitors and the importance
of corporate-level changes in management organization in such a process What is clear from the discussion is
that competitiveness is an elusive concept, but that concentration on improving the quality of all inputs is an
essential ingredient if the EU is to improve the standard of living of its inhabitants

*

 
 variety of national and international organizations regularly present reports that make predictions of likely
economic developments and also provide interpretations and comment on past macro and microeconomic
experience These include:

ƥ The International Monetary und
taff Reports;

ƥ International Monetary und, World Economic Outlook;

ƥ OECD Economic Surveys (individual countries) In the UK:

ƥ Bank of England Quarterly Reports;

ƥ National Institute Economic Review published by the National Institute of Economic and Social Research,
London There are several useful web sites including:

ƥ www   
e Finan  T es;

ƥ www   
e W  S
ee J
 ;

ƥ  e   
Te E ;

ƥ  be

 
N   (US) B
e   E  Ree


 '
 

@ ÊIf most of the investment, saving, and consumption of nations tends to be domestic in origin, why are such
countries worried about the effects of globalization and structural change?
2 ÊExplain how a study of multinational activity helps us to understand that EU competitiveness is not the same thing
as the competitiveness of EU companies
3 ÊWhy is it important to distinguish between homogeneous and differentiated products when discussing the nature
of competition in the EU?
4 ÊIn what ways has the
MP changed the economic landscape of the EU? Why have its effects on the manufacturing
sector been different from those on services?
5 ÊExplain why it is essential to study economic activity at both the national and the corporate level if the standard of
living of a nation/blocs of nations is to improve

Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries

Published in the United
tates by Oxford University Press, Inc , New York

© Oxford University Press 2

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Edited by Keith Blois

Oxford University Press, Great Clarendon
t, Oxford OX2 6DPll rights reserved No part of this publication may be
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