Insufficient R&D as a Determinant of Poor Service ...

Insufficient R&D as a Determinant of Poor Service Competitiveness in OECD Countries Valtteri Kaartemo* University of Turku, Turku School of Economics Rehtorinpellonkatu 3, 20500 Turku, Finland. E-mail: [email protected] * Corresponding author

Jari Kaivo-oja University of Turku, Finland Futures Research Centre Rehtorinpellonkatu 3, 20500 Turku, Finland. E-mail: [email protected]

Sam Inkinen University of Turku, Finland Futures Research Centre Rehtorinpellonkatu 3, 20500 Turku, Finland. E-mail [email protected] Abstract: The conference paper discusses the correlation of service innovation input with international competitiveness. The study is based on longitudinal trend analysis of official statistics. Firstly, the paper relies on export trade data by WTO in 1982–2007. Secondly, the paper is based on the OECD data on R&D input in service in 1981–2007. We are able to indicate that the OECD countries have lost their service competitiveness. Poor performance can be explained by insufficient business expenditure on R&D in service industries. The paper is among first of a kind which analyses the correlation between service innovation input and output. Therefore, it is expected to be an important contribution in the field of service innovation research. The research findings are of utmost importance to the decision-makers and business managers by indicating how R&D in service contributes to international competitiveness. Keywords: service; R&D; competitiveness; service trade; trend analysis; innovation; OECD.

1. Introduction The transition to service economy is a frequently cited phenomenon in business literature (e.g. Akehurst 1987). Majority of the GDP in industrialised, or should we say “servicised economies,” is currently created in the service sector (see Miles 1993). Typically percentage of service sector is about 70–85 % of the GPD, and its share of employment is significant, too. The increasing export of services in post-industrial society has neither remained unnoticed (e.g. Beyers & Alvine 1985; Daniels 2004). The exports in commercial services have grown 10 folded since 1980 in the world, and the value is already US$ 3,700 billion (WTO 2009). Consequently, all countries except for Gabon mark higher export figures in commercial services in their latest statistics compared to what they did in 1980. The general growth rate of services in the world trade has left us with a feeling that all world regions are doing well and benefiting from the expansion of global service trade. However, this report indicates that all regions are not in fact benefiting equally from the expanding service trade. When we look at the country level, competitiveness is about the way in which the pattern of international trade evolves over time to reflect changing patterns of capabilities and hence competitive advantage is the conventional focus of trade theory. Competitiveness can change on the basis of (1) short term price competitiveness and on the basis of (2) long-run technological competitiveness. (Cantwell 2006, 545–546). Innovation activities can have impacts on both price and technological competitiveness (cf. Inkinen & Kaivo-oja 2009). Today neo-Schumpeterian approaches to international competitiveness focus on this kind of process forging technological competitiveness, which for those whose innovative efforts are most successful, implies a sustainable increase in the share of world trade. In the post-Schumpeterian perspective competition entails the positive sum game of establishing new spheres of value creation, so innovations expand the overall magnitude of world trade and the world markets (Cantwell 2006, 545–546). Thus, in this paper we adopt this kind of neo-Schumpeterian approach. We can note that the world trade of commercial business services seems to be increased in a considerable way as neo-Schumpeterian theory indicates. The overall magnitude of business service trade has more than 10-folded in the years 1980–2008. Theoretically, this paper is based on typical competitiveness analysis where market shares are used as a key index of competitiveness (Porter 1980). In this paper we measure countries’ market shares of business service exports and imports and make conclusions concerning competitiveness of countries commercial business service production. Innovation is nowadays a necessity in any competitive global business (Baumol 2004). In recent years the new industrial powers like Brazil, Russia, India and China have provided new venues for traditional economic powers. Industrialised countries have responded by coming up with new ideas – by active innovation policies. If a company is not the cheapest producer, its only option is to differentiate its production. Thus, nowadays many firms must differentiate its products and it requires innovation. Rather than hollowed out, also developed economies have transformed, with varying success, into innovation societies.

Innovation and competitiveness are closely related issues to each other. Governments invest billions to attain or maintain supremacy in innovation and firms describe it as essential factor to increase sustainable profits and market share. The sixth industrial revolution is the revolution of innovation economy (Westland 2008, 10). Accordingly we expect that there is a causal link between the effectiveness of innovation policies and commercial business service competiveness as Michael Porter has pointed out in a general level (Porter 1980; Porter 1998; Porter & Stern 1999). In this way our study follows Porter’s competitiveness research tradition. This study is an international level study, not micro level company or macro level study. In microeconomic business studies analogical measure index is revenue market share and income market share, which are typical measurements of competitiveness (Ferris et al. 2006, 12). In this study we have following basic research questions: 1.

How successful OECD countries have been in their trade policy efforts when success is measured by export and import share in commercial business services?

2.

To what extent can we explain the changes in service competitiveness on the basis of investments in research and development?

The aim of this study is to provide updated trend analysis of commercial business trade and competitiveness developments concerning OECD and emerging BRIC country group. In this sense we vaguely follow the ideas of Mattoo et al. (2008). However, in this article we are going to present an empirical analysis concerning global business service industry. We shall analyze market shares of business services. As we know market share is considered to be the key indicator of global competitiveness. From this competitiveness perspective it is important to analyze how the OECD countries’ business service industries have performed during latest decades. We analyze both export and import market shares in commercial services. The topic of this empirical export and import analysis of commercial services is highly policy-relevant for the OECD countries. This article takes seriously the challenge which Prof. Ian Miles has presented (Miles 1999). We must connect foresight analyses to the development of service economy. Commercial services are typically knowledge intensive business services (KIBS), which is one of the key clusters in the advanced knowledge societies (Miles 2003). Globalisation makes it necessary to increase innovativeness in order to keep up competitiveness. The use of business services that support innovation activities is one of the strategic means by which succeeding in the fierce innovation competition can be improved, and by which the new business opportunities available can be utilised. The statistical analysis of this article covers the years 1982–2007 for service trade and 1981–2007 for service innovation data. This is due to limitations in the available data among the OECD countries. Despite these shortcomings, statistical analysis of nearly three decades is long enough to draw some conclusions concerning the success rate of STI policy of business services and European KIBS sector. The commercial service database of this article is based on WTO statistics (WTO 2009). For the analysis of service innovation inputs we use the OECD statistics (OECD 2009a). Some of the data for the OECD countries had to be interpolated and extrapolated by using exponential trend analysis. This provided us possibilities to calculate OECD-level correlation with the macro level export data.

It is interesting to analyse global trends of commercial business trade in relation to service trade flows. We also want to study the potential needs for an early warning of crisis of OECD service industry (Nikander 2002). In fact, some OECD member states are losing a significant amount of money because they have lost their market shares in the global service trade. This kind of information gives us evidence-based reasons to hesitate whether they have really succeeded in their knowledge society strategy and associated science, technology and innovation (STI) policies. We are aware of the various challenges related to the service statistics, such as blurred boundaries between service and manufacturing sector (EC 2007), and the lack of data on bilateral trade (OECD 2009b). However, we believe that the long-term trend analysis of service trade gives us a fairly reliable overview on the competitiveness of the sector in the OECD countries. In addition, the findings on service research and development provide us statistically significant results. Although the changes would result from the changes in intra-company activities or from the change in statistical codes, they indicate that these business services are produced relatively more outside the OECD countries, and the insufficient level of research and development investments in service industries among the OECD countries partially explain this trend.

2. World and OECD Exports in Commercial Services In this chapter, we shall present statistical trend analysis of exports in commercial services. First, we shall analyse exports of OECD and world. In Figure 1 this export of commercial services analysis is presented. The world exports in commercial service have grown from US$ 360 billion to US$ 3,350 billion during 1982–2007. Simultaneously, the OECD exports have grown from US$ 290 billion to US$ 2,460 billion. The exponential trend line estimates that the world exports in commercial services are approximately US$ 4,500 billion in 2012. The OECD exports are estimated to increase to US$ 3,300 billion. Figure 1. World and OECD exports in commercial services in 1982–2007 (US$ billion), and trend analysis 5 years forward.

Figure 1 indicates that the gap between the world exports in commercial services and the OECD exports in commercial services has been widening. Thus, the OECD countries have been losing markets in commercial services since 1992. The gap widened dramatically after the late 1990’s again. These two turning points of unsuccessful OECD trade policy can be seen in Figure 1. The challenges in competitiveness are particularly evident in the lost share of OECD exports in commercial service to other countries. Figure 2 represents the percentage of the OECD of the exports in commercial business services in the years 1982–2007, 1 and associated trend line based estimation 5 years forward. We can observe a decreasing trend of market share in commercial services exports.

Figure 2. Share of the OECD and BRIC of the exports in commercial services 1982–2007, and trend line based estimation 5 years forward.

1

As the database does not include the export data for 2008 for all countries, the share of world exports is calculated until 2007. The initial figure for 2008 is not indicating dramatic change in the exponential trend line.

OECD countries increased their share of world service exports until the end of 1980’s. Since then the problems in service competitiveness have accumulated. Since 1992, the figure has been decreasing. Particularly, the BRIC countries have increased their share of commercial service exports since 1994 when the data for all BRIC countries has been available. A loss of market share has led the OECD countries to lose a lot of potential incomes. In Figure 3 we have calculated the annual losses of the OECD countries from losing the trend line based market share of 1981 (81.8%).

Figure 3. Gains and losses of OECD countries from changing market share of estimated 1981 commercial service exports (US$ billion).

The Figure 3 indicates that the OECD countries held their position quite well until early 1990’s. Since then the OECD countries seem to have lost remarkably their competitiveness in commercial services. The total sum of accumulative OECD trade losses in commercial services trade is US$ 1,500 billion in 1982–2007. In other words, should the OECD countries been able to keep the share of 1991 until 2007, the total OECD exports had been US$ 1,500 billion more. The estimated loss in 2008–2012 is US$ 1,300 billion. This is an enormous financial loss for the OECD countries – from the loss of market share, which in the first instance seems only to be a marginal dip of few percentage points. Thus, there is a place for an early warning of crisis of the OECD countries.

World and OECD Imports in Commercial Services Next, we shall analyse the other side of the coin: the OECD imports in commercial services. First, we shall analyse imports of OECD and the world. Despite slightly different figures compared to the export data, the import figures have also grown exponentially during 1982–2007. Similarly, the Figure 4 indicates that the OECD imports in commercial services have decreased relative to the world import volume. The slope of OECD trend is less steep than the trend of world imports in commercial services. Also in this import side analysis we can observe a widening gap.

Figure 4. World and OECD imports in commercial business services in 1982–2007 (US$ billion), and trend analysis 5 years forward.

The Figure 5 indicates the percentage of the OECD countries of the imports in commercial business services in the years 1982–2007, and the associated trend line 5 years forward. We can observe an increasing trend of the share until the late 1980’s. Since then the OECD countries have increased imports of commercial services less rapidly than other countries. Figure 5. Share of the OECD countries of the imports in commercial services 1980–2007, and trend line based estimation 5 years forward.

The Figure 6 indicates the annual losses from importing more commercial services based on a trend line based market share of 1981 (74.2%). The OECD countries used to import higher shares during 1986–1994. However, since then the market share has decreased and the OECD countries can be seen as gaining from importing less. Particularly, since 2004 the OECD countries have gained remarkably. Figure 6. Gains and losses of OECD countries from changing from the trend line based market share of 1981 in commercial service imports (US$ billion).

The trend line based analysis in Figure 6 indicates that the OECD countries are on a positive trend. As a result, the total sum of accumulative OECD trade gains from changing import in commercial services trade is US$ 300 billion in 1982–2007. The estimated gain in 2008–2012 is US$ 200 billion. However, the financial gain is in this regard much smaller than the sum of losses stemming from losses in export markets.

Figure 7. The net difference between gains and losses of changing market shares in OECD countries’ commercial service trade (US$ billion).

The Figure 7 indicates that the net difference between the losses from exporting less and the gains from importing less is negative for the OECD countries. The OECD countries held their position quite well until the mid-1980s and again until 2001. Since then, the OECD countries seem to have lost remarkably their competitiveness in commercial services. Net loss (sum of losses and gains calculated) of lost opportunities is already US$ 1,200 billion. Another loss of US$ 1,200 billion is estimated during 2008–2012. This may mean that the STI policies have not been efficient enough to introduce new service innovations. Also price competitiveness of commercial services has not been competitive enough. Competitiveness failures of quality and price of OECD business services are evident. OECD countries have not developed enough their competitiveness in business services during the past decades. This gives strong evidence that something must be changed in the OECD STI and trade policies. Thus, there is a place for an early warning of crisis of the OECD countries. We can conclude that the OECD countries have not succeeded in the trade policy and STI policy of commercial services.

3. OECD Service R&D and Export Performance The business expenditure in research and development (BERD) in service industries have grown exponentially in OECD countries since 1981. In early 1980’s the BERD in service industries accounted only US€ 5 billion in OECD countries. In 2007, the figure is closer to US$ 200 billion.

Figure 8. BERD investments in service industries in OECD countries in 1981–2007 (US$ billion).

We were able to identify that there is a strong, statistically significant correlation between business expenditure on R&D in service industries and export of business services among OECD countries. We found out that after 4–7 years of service R&D input, the export performance can be explained by innovation data. This is illustrated in Figure 9. Thus, the dramatic shift in OECD competitiveness can be partially explained by insufficient R&D investments in service industries. Figure 9. Correlation between BERD in service industries and commercial service exports in OECD countries in 1982–2007.

In this sense, the relatively low investment rates in 2004–06 are worrisome to the OECD countries, as their influence is expected to be witnessed in 2008–2013 export figures. The giant leap in 2007 may be partially caused by the extrapolation of the data and does not necessarily resemble the actual state of the business expenditure on research and development in service industries in 2007.

4. Concluding Remarks In this statistical indicator based paper we have analysed exports of commercial services in OECD countries and OECD business enterprise research and development in service industry. We can conclude that the OECD countries have not succeeded in the trade and STI policy of commercial services. In many OECD countries knowledge intensive business services have a key role and strategic influence in the economy. The OECD countries need to rethink their export and import strategies of commercial business services. This article brings new light on this strategic issue and expected future challenges of OECD service economy. The results of the analysis indicate that the OECD countries have lost competitive position in the global commercial service market. A market share of the OECD countries has been decreasing in the long run. The annual loss of the OECD countries from losing the market share of 1994 is remarkable as the annual losses of above US$ 200 billion are more than the overall BERD investments in service industries in OECD countries. Earlier innovation strategies of the OECD countries have mostly been related to manufacturing sector. The losses presented in the article encourage putting more emphasis on the development of service innovation strategies. Although the results would partially stem from statistical reasons, the research findings provide an alarming signal on the competitiveness of OECD countries in service sector. In minimum, the article calls for more detailed, country- and sector-specific studies on the phenomenon in order to take necessary measures in the development of service STI activities in the OECD countries.

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