Full Report DF

FINAL REPORT
DRIVING FACTORS AND CHALLENGES FOR EU INDUSTRY AND THE

ROLE OF R&D AND INNOVATION
Framework Service Contract

150083-2005-02-BE
Version 08.01.2007
Acknowledgements
This draft report has been produced by the following ETEPS AISBL team:
Dr. Carlos Montalvo (team manager and report overall editor),

Dr. Orietta Marsilli
BSc Joost Hoogendorn
Drs. Geert Jansen
Ir. Maurits Butter TNO, The Netherlands
Prof. Marco Vivarelli Catholic University of Milan Italy
Prof. Jordi Molas-Gallart INGENIO, University of Valencia Spain
Dr. Puay Tang SPRU, University of Sussex United Kingdom
Dr. Anette Braun VDI Germany
TNO, SPRU, Catholic University of Milan and VDI were responsible of providing inputs to task
one. TNO, SPRU, INGENIO-University of Valencia and Catholic University of Milan, were re-
sponsible of providing inputs to task two. In task three Catholic University of Milan provided a
quantitative analysis to rank sectors of economic activities that facilitated the selection of three
strategic sectors for Europe. TNO, SPRU and INGENIO-University of Valencia conducted the
analysis in the sectors selected and explored the role of R&D and innovation.
The IPTS provided timely and constructive comments in the chapters that compose this draft re-
port (Dr. Hector Hernández, Dr. Cristiano Cagnin, Dr. Fabiana Scapolo, Dr. Pietro Moncada, and
Prof. Ron Johnston).
The responsibility of compiling and editing the report rested on TNO s Innovation Policy Group.
The report has benefited from comments and revisions conducted by the following experts: Dr.
Andrew Dearing (European Industrial Research Management Association), Ass. Prof. Dr. Enrico
Pennings (Erasmus University Rotterdam), Dr. John van den Elst (Philips Applied Technologies),
and Prof. Dr. Knut Blind (Fraunhofer Institute for Systems and Innovation Research).
Dr. Carlos Montalvo (team manager and report overall editor)

TNO-IPG, Delft 08.01.2007
This report should be cited as:
Montalvo, C., P. Tang, J. Mollas-Gallart, M. Vivarelli, O. Marsilli, J. Hoogendorn, J. Leijten, M. Formatted: Spanish
Butter, G. Jansen and A. Braun (2006). Driving factors and challenges for EU industry and the (Spain-Modern Sort)
role of R&D and innovation, Brussels: European Techno-Economic Policy Support Network
(ETEPS AISBL).
Framework Service Contract 150083-2005-02-BE

Driving factors and challenges for the EU industry and the role of R&D and innovation
(SC06_05 R&D Innovation)
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Table of Contents
Table of Contents............................................................................................ 4
Background ..................................................................................................... 8
Rationale of this study ............................................................................................................ 9
Objectives and Methodology ......................................................................... 9
Objectives............................................................................................................................... 9
Methodology and overall approach ........................................................................................ 9
TASK ONE: .................................................................................................... 11
Main driving factors that will shape the market in the world over the next 15
years ............................................................................................................... 11
I. Introduction ................................................................................................ 11
II. Demand side.............................................................................................. 12

2.1 Global challenges........................................................................................................... 12
2.2 Consumption trends ....................................................................................................... 18
III. Supply side ............................................................................................... 23
3.2 Globalization................................................................................................................... 26
3.3. Supply of new inventions: new research paradigms..................................................... 28
3.4. Supply of new economic multipliers: innovation waves ................................................ 31
IV. Institutional side ...................................................................................... 35
4.1. Increasing globalization in a context of innovation and rationalization ......................... 35
4.2 Intellectual property rights .............................................................................................. 35
4.3. International outsourcing and the labour markets......................................................... 38
4.4. The role of organizational change................................................................................. 39
4.5. Conclusion..................................................................................................................... 40
V. Emerging economies ............................................................................... 41
5.1 India .......................................................................................................... 41

5.1.1 Social Drivers .............................................................................................................. 42
5.1.1.1. Demography ........................................................................................................ 42
5.1.1.2. Life expectancy.................................................................................................... 42
5.1.1.3. Education: Improved literacy rate and the wide use of English........................... 42
5.1.2 Economic Drivers ....................................................................................................... 43
5.1.2.1. Global IT boom and the foreign demand for outsourcing.................................... 43
5.1.3 Institutional Drivers...................................................................................................... 45
5.1.3.1. Central level......................................................................................................... 45
5.1.3.2. State level ............................................................................................................ 45
5.1.3.3. Deregulation and privatization of industry ........................................................... 46
5.1.3.4. Trade Liberalization; Globalization ...................................................................... 47

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5.2. China ....................................................................................................... 49
5.2.1. Social drivers.............................................................................................................. 49
5.2.1.1. Reforming the Educational System ..................................................................... 49
5.2.2. Economic drivers........................................................................................................ 51
5.2.3. Institutional drivers ..................................................................................................... 52
5.2.3.1. Liberalization ....................................................................................................... 53
5.2.3.2. Privatization and deregulation ............................................................................. 54
5.2.3.3. R&D Expenditures and Developing Research Capabilities................................. 55
5.2.3.4. Laws .................................................................................................................... 57
5.2.3.5. Decentralization................................................................................................... 58
5.2.3.6. Financial .............................................................................................................. 58
5.3 Conclusion...................................................................................................................... 59
TASK TWO ..................................................................................................... 60
World markets trends: Implications for European Industry

Competitiveness ........................................................................................... 60
I. Introduction ................................................................................................ 60
1.1 Competitive process focus ........................................................................................ 60
1.2 Note on Methodology ..................................................................................................... 61
II. Structural, organizational and sectoral composition............................ 63
2.1 Introduction..................................................................................................................... 63
Industry structure .............................................................................................................. 63
Industry dynamics............................................................................................................. 63
Sectoral distribution .......................................................................................................... 64
2.2 Demographic change ..................................................................................................... 64
2.3 Supply side..................................................................................................................... 65
2.3.1 Globalization ............................................................................................................ 65
2.3.2 The service economy .............................................................................................. 65
2.3.3 The entrepreneurial economy.................................................................................. 66
2.3.4 Open Innovation .................................................................................................... 66
2.3.5 Supply of new inventions: new research paradigms ............................................... 67
2.4 Institutional side......................................................................................................... 67
2.4.1 Intellectual property rights ....................................................................................... 67
2.4.2 Organizational change............................................................................................. 68
III. Research, technological development and related requirements...... 69
3.1 Introduction..................................................................................................................... 69
3.2 Climate change, environmental degradation and over-exploitation of natural resources69
3.3 Ageing population and changing health care concerns ................................................. 70
3.4 Changing diets and healthier food ................................................................................. 71
3.5 Increased demand for transport services....................................................................... 72
3.6 Epidemics and pandemics ............................................................................................. 73
3.7 Terrorism and pervasive insecurity ................................................................................ 73
IV. Human resources, skills, labour market conditions............................ 75
4.1 Globalization and technological change employment impact ........................................ 75
4.2 Employment and new technologies ............................................................................... 76
4.3 Innovation, globalization and skills: challenges and possible solutions......................... 77
3.4 Skill bias and increasing wage inequality....................................................................... 78
3.5 Innovation, organizational change and human resources management .................. 79
V. Localization of economic activities ........................................................ 81

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5.1 Introduction..................................................................................................................... 81
5.2 Population ageing in Europe .......................................................................................... 82
5.3 Energy ............................................................................................................................ 83
5.4 Mobility and trade ........................................................................................................... 84
5.5 Off-shoring, trade and environment ............................................................................... 84
5.6 Knowledge infrastructures and innovation science........................................................ 85
5.7 Emerging economies ..................................................................................................... 85
VI. Investment attractiveness ...................................................................... 86
6.1 Introduction..................................................................................................................... 86
6.1.1 Determinants of investment..................................................................................... 87
6.2 Pull factors: Social and economic environment ............................................................. 88
6.3 Pull factors: Institutional structures, practices and policies............................................ 89
6.3.1 Institutional structures and practices ....................................................................... 89
6.3.2 Policies and regulations........................................................................................... 90
6.4 The push factors: policies of the investing country ........................................................ 91
VII. Summary ................................................................................................. 92
Conclusions and policy implications ......................................................... 97

1. Introduction....................................................................................................................... 97
2. Patterns of drivers and challenges for European competitiveness.................................. 97
3. Policy implications - The role of R&D and Innovation policy.......................................... 101
References ................................................................................................... 104
Annexes ....................................................................................................... 116
Annex 1. Task three - Strategic Industrial Sectors for the EU ............... 116
A1.1. Health Sector Telemedicine .......................................................... 117

A1.1.1 Introduction ............................................................................................................. 117
Telemedicine technologies ............................................................................................. 117
Telemedicine services .................................................................................................... 118
A1.1.2. Main drivers affecting the sector............................................................................ 119
Ageing 119
Increasing demand ......................................................................................................... 119
Cost savings ................................................................................................................... 120
Obstacles 120
A1.1.3. Market trends ......................................................................................................... 122
Sector composition ......................................................................................................... 122
Service economy ............................................................................................................ 122
Institutional and organizational change matters ............................................................. 123
A1.1.4. The role of R&D and innovation............................................................................. 125
A1.2 Transport sector: Aeronautics.......................................................... 126
A1.2.1 Introduction ............................................................................................................. 126
A1.2.2 Main drivers affecting the sector............................................................................. 127
Globalization ................................................................................................................... 127
The environment............................................................................................................. 127
Security 128
A1.2.3 Market trends .......................................................................................................... 128
Service economy ............................................................................................................ 129
A1.2.4 Institutional matters, organizational change and research priorities ...................... 131

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A1.3 Environmental sector......................................................................... 133
A1.3.1. Introduction ............................................................................................................ 133
A1.3.2. Environmental technologies................................................................................... 134
A1.3.3. Market trends ......................................................................................................... 135
A1.3.4. Main drivers affecting the sector........................................................................... 136
A1.3.5. Institutional matters, organizational change and research priorities ..................... 137
Industrial classification of the environmental sector ....................................................... 138
Competition in the markets or for the markets ........................................................... 138
How clean is clean enough?........................................................................................... 138
Annex 2 Method to explore and screen challenges and drivers ........................................ 141
Conceptual method to screen foresight studies................................................................. 141
Organization of information gathered................................................................................. 142
Annex 3 Summary of global drivers ................................................................................... 144
Table A3.1. Demand side - Overview of global challenges............................................ 144
Table A3.2. Demand side - Summary of global consumption trends ............................. 145
Annex A3.3 Demand side - Summary of consumption trends in European Union ........ 146
Annex A3.4 Supply Side: Changes in industrial organization ........................................ 147
Annex A3.5 Supply side: Overview of paradigm shifts................................................... 148
Annex A3.6 Supply side: Overview of innovation waves................................................ 149
Annex 3.7 Summary Institutional Side: Key Future Drivers ........................................... 150
Annex A3.8 Summary of China s Drivers for Growth ..................................................... 151
Annex A3.9 Summary of India s Drivers for Growth....................................................... 152
Annex 4. Sectors ranking on production, employment and exports .................................. 154

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Background
According to industrial economist theorists what determines and structures global industrial or-
ganization in the last three decades resume to few large forces that have their own internal dy-
namics:
- New technologies that enable the relocation and control of distant industrial operations (in-
cluding R&D) and the creation of new markets for mass and customized mass production;
- Flexibilization of labour and regulation (fiscal, product, safety, health, etc.);
- Deregulation of capital flows so that specific industrial operations can be considered as
cost/profit centres, thus facilitating foreign direct investment and fast relocation (or re-
assignment) of industrial activities.
These three global drivers have led to changes in global patterns of industrial production and
posed great challenges for industries and countries with a low proportion of their domestic capital
engaged in the international production of goods and services. For those economies whose firms
are able to operate at the global level, these drivers have enabled not only to benefit from global
efficiencies but also to profit from rapid innovation and fast changing markets. So currently, na-
tions (in some instances trade blocks) compete in several fronts not only to conquer new interna-
tional markets for final and intermediate goods but also to retain critical industrial sectors that
work as multipliers of their national economies.
It is clear that next to the above-mentioned generic drivers the nature and growth of markets (and
this includes the level of regulations and restrictions) is a very important factor behind changing
global patterns of industrial production. By way of a so far hypothetical example it could be ar-
gued that until the internet bust of 2001 the most interesting markets in the world seemed to be in
the US and Europe. Until then a major factor that seemed to govern global patterns of production
was the costs of labour. The impact was considerable, but somehow the logic of the process was
clear to everybody. But since the internet bust another factors seems to come into play, e.g. the
fast growth of markets such as those in China and India. This poses a series of new challenges
of which the outcomes for the global pattern of industrial production are largely unknown. It could
be argued (but also this line of argumentation needs confirmation) that in general production fol-
lows markets. And it could also be true for many good reasons to be found in the literature about
interactions between R&D and production that R&D simply follows production.
Now it is well understood by policy makers in leading and competitive nations that the level of
investment on knowledge infrastructures, R&D and innovation is strongly related to the current
and future competitiveness of their industries. It is also well known that the creation of competitive
edge is a long process of knowledge and skills accumulation at the societal level. Given the fact
that economic resources are limited, the investments on innovation and R&D must be targeted in
strategic areas that appear to promise to function as economic multipliers of economic activities.
In the case of the EU, industry faces the challenge of not only remaining competitive in traditional
sectors but to be the forerunner in new markets where the race and competition is done for the
markets and not in the markets. Here R&D and technological innovation play a central role. But is
solely raising the level of R&D, innovation and creativity sustainable? The inevitable ´hit-parade´
kind of markets and market structures that result (very few dominant successes) may very well
meet explicit and implicit resistance as the number of failures is simply too large. Here there is a
counter tendency as well: most industrial products are nowadays surrounded by and array of ser-
vices without which they cannot function. This leads to pressures for industry to align with many
partners (potentially contradicting the dominant neo-liberal market policies) in some sort of joint
market strategies.

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There are indications that the European industry is struggling with these challenges. Visions and
policies at the national and at the EU level will most likely be an important factor in determining
future outcomes.
Rationale of this study
This study is part of the JRC-IPTS activities to support the EU Policies concerned with industrial
and technology strategies. EU policies have to address major challenges that are posed to the
European industry. Issues such like productivity growth, international competition, knowledge
management, reallocation of resources and structural changes. It is widely recognized that tech-
nological progress can make a key contribution to deal with those challenges and thus there is
the need to generate policies that are aimed at fostering the EU innovation and technological ca-
pabilities.
In this context it is of fundamental importance to estimate the current and future policies needed
raised by these challenges. However, the analysis of such issues is difficult due to the intrinsic
uncertainty of the many factors involved and their complex effects. Therefore, it is necessary to
conduct a comprehensive forward looking analysis to explore the future evolution of markets for
goods and services. Such an analysis has to consider the internal and external dimensions, the
interaction of supply structures and demand factors, including issues such as the influence of
emerging economies, new technologies, scarce resources and demographic aspects.
This study will contribute to the identification of the key factors that will shape the development of
scenarios to examine the evolution of markets in the next five years. This will be done in a follow
up activity that will be conducted by the IPTS.1 These key factors will include insights on possible
challenges ahead in terms of globalization, localization of activities, infrastructure, technological
know-how, human resources, knowledge generation, R&D and innovation. The idea behind the
project is to exploit further available expertise at the JRC-IPTS, incorporating a forward looking
dimension to generate a holistic picture that embeds all relevant aspects of the future of industry.
The approach will also enable synergies between JRC-IPTS activities and allow the comparison
of expectations on the future with current observed trends.
Objectives and Methodology
Objectives
This study will serve as a preliminary study for a more ample research that aims to draw the out-
look of the EU industry in the long-term. In particular this study aim to fulfil two objectives:
To identify and analyse the main socio-economic and institutional driving forces that are
likely to shape the markets in the world up to the year 2020.
To trace the links between these driving forces and the likely evolution of the European
industry and the challenges that the EU economy will face in the future.
Methodology and overall approach

The analysis of the drivers and challenges that the European industry will face in the medium
term implies the capacity to link determinants of competitiveness and competitive performance.
Both aspects of competitiveness have been widely studied at the level of products, services, in-
1
Markets of intermediate goods and services.

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dustrial sector, nations and regions. Despite this there is still no comprehensive theoretical frame-
work to analyse competitiveness. The state of the art in the field still resembles the story of the
elephant and the blind man. The study is especially ambitious as it aims to link trends at the
global level down to European and the sector levels.
The approach to the completion of the study is following. The study was based primarily on desk
research and analysis. It builds on existing studies and has an exploratory nature. Specifically,
the study build upon a review of the relevant literature of the past five years and on reports of
past and current activities of the JRC-IPTS that deal with the future of manufacturing (e.g., Fut-
Man and ManVis) and other studies that contribute insights on the performance and future of the
EU industry (e.g., EU Industrial R&D investment scoreboard). The research conducted by the
research team will be complemented with insights provided by a number of experts in different
areas of enquiry relevant to this study (i.e., economics of technical change, industrial economics,
international economics and prospective technology studies).
This will be done by requesting two types of inputs from leading scientific experts (for industry
experts see point five below). The first refers to request references of the most updated and rele-
vant literature in their field of expertise. The second concerns the review of the draft final report of
this study and production of a short written report consisting of comments and suggestions to im-
prove the final draft report. The same experts will be invited to attend a one day workshop to
comment on the report findings. The analysis conducted will be mostly qualitative but comple-
mented with quantitative information where available and appropriate.
In order to achieve these objectives, four tasks were conducted:
Task 1: Identification of the main drivers affecting the shape of future markets over the next 15
years;
Task 2: Analysis of the implications of the insights gained in task 1 for the EU industry, in
particular for its competitiveness;
Task 3: Identification of industrial sectors of strategic interest for the EU and those particularly
affected by the outcomes of tasks 1 and 2.
Task 4: Organization of a one day expert workshop with the aim of constructively criticizing
and validating the results of this research.
Each of three first tasks has a brief methodological discussion. The overall structure of the re-
port is simple it consist of four parts. The first part corresponds to task one. It provides a set of
definitions and trends on global challenges and drivers. At this point no conclusion or ranking of
importance is given concerning the global drivers identified. The second part develops task two.
It looks into a number of themes that define the competitiveness of a region or a country and
makes an attempt of make a qualitative impact assessment of potential effects of global trends
in the future competitiveness of European industry. Part three presents some conclusions and
lessons learned from tasks one and two and from an analysis conducted in three sectors the
analysis on lead markets in presented in Annex one).

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TASK ONE:
Main driving factors that will shape the market in the

world over the next 15 years
I. Introduction
World production and consumption systems and associated institutions are more than ever be-
fore is a state of rapid flux, in which science and technology (S&T) play an important role, some-
what similar to ancient oracles and magic spells. In the face of new regional and global trends the
European economy must expect to face great challenges. In particular, its industry characterized
by medium-advanced technologies (e.g., automotive, steel, textile and clothing, footwear, etc.)
faces both threats and opportunities with the entry of new players in global production systems,
and the emergence of new markets. The aim of this exploratory and qualitative study, based on
desk research, is to map the factors that are likely to shape the world market over the next 15
years. In this report on global trends, likely drivers have been classified into three broad catego-
ries that provide the structure for this report: demand, supply and institutional settings.
In section II we look at the demand side; international competition has brought better and
cheaper products, and many sectors that are characterized by consumers are becoming more
aware of consumer behaviour (i.e. their products must meet tight quality standards). Levels of
consumption are likely to be affected by the degree of trust in the economy (individual and re-
gional), lifestyle patterns, demographic developments, environmental awareness, etc. We con-
ceptualize the demand side as producing issues that will need to be resolved by the supply and
institutional sides. This section describes global challenges and consumption trends identified in
the literature as highly relevant.
In section III, we describe the major transformations that have occurred on the supply side. We
look at five major trends: the increasing role of knowledge as a source of economic value; the
growing openness of the market system; the rising importance of networks and the interactions
they promote; new scientific and technological paradigm shifts; and underpinned by the fourth
transformation, emerging areas of economic activity and new business models. In section IV we
examine the institutional side; the frameworks within which industry operates could be affected by
regulation, trade relations, labour, financial aspects, intellectual property rights (IPR) regimes, etc.
Several trends can be identified, such as the increasing conflict between global markets and re-
gional economies; the relocation of industrial activities including research and development
(R&D), shift in foreign direct investment (FDI) to emerging markets, the growing importance of
IPR, organizational changes and spill-overs and changes in labour markets and the race to the
bottom .2 Section V looks at developments that are already affect global markets, in two crucial
emerging economies, China and India. This section explores social, economic and institutional
developments that will determine their full effect in global markets. Annex I describes the meth-
odological approach followed to explore and organize the barriers and drivers identified in recent
literature (2000 to 2006). In addition it provides how the research team conceptualized the sys-
tem demand-supply-institutions and the level of aggregation utilized. Following the format pre-
sented in Annex I, Annex II provides an overview of the trends and drivers which will be analysed
further in task two.
2
The race to the bottom refers to the efforts that some countries are taking to attract FDI (e.g., wage minimization, tax
exemptions, decreased regulation, diminishing labour-union power, etc.)

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II. Demand side
This section looks at those trends where solutions are needed via the provision of services, and
new social and institutional infrastructures from the supply and institutional sides. It examines
global challenges in general and consumption trends in particular.
2.1 Global challenges
Global challenges are major cross-border issues that affect the whole of society . They are prob-
lematic and their resolution requires careful discussion, appropriate measures and observation
over several years. Necessarily, global challenges are on the international political agenda, and
require collaboration between countries. Current examples of global challenges are ageing popu-
lations, global warming, terrorism, and epidemics and pandemics. Because of such aspects as
overpopulation, migration, and environmental degradation, most nations have recognized their
own limited capacities to respond effectively to these challenges. This has had an important con-
sequence: the internationalization of certain tasks such as peace keeping or, to a more limited
extent, protection of the environment. This has resulted in both a closer integration of nations into
the international community and a closer interdependence of nations. Due to their nature, global
challenges are identified by international oriented organizations such as the United Nations (UN),
G7/G8, OESO, OECD and the European Union (EU). For example, the UN has defined eight Mil-
lennium Development goals [UN, 2005):
Eradicate extreme poverty and hunger;

Achieve universal primary education;
Promote gender equality and empower women;
Reduce child mortality;
Improve maternal health;
Combat HIV/AIDS, malaria and other diseases;
Ensure environmental sustainability;
Develop a global partnership for development.
The G7/G8 agenda and the European framework programmes were designed to solve a wide
variety of these global challenges, while organizations such as Greenpeace, OESO and OECD
focus on specific global challenges. On an underlying level, societal developments are often ana-
lysed from the perspective of demography, economy, and social, technological, ecological and
political domains. Identifying global challenges has generally been frequent, but no generally
agreed list of priorities exists. The literature identifies: ageing populations, climate change, envi-
ronmental degradation, epidemics and pandemics, global shifts in economic power, increasing
pressure on health care, over-exploitation of natural resources, overpopulation, pervasive global-
ization, social equality, sustained economic growth, terrorism and pervasive insecurity as some of
the most immediate priorities. Table A1 in annex 2 provides an overview of identified global chal-
lenges and a short description.
2.1.1 Ageing population
Over the last century, the life expectancy of humans in Western society has increased as a result
of better health care. According to UNDESA (2002) the older population is growing faster than the
total population in practically all regions of the world and the gap in growth rates is increasing. In
the period 1950-1955, the global average annual rate of increase in the number of persons aged
60 years or over was only slightly higher than the rate for the total population (both around 1.8%).
It is an established fact that the EU population is having fewer children and is getting older. There
will be a large increase in older people when the1950s baby boomers reach old age . This in-
crease will start around 2011 and reach a maximum around 2103. This trend is expected to in-

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crease the prevalence of health impairments and chronic illnesses, which will affect mobility and
the physical maintenance of social relationships (ERA-AGE 2006).3
A B
Figure 1 World trends in population ageing

A) Average annual growth rate of total population and population aged 60 or over: world, 1950-2050
B) Population aged 60 or over: world and development regions, 1950-2050
Source: UNDESA 2002
2.1.2 Climate change
According to the Intergovernmental Panel on Climate Change (IPCC) of the United Nations, the
threat of climate change will have major environmental, social and economic consequences for
the planet. During the last century, the average surface temperature of the earth rose by around
0.6°C. In its Third Assessment Report, published in 2001, the IPCC projects that global average
surface temperatures will rise by a further 1.4 to 5.8°C by the end of this century (IPCC, 2001).
This increase in the global temperature is likely to have serious consequences for humanity and
other life forms and will result in a rise in sea levels of between 9 and 88 cm by the end of this
century, which will endanger coastal areas and small islands, and increase the frequency and
severity of extreme weather conditions.4
2.1.3 Epidemics and pandemics
A pandemic is the worst type of epidemic: a disease that spreads around the globe. Avian influ-
enza is the term used to describe influenza viruses that primarily affect birds. On rare occasions,
these bird viruses can infect other species, including humans. A human influenza pandemic oc-
curs when a new subtype emerges that has not previously circulated in humans and against
which the human immune system has no defences and for which no vaccine is immediately avail-
able. H5N1 is a strain of avian influenza with pandemic potential, since it could adapt into a strain
that is contagious among humans. Influenza pandemics are rare, but recurring events. There
th
were three pandemics in the 20 century: Spanish flu in 1918, Asian flu in 1957, and Hong
Kong flue in 1968. The 1918 pandemic killed an estimated 40 50 million people worldwide. It
3
Relation to innovation: the elderly are expected to become one of the most frequent users of self-care and e-health ser-
vices at home. This will be contingent on the availability of mobile phones and computer access at home (see ERA-AGE
2006; Braun et al, 2003b; Gavigan et al., 2003).
4
The EU is at the forefront of international efforts to combat climate change and has played a key role in the development
of the two major treaties addressing the issue, the UN Framework Convention on Climate Change and its Kyoto Protocol.
See http://europa.eu.int/comm/environment/climat/docs.htm

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was exceptional and is considered one of the deadliest disease events in human history. The cur-
rent H5N1 strain first infected humans in Hong Kong in 1997, resulting in 18 cases, including six
deaths. Since mid-2003, this virus has caused the largest and most severe outbreaks in poultry
on record. In December 2003, infections in people exposed to sick birds were identified. Since
then, more than 138 people have been infected, half of whom died. This is not a pandemic, but it
raises concerns among health experts that a new pandemic is becoming a closer reality. Once a
fully contagious virus emerges, its global spread is considered inevitable. Through measures
such as border closures and travel restrictions, it is possible to delay the arrival of the virus, but
not to cannot stop it completely. Therefore, as far as a human pandemic is concerned, all coun-
tries are at risk (EU COM, 2006; FAO, 2005) .
2.1.4 Global shifts in economic power
In the last 25 years, major emerging market economies have generally experienced substantially
higher growth rates than the G-7/8 members. Five emerging market economies now rank among
the ten largest economies in the world, measured by gross domestic product (GDP) at current
exchange rates: China is the fourth largest economy in the world. Brazil, Mexico, India, and South
Korea are already major economic forces. If higher economic growth continues in large, middle-
income economies, and demographic trends proceed as anticipated, the structure and dynamics
of the global economy will become increasingly multi-polar. Goldman Sachs projects that by
2050, the non-Western G-20 market economies emerging from the developing world may repre-
sent as much as 70% of the G-20 economies total GDP, a huge rise from the 17% level of today
(O Niel and Hormats, 2004; OECD, 2004; Colin et al, 2004).
Figure 2 Expected shift in GDPs between 2003-2050 (GDP in US bn$)

Source: O Niel and Hormats, (2004)
2.1.5 Increasing pressure on health care
It is acknowledged that, in the future, EU healthcare systems will be under pressure from a series
of factors inducing a general restructuring process. Specific issues that will increase the pressure
on healthcare are:
sustainability of systems; 5
tele-care and e-health; 6
7
cyber-security (identity, privacy and security);
5 Sustainability is defined in this report as 'development that meets the needs of the present generation without compro-
mising the ability of future generations to meet their own needs . Sustainability issues have been discussed and analysed
in-depth, see, for instance, Life styles, Future Technologies and Sustainable Development (ISBN 3-929118-05-X)
http://www1.faw.uni-ulm.de/asis/html/f-background.html.
6
http://www.seniorwatch.de/swa/frame.html
7
These have been discussed and analysed in-depth, see for instance, some IPTS (socio-economic) impact studies
http://cybersecurity.jrc.es, and the IPTS Report Special Issue: Vol. 57 September 2001

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Population ageing, its effect on healthcare systems and cost/benefit aspects;8
Challenges and opportunities from EU enlargement. 9
The challenge is to identify policy opportunities that arise from this dynamic, and to identify areas
with significant potential for policy action.
2.1.6. Over-exploitation of natural resources
Natural resources are vital to the survival and development of the human population. In the case
of renewable resources (fish stocks, fresh water, rainforests, etc.), renewal is conditioned by their
scale and rate of exploitation. Current exploitation trends in many cases are surpassing the
earth's capability to renew them. Fresh water, forests and harvested products are renewable,
provided that exploitation does not exceed their regeneration. In the case of non-renewable re-
sources such as fossil fuels and metal ores, although many effects of overexploitation are felt
locally, the growing interdependence of nations, and international trade in raw materials make
their demand and sustainable management a global issue. In recent years, the depletion of natu-
ral resource capital and attempts to move to more sustainable development have been a major
focus of the development agencies. There is particular concern about the rainforest regions,
which hold most of the earth's natural biodiversity - irreplaceable genetic natural capital (EEA,
2003). Despite 34 years of campaigning, and policy and regulatory efforts, the environmental
damage generated by over-exploitation of resources continues (IISD, 2005).
2.1.7 Population growth
Overpopulation (resulting from higher birth rates and improved infant mortality, declining mortality
rates, increasing life expectancy) occurs when the population density is so great as to actually
cause reduced quality of life, environmental degradation, and long-term shortage of essential
goods and services. The UN estimates that as the 21st century begins, more than a billion people
lack basic needs. Nearly 60% of the 4.8 billion people in developing countries have no basic sani-
tation (UNPD, 2003). Almost a third lack access to clean water. A quarter has no adequate hous-
ing, and a fifth go without modern health services. According to the UN, population increases
have slowed or even stopped in Europe, North America, and Japan. Nevertheless, global popula-
tion continues to rise at a rate of roughly 78 million people per year. Most of the growth is taking
place in sub-Saharan Africa and parts of South and Western Asia (see Table II.1 below). Not co-
incidentally, these same places are afflicted by deforestation and other unsustainable exploitation
of natural resources (UNPD, 2003).
8
These have been discussed and analysed in-depth in European Commission (2001), Communication from the Com-
mission to the Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions
on The future of healthcare and care for the elderly: guaranteeing accessibility, quality and financial viability , COM (2001)
723 final, European Commission, Brussels. European Commission (2000), Communication from the Commission to the
Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions on the Health
Strategy of the European Community , COM(2000)285 final, European Commission, Brussels.
9
These have been discussed and analysed in-depth, see for instance, http://enlargement.jrc.es, and
http://europa.eu.int/comm/ enlargement.

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Table 1. Projection of world population growth.
Source: United Nations Population Division (2003)
From UNPD (2003) projects presented in Table 1 it can be suggested that the world population
will pass the 7 billion mark in 2013; the 8 billion mark in 2028; the 9 billion mark in 2054 and sta-
bilize at just above 10 billion after 2200. The most recent increase of 1 billion occurred in only 12
years.
2.1.8. Pervasive globalization
Globalization has become the buzzword of the new millennium. It is viewed as the cause of as
well as the panacea for many of the world's problems. The debate over related global challenges
is manifested in the international approaches to threats such as avian flu, the September 11th
attacks, and the consequences of the Human Genome Project, and the management of the In-
ternational Space Station. Globalization will be driven by rapid and largely unrestricted flows of
information, ideas, cultural values, capital goods and services and people. This will increase both
global economic growth and global challenges, defined by the increasing acceleration, complex-
ity, and globalization, which increase the need for global, long-term perspectives. This global
challenge will be further discussed in section 4 (NIC 2004).
2.1.9. Social equality
Social equality is the process of dealing with the balance between economic growth, environ-
mental impact and social problems such as poverty and social exclusion, the education and skills
gaps, poor or no access to information, and personal factors such as age, gender or disability.
The EU's enlargement on 1 May 2004 has exacerbated these disparities; populations in the ten
new member states have on average lower income levels and lower ICT penetration rates. Ac-
cording to Commission figures, the income, rural, educational and age gaps are greater in the ten
new member states than in the former EU-15 (SPVI, 2001; EU COM-DG ESA, 2006).

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2.1.10. Sustained economic growth
The Asian tigers, reduction in trade barriers, increased technological possibilities, demand for low
cost products, increased oil price are all examples of trends and drivers that put pressure on the
economic growth of the industry. Although some sectors such as pharmaceuticals and construc-
tion, are experiencing continuous growth, other sectors are under economic pressure due to in-
creasing competitiveness and government regulation. The industry related to process technology
can be characterized as susceptible to this increase in economic competition. Profit margins are
under pressure, but innovation is needed to increase quality and address other market demands.
The projection for the world economy is to maintain the trend that began in 2005. In 2007 eco-
nomic growth will be relatively more pronounced in developing countries (5.5%) than in OECD
(2.7%) and the Euro zone (2%). It is expected that East Asian and Pacific countries will have the
highest growth rate (7,4%) and that Sub-Saharan countries will recover and surpass the rate of
growth of the Latin American countries. Here, again the effect of China and India is noticeable as
they account for almost 1% of total growth in real GDP in developing countries (World Bank,
2006)
Table 2 Projected economic growth in the world

Real GDP growth e 2003 2004e 2005f 2006f 2007f
World 2,5 3,8 3,2 3,2 3,3
Memo item: World (PPP weights) f 3,9 5,0 4,4 4,3 4,4
High income
1,8 3,1 2,5 2,5 2,7
OECD Countries 1,8 3,0 2,4 2,5 2,7
Euro Area 0,7 1,7 1,1 1,4 2,0
Japan 1,4 2,6 2,3 1,8 1,7
United States 2,7 4,2 3,5 3,5 3,6
Non-OECD countries 3,7 6,3 4,3 4,2 4,0
Developing countries
5,5 6,8 5,9 5,7 5,5
East Asia and Pacific 8,1 8,3 7,8 7,6 7,4
Europe and Central Asia 6,1 7,2 5,3 5,2 5,0
Latin America and Caribbean 2,1 5,8 4,5 3,9 3,6
Middle East and N. Africa 5,2 4,9 4,8 5,4 5,2
South Asia 7,9 6,8 6,9 6,4 6,3
Sub-Saharan Africa 3,6 4,5 4,6 4,7 4,5
Memorandum items 2003 2004e 2005f 2006f 2007f

Developing countries
excluding transition countries 5,3 6,8 6,1 5,8 5,6
excluding China and India 4,1 6,0 4,9 4,7 4,6
Note: PPP = purchasing power parity; e = estimate; f= forecast.

a. Canada, France, Germany, Italy, Japan, the UK, and the United States.
b. In local currency, aggregated using 1995 GDP Weights.
c. Simple average of Dubai, Brent and West Texas Intermediate.
d. Unit value index of manufactured exports from major economies, expressed in USD.
e. GDP in 1995 constant dollars;1995 prices and market exchange rates.
f. GDP mesaured at 1995 PPP weights.
Source: World Bank 2006.
Turning to the Euro zone, after several years of stagnation, GDP growth is expected to increase
from 1.4% in 2006 to 2.4% in 2007. According to the EU Commission (2006b) growth has been
hampered by structural rigidities, and member state economies have been deteriorating in recent
years. Confidence in the Euro zone has suffered as a result of the management of public fi-

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nances in France and Germany. Added to this are the large public deficits in GDP ratios and high
debts of over 100% in Hungary, Italy and Greece. All these aspects are challenging the enforce-
ment of the EU's recently reformed Stability and Growth Pact. Economic activity is set to grow by
1.5% in 2006 to 2.1% and to accelerate further to 2.4% in 2007 (EU COM 2005).
2.1.11. Terrorism and pervasive insecurity
In response to the September 11 attacks, political leaders from Europe, North America, Asia, and
the Middle East have placed the phenomenon of terrorism within the context of a global struggle
against systems of government perceived by those accused of using terrorist tactics as harmful to
their interests. Differing social philosophies, religions, globalization, sustainability issues (e.g.
poverty, access to natural resources) can lead to tensions between and within societies. Non-
state organizations such as Al-Qaeda are increasingly performing terrorist actions intended to
coerce or to intimidate governments or societies, in the pursuit of goals that are generally politi-
cal, religious, or ideological. This forms a threat to economy and society and leads to the need for
mechanisms to counteract terrorism, the organization of defence and mechanisms to deal with
cultural differences. Related themes include the detection of terrorist hazards and the reduction of
terrorist threats to industrial complexes (European Commission, 2002).
2.2 Consumption trends
Consumption trends are directly related to income and growth levels. As population and eco-
nomic growth have steadily risen over the last three decades, levels of consumption have also
increased. In this section we look at key global consumption trends that are clearly linked to in-
come and population levels. Income and population trends are depicted in Figure 3. Key con-
sumption indicators according to UNEP-DTIE (2004) are energy, materials usage and waste, wa-
ter, mobility, urban concentration and food.
2.2.1 Energy
Energy consumption levels are directly 350 Electricity production

related to economic development, GDP
population size, final goods consump-300 Industrial value added
tion, transportation intensity, and the Energy use

CO2 emissions
provision of basic and more sophisti-
Population
cated services and to environmental SO2 emissions
impacts (see Figure 3). The dominant200
sources of energy are petroleum and
electricity, and demand for them has
grown steadily over the years. Accord-
100
ing to UNDESA (2006) the level of con-
sumption worldwide has doubled since
1971 1980 1990 2002
the mid 1970s, a trend that mirrors
Figure 3. Growth in economy, energy and emissions
GDP growth. Several challenges are Source: UNDESA 2006
associated with the current trends in
consumption. The most important are: limited availability of fossil fuels in the long term; environ-
mental degradation arising from exploration, extraction, refining and usage of petroleum deriva-
tives; effects on economic growth of high oil and derivates prices. Use of renewable energy has
increased from 2.2% to 4.1% of total energy consumption (10,723 million tonnes of oil equivalent
world consumption in 2003). If demand for oil crude continues to rise, oil prices are likely to in-
crease from their current levels. Figure 4 below shows the evolution of oil and natural gas prices
over the last 30 years.

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100 12
90
10
Dollars per 1000 cubic feet (gas)

80
Oil price (constant)
Dollars per barrel (oil)
70 8
60
50 6
40 Oil price (current)

4
30
20 2
10 Gas price (constant)

0
0
1976 1980 1985 1990 1995 2000 2005
Figure 4. Crude oil and natural gas prices 1976-2005

Source: UNDESA 2005
2.2.2 Materials usage and waste
In 1972 the Roma Club published The Limits of Growth, which speculated about the collapse of
global resources (Meadows et al., 1972). Since then although there have been many discoveries
of new reserves of many raw materials contradicting much of the study - global consumption of
the most important raw materials has continued to increase rapidly. There is only one earth, thus
there are inevitably limits to the current rates of growth. There was little information found on
world trends in raw materials usage and solid waste disposal. The information that does exist re-
fers to specific types of materials or combination of a few types of materials and refers to solid
waste disposal globally. Nevertheless, in the last 20 years there has been a considerable in-
crease in the use of resources. This is demonstrated by the levels of energy (Figure 3) and the
levels of water used globally (Figure 5). We adopted a throughput perspective to show trends in
solid waste disposal in the EU.
According to the European Environmental Agency

(2005), one of the targets set in the 5th Environmental
Action Programme was to reduce the generation of
municipal waste per capita per year to the average
1985 EU level of 300kg, by the year 2000 and to main-
tain it at that level. Figure 4 indicates that this target
was far from being reached in 2003. The average
amount of municipal waste generated per capita per
year in many western European countries has reached
more than 500kg. Municipal waste generation rates
in central and Eastern Europe are lower than in west-
ern European countries and generation is decreasing
slightly. According to the OECD Observer (2004) the
US processes 2 kg of municipal waste per person per
day, the Europeans 1.1 kg; for OECD countries the
total is over half a tonne per person per year, only 16%
of which is recycled. Six per cent goes for composting,
the rest is put in landfill or is incinerated (OECD,
2004b).
.
Figure 4 Municipal waste generation in western European (WE) and central and eastern Euro-
pean (CEE) countries. Source: European Environmental Agency 2005

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2.2.3 Water
Water is an element that enables not only life itself, but determines the location of human settle-
ments, and economic and social development. Figure 5 illustrates that trends in water consump-
tion drastically increased after 1950, the extreme being found among the Asian countries.
Figure 5. Global trends in water consumption 1900-2025

Source: Igor A. Shiklomanov, SHI (State Hydrological Institute, St. Petersburg), and UNESCO, Paris, 1999; World Re-
sources 2000-2001: People and Ecosystems: the Fraying Web of Life, WRI, Washington DC, 2000; Paul Harrison and
Fred Pearce, AAAS Atlas of Population 2001, AAAS, University of California Press, Berkeley.
The latest diagnosis by UNEP (2006) of the state of waters in the globe indicates that there are
great challenges to be faced by 2020. A summary of the trends identified is presented in Box 1
below.
Box 1. Effects of water consumption trends and associated socio-economic impacts
In more than half of the regions/sub-systems considered in UNEP (2006) the overall envi- Acute freshwater shortages
ronmental and socio-economic impacts of freshwater shortages were found to be moderate Conflicts over water resources
or severe; Degradation of grazing lands
Displacement of people
Impacts of the modification of stream flow caused by dams or river diversions were more
Impacts on coastal fisheries
widespread and severe than those caused by pollution of existing supplies or changes in the
water table; Increase in infectious diseases
Increased vulnerability to flooding
Water for irrigation is causing the most severe environmental and socio-economic impacts; Increased water-related diseases
Interruptions in water supply
Over extraction of aquifers is becoming severe in many areas that depend heavily on irri- Lack of potable water
gated agriculture or are densely populated;
Loss of crops
The extraction of fossil water from deep aquifers is unsustainable as they will not be refilled Loss of farmland and infrastructure
on human time scales. Knowledge of aquifers is insufficient and further studies are needed in Loss of fisheries
order to comprehensively assess trans-boundary aquifers; Loss of traditional livelihoods
Loss of traditional sites
Land-use changes, including deforestation and the cultivation of wetlands, affect the water Political disputes
budget, thus causing floods or droughts in many regions; Reduced agricultural output
Reduced availability of fish
Agricultural land is becoming too saline to support important crops, the salinity of aquifers is
too high for human use, and saline waters encroach further up rivers during dry seasons. Reduced productivity of farmland
Upstream/downstream conflicts
Source: UNEP (2006)

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2.2.4 Mobility
Economic growth, technological possibilities and globalization have led to increased mobility.
However, transport is one of the most prominent environmental pollutants, leading to health prob-
lems, congestion, environmental impact and delays. This has consequences for spatial planning,
technology, design of infrastructure, modality (OECD, 2002). Related themes are reductions in
emissions and waste from transport. With rising oil prices and the demand-supply problems re-
lated to oil, the transport sector is searching for alternative sources of energy (ERTRAC, 2004).
Transport is the fastest growing source of greenhouse gas emissions, which are contributing to
global climate change (OECD, 2002; WBCSD, 2005). In the industrialized countries the emis-
sions arising from international aviation have grown twice as fast as overall transport emissions
(UNDESA, 2006).
2.2.5 Urban concentration and consumption
According to UN-Habitat, in 1950, one-third of the world s peoples lived in cities. Just 50 years
later, this proportion has risen to one-half and will continue to grow to two-thirds, or six billion
people, by 2050. In terms of population densities, spatial distribution, economic activity and social
attitudes, the world has become urbanized. Cities have always been the focal points for invest-
ment, commerce, production and consumption. Urban concentration brings many challenges at
the global level including cities are magnets for immigrants seeking a better life. The problems
that result from these profound economic and demographic trends include urban poverty and the
growth of slums that now envelope nearly one billion persons worldwide (UN-Habitat, 2005). In
addition, cities have evolved into a highly subsidized habitat system compared to natural habitats.
Such a concentration of population brings challenges not only in terms of the necessary inputs,
but also in terms of the waste generated (UNEP, 2005).
Figure 6 Concentration of human settlements

Source: UNHabitat, 2005
2.2.6 Food
There are two main global challenges related to food: lack of it and overeating. According to the
most recent estimates of the UN s Food and Agriculture Organization (FAO), there are 852 million
undernourished people in the world. Chronic hunger, malnutrition and related diseases cause the
deaths of 25,000 people every day, with children accounting for more than 70% of these deaths
(UN-WPF, 2004). In addition, according to the World Health Organization (WHO), currently there
are more than 1 billion adults that are overweight - and at least 300 million that are clinically
obese. Obesity levels range from below 5% in China, Japan and certain African nations, to over

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75% in urban Samoa. But even in countries with currently low levels of obesity, rates are almost
20% in some cities. Obesity accounts for 2-6% of total health care costs in several of the devel-
oped countries; some estimates put the figure as high as 7%. The true costs are undoubtedly
much greater as not all obesity-related conditions such as diabetes and coronary diseases - are
included in these calculations (WHO, 2003).

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III. Supply side
This section outlines ongoing trends in the organization of production in the industrial system and
in the multipliers of economic activities arising from the S&T infrastructures that are influencing
what will be on offer in global markets over the next 15 years. Some fundamental changes are
highlighted in this section. In terms of the organization of production increasing the role of knowl-
edge is an important source of economic value. The generation of new knowledge, through inno-
vation, has become the key driver of competitive advantage at firm and country level. In the new
knowledge economy,10 public organizations supporting innovation (S&T policies) and a variety of
public and private organizations producing and diffusing new knowledge in the industrial system
have assumed a key role (entrepreneurial firms, entrepreneurial universities, innovation factories,
etc.). A second transformation is the increasing openness of the system, in several dimensions.
Markets have become more open to international competition and to globalization of production
and distribution of products, services and knowledge. Firms themselves have become more
open, increasingly outsourcing activities, widening their supply chains, and relying on collabora-
tions with external parties for R&D, innovation and production. A third transformation concerns
the increasing importance of networks. Industrial firms increasingly see themselves as network
organizations whose competitive advantage depends more on their ability to interact in order to
connect technologies, people and organizations, than on a their own R&D investment. A fourth
transformation, concerns new scientific and technological paradigms shifts, which include ad-
vanced biomedical sciences, cognitive sciences, molecular biology, etc. Underpinned by this
there are whole new areas of economic activity and business models, such as cleaner environ-
mental processes, effect-based security operations, effective health care, smart housing, sus-
tainable agriculture, etc.
3.1 Innovation as source of competitive advantage

In a 1999 article entitled Industry gets religional , the Economist highlighted that innovation has
become the industrial religion of the late 20th century . Governments depend on policies support-
ing innovation to enhance competitiveness and economic growth. Firms seek to introduce new
products and new processes in order to enhance their competitive advantage and increase mar-
ket share. Innovation is perceived by corporate organizations as well as by policy makers as the
key source of economic performance. In the OECD countries a transition towards a knowledge
economy has been under way. High-tech industries account for a growing share of value added
in the OECD countries (OECD, 2004). Companies and countries will increasingly rely on the
creation, diffusion and exploitation of knowledge, including scientific and technological knowl-
edge.
Knowledge intensive sectors are becoming more important to national economies and to interna-
tional trade. These sectors account for an increasing share of the value added and the exports in
the economy. In addition, the most intensive R&D sectors are those that have experienced the
highest growth rates in the 1990s: office, accounting and computing machinery; pharmaceuticals;
and aircraft and spacecraft (OECD, 2004).
3.1.1 Increasing government support for science, technology and innovation
Governments have been devoting increasing attention to science, technology and innovation
(STI) as the sources of economic growth and societal wealth. In the OECD countries, several
governments have increased public expenditure in R&D, often by setting explicit targets in terms
10
Terms such as the knowledge economy or the learning economy are now commonly used to indicate the increasing
role of knowledge, alongside labour and capital, as an input to economic processes. The OECD defines knowledge-based
economies as economies which are directly based on the production, distribution, and use of knowledge and information
(OECD 1996, p. 7)

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of R&D intensity or ranking among OECD countries In particular, public expenditure on R&D has
increased in areas of growing technological opportunity, such as information and communication
technology (ICT), biotechnologies and nanotechnologies (OECD, 2004). The increased commit-
ment of governments to STI is reflected in the increased funding for R&D in the higher education
(HE) sector and, to a lesser extent, in the increased spending by government laboratories. This
latter mainly goes on defence. The traditional gap between R&D performed by the HE sector and
by government laboratories has become broader, indicating a shift in government R&D spending
from defence to more general knowledge-creation (OECD, 2004).
3.1.2. Increasing reliance on collaboration and Open Innovation
Firms are expected to collaborate more and exploit external sources of innovation in order to en-
hance their internal capabilities and to cope with uncertain economic conditions (OECD, 2004). A
new model of Open Innovation has emerged in contrast to the old Closed Innovation model in
which innovations are generated mainly from within the R&D laboratories of firms, operating in
close cooperation with other firms. The Open Innovation model states that technological break-
throughs often require the contribution of a broad and diverse range of sources of ideas and
technologies. As a consequence firms need to be more open towards the external environment
and to engage in close cooperation with other companies, universities and research institutes
(Chesbrough, 2003). Leading firms distinguished by their technological breakthroughs have em-
braced the Open Innovation model as a key driver of their corporate strategy (Philips Research
Press Release, April, 2004). In this new environment, networks linking organizations and people
have become increasingly important for the identification and realization of new ideas. Some
companies have almost entirely replaced traditional R&D activities with recombinant activities by
bringing together different technologies from a broad and diverse range of external sources. The
best known example is Procter & Gamble, which adopted an explicit strategy of Connect and
Develop in place of the traditional strategy of Research and Develop (Dodgson et al. 2005).
The new model has led to a more distributed approach to innovation in the industry.
3.1.3. Increasing importance of Entrepreneurship
The identification, evaluation and exploitation of opportunities for new businesses are increas-
ingly recognized as being very important for economic growth and job creation. Audretsch and
Thurik (2000) pointed out that the OECD countries have moved away from a managed econ-
omy towards an entrepreneurial economy and that this shift demands new policy approaches.
This change, they argue, is the main manifestation of the shift that is occurring in the sources of
competitive advantage from labour and capital to knowledge-based economic activities, which
marks the emergence of The New Economy. The managed economy as characterized by Chan-
dler (1990) is based on the exploitation by corporate organizations of scale and scope econo-
mies. The entrepreneurial economy is characterized by a process of identification and exploita-
tion of new opportunities by new and small firms, often with potential for rapid growth. In the en-
trepreneurial economy innovation is the main source of competitive advantage (Audretsch and
Thurik, 2000). Among entrepreneurial firms, fast-growing enterprises or gazelles 11 have entered
the policy agenda, as a key driver of innovation and economic growth (EC, 2004).
3.1.4. Growing role of the service sector
The distribution of industrial activities across sectors has changed over time as the service sector
has assumed increasing importance in both industrial production and R&D. The OECD s Science,
Technology and Industry Outlook (2004) reports that in most OECD countries, the share of mar-
ket services in total value added has increased from 35-45% in 1980 to 45-55% in 2001. In addi-
11
The term gazelles was originally used to label the young and small firms that grow at least 20% a year over a four-year
period (Birch, 1979).

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tion, innovation has become more important in the service sector. Service firms are generally re-
garded as less innovative than manufacturing firms; partly because innovations in services are
more difficult to measure than in manufacturing. However, more recent evidence based on the
Community Innovation Survey (CIS) shows that this difference is minor.12 Indeed, some areas of
the service sector, like business and financial services, are more innovative than the average in
manufacturing firms (OECD, 2004). In particular, a distinction has been made between traditional
services and Knowledge-Intensive Business Services (KIBS). KIBS are services that rely heavily
on professional knowledge and their typical main clients are other businesses. By providing
knowledge and information inputs to other businesses, they are seen as playing a major role in
diffusing innovation across the economy (Metcalfe and Miles, 1999). Examples of KIBS are com-
puter-related services, software consultancy, data processing, R&D consultancy, architectural
and engineering consultancy, technical testing and analysis, legal services, etc.
3.1.5. Interdependence of services and manufacturing
The boundary between services and manufacturing activities has blurred because of ongoing
transformations of business activities along the value-chain. Upstream in the value-chain, produc-
tion is becoming more service intensive, as the amount of service activities that are embodied
into the manufacturing processes has increased in recent years (OECD, 2005). In a study based
on input-output data for the OECD countries, Pilat and Wölfl (2005) observe that in the mid
1990s, services accounted directly or indirectly for about 22% of manufacturing production. At the
same time, transformations have taken place downstream in the value chain. Manufacturing firms
have differentiated their market offering into services that provide greater potential for value crea-
tion. This is part of a more general trend that sees firms developing new business models: firms
have changed the way they carry out transactions and position themselves along the value chain
with the purpose of generating revenues.13 These transformations have implications for industrial
innovation and economic growth. For example by coupling manufacturing and services, and add-
ing service components to their more traditional products, firms have created new opportunities
for growth in saturated markets (Pilat and Wölfl 2005). In other sectors, new forms of organization
of production activities, that involve the provision of high-value integrated solutions , have
emerged (Davies, 2004). They consist of innovative combinations of products and services that
are tailored to each customer's needs, and that require firms to develop new capabilities in ser-
vice provision, and in the design and integration of complex systems (Davies, 2004).
3.1.6. Increasing reliance on human resources for science and technology
The increasing emphasis on technological innovation and knowledge intensive activities de-
mands a skilled labour force of scientists and engineers. From 1995 to 2000, employment in hu-
man resources for science & technology (HRST) has grown twice as fast as total employment,
while in several countries the number of science and engineering graduates has declined (OECD,
2004). There is therefore a general concern that in the future a limited and highly unpredictable
domestic supply of HRST will set constraints on the potential for economic growth in the OECD
countries. This trend will be partly offset by the fact that tertiary enrolment of science and engi-
12
According to the results of the third CIS (CIS-3), the percentage of firms that reported being innovative in the service
sector varies from more than 55% in Germany to about 25% in Spain. In most of the surveyed countries, the percentage
of innovative firms in the total number of respondents is lower for service firms than for manufacturing firms. The largest
gap, observed in Belgium, Denmark and the Netherlands, is about 20 percentage points difference. In addition, the per-
centage of innovators varies considerably across service sectors. It is the highest in business services (60%) and in fi-
nancial intermediation (50%) and reached values that are above the average percentage of innovators in manufacturing,
which is equal to slightly less than 50% (OECD, 2004).
13
E-business is a typical example of a new business model that has emerged with the advent of the Internet (Amit and
Zott, 2001). Chesbrough and Rosenbloom (2002) give a definition of a business model that put emphasis on the Interde-
pendence between technological change and economic value creation. In this sense, a business model is a coherent
framework that takes technological characteristics and potentials as inputs, and converts them through customers and
markets into economic outputs (Chesbrough and Rosenbloom, 2002, p. 530).

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neering students has increased in some countries, implying a greater future supply of HRST if
those students graduate. In addition, international mobility, especially of PhD students, from non-
OECD countries has supplemented domestic availability of HRST in the OECD countries (OECD,
2004). Accessing and retaining skilled labour is increasingly important for companies who want to
build their internal resources and capabilities.
3.2 Globalization
The phenomenon of globalization is revealed by the sharp increase observed in recent years in a
number of indicators, such as measures of international trade (import and export), FDI (inflows
and outflows) and integration. Globalization involves numerous aspects (Audretsch and Thurik,
2000). It has been characterized by increasing competition from low-cost high skilled labour in
China (in manufacturing) and in India (in services). The potential role of emerging economies is
discussed further below. At the same time, the ICT revolution has reduced the cost of relocating
standardized economic activities from high-wage to low-wage countries. Not only have production
activities assumed a global dimension, but, also, STI activities are becoming global. This trend is
manifest in the increasing share of R&D expenditure that is performed in non-OECD countries,
for example the overall share of R&D expenditure in China, Israel, and Russia has significantly
increased in recent years (OECD, 2004). This issue and the increasing importance of local prox-
imity and regional clusters are discussed further in Section 5.
As far as R&D and innovation are concerned, while increasing globalization has initially affected
production and trade of manufacturing goods, it has progressively involved tradeable services,
technology transfer and the location of innovative activities, including R&D laboratories, basic and
applied research, prototyping, commercialization and marketing of innovation (see ILO, 2001;
Cimoli and Katz, 2003). For example, US affiliates in China have increased their ratio of R&D
spending to value added from 1% in 1994 to 9.2% in 2000 (source: US Bureau of Economic
Analysis, Survey of US Direct Investment Abroad, Washington DC).
Thus, the scope of catching-up by emerging economies is now extending to R&D and knowl-
edge intensive activities. Table 3 shows that the main emerging economies are rapidly catching-
up with the developed ones in terms of local technological capabilities (measured by numbers of
R&D workers).
Table 3: the incidence of R&D

Researchers in R&D Researchers in R&D Rate of growth 1996-2000
(per million people) 1996 (per million people)2000
USA 3,881 4,526 9.7%
Brazil - 324 -
Mexico 215 259 20.5%
European Monetary 2,175 2,479 13.98%
Union
Russian Federation 3,804 3,479 -8.5%
Japan 4,909 5,104 4%
China 450 550 22.2%
Hong Kong (China) 1,042 1,159 11.23%
India 157 120 (1998) -
Source: World Bank, World Development Indicators 2005.
The intensity of R&D expenditure financed by industry has seen a decline in recent years in the
OECD countries, but with some regional differences. The slowdown in industry funded R&D has
been driven mainly by declining industrial R&D expenditure in North America after a period of
growth in the 1990s, although it continued to grow in Asia-Pacific and Europe (OECD, 2004). The
slowdown in industry R&D expenditure recently observed in the US is expected to continue in the

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near term. Recent surveys indicate that US firms are more often planning to reduce their R&D
spending than to increase it, while European firms, although generally keen to increase R&D
spending, claim that most expenditure would likely be channelled outside the EU. Longer term
trends are unpredictable and are conditional on changes in the economic environment (OECD,
2004).
3.2.1. The emergence of markets for technology
Another trend identifiable in the economic organization of innovation is the increasing specializa-
tion and division of labour among firms in the innovation process (Arora, Fosfuri, Gambardella,
2001). The process of specialization in innovation has seen some firms focus on creative activi-
ties. These are generally new and small firms that have the skills and mindsets needed to create
new products (especially radically new products), which established firms are less likely to have.
However, established and large firms are more likely to be specialized in development activities,
which demand large investment, and in the commercialization of innovation, which requires com-
plementary assets (in marketing, manufacturing, distribution, etc.) (Gans and Stern, 2003). New
technologies are not brought to the product market directly from the entrepreneurial firms that
developed them; but they are traded in the market for ideas through licensing or collaboration
agreements with established firms. The emergence of the market for technology has seen the
creation of internet based market places for technology that facilitate the exchange and trade of
intellectual assets. A new typology of innovative firms has emerged that has been labelled inno-
vation factories that specialize in the design of new products and services, which are manufac-
tured and offered to customers by other firms (Hargadon and Sutton, 2000). These are product
development companies that mostly work on an innovate for fee basis and whose customers are
firms from a broad range of different industries.
3.2.3 More sophisticated use of customers as sources of innovation
Von Hippel (2005) argues that the innovation is being democratised in recent years and that the
innovation system has been radically transformed from a manufacturer-centred system to a user-
centred system. Users of products and services, both from industry and from the final consumer
sector, are increasingly available to carry out innovations themselves. This is a further develop-
ment of the process of customization of production and innovation, which goes beyond a recogni-
tion of the importance to the firm of understanding users needs in the development of new prod-
ucts and services. It assigns a central role to users as the direct sources of innovation. Users are
best able to identify their own needs, and develop new products and services that respond to
those needs; they can design exactly what they want as they have a market of one (Von Hippel
2005). In contrast, users needs can only be partially captured and represented by manufacturer
firms, because of the sticky nature of knowledge that make those needs difficult to communicate,
and because manufacturers have much larger markets. Individual users are willing to share their
innovations within a user community, in which participants can benefit from the innovations de-
veloped by others (Von Hippel 2005).
3.2.4 Rise of innovation technologies (IvT)
Dodgson, Gann, and Salter (2005) argue that a profound transformation has taken place in the
innovation process. They propose that a new category of technology, which they call innovation
technologies (IvT) has emerged. The application of new technologies (e.g. ICT) to support the
process of innovation has led to greater efficiency in research, design and engineering proc-
esses. New technologies, such as visualization, simulation and modelling, system analysis, 3D
prototyping, are increasingly being applied to support the research, design and development
(RD&D) of new products and processes. One of the consequences of the application these new
technologies is the increased codification of knowledge. In some cases, such as chemicals, they

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have radically transformed the approach to problem solving. They have modified the way compa-
nies manage industrial innovation, and their organizational structure and capabilities.
3.2.5 The experience economy
Traditionally firms are considered as and see themselves as suppliers of manufactured goods
and services. Goods and services are more and more becoming commodities that, with the ad-
vent of mass customization, can be tailored to the specific requirements of customers and yet be
produced on a large scale. Pine and Gilmore (1999) argue that because of the process of com-
moditization, the value of economic activity has to be found in the offering of experience. The
process of shifting the economic offering downstream in the value chain (what Pine and Gilmore
call the progression of economic value ), which has for a time moved from the making of goods
to the provision of services , has now reached a new phase, the staging of the experience . In
this definition, the experience should not be considered a subset of services and is more than
entertainment. While services can be customized, experiences are personal. They provide con-
sumers with offerings, to which a feeling or sensation (rather than a benefit) is attached, and
which will be remembered for a long time. Indeed, consumers are active participants who are di-
rectly involved in the staging (rather than the provision) of the economic offering. They are guests
rather than users or clients. The emergence of the experience economy and of consumers that
are more concerned with experiences and creative content, have transformed the process of new
product development. Branding and advertising have assumed a greater relevance and become
closely connected with new product development.
3.3. Supply of new inventions: new research paradigms14

Research revolves around the creation of scientific knowledge and the translation to new ena-
bling technologies. Scientific knowledge generation (science) aims at creating an awareness and
understanding of facts, truths or information gained, in the form of experience or learning (a pos-
teriori), or through introspection (a priori). The conversion from science to technology is aimed at
the development of tools, machines, materials and processes to help solve human problems. Ac-
cording to the Frascati Manual (OECD, 2002) a distinction must be made between basic re-
search, strategic research and applied research). Basic research focuses on expanding knowl-
edge about fundamental processes related to the production processes in the firm. Strategic re-
search has industrial relevance, but no immediate specific application.
The development of S&T (research) takes place in the Research Arena. The Research Arena
consists of the academic community, Research and Technology Organizations (RTOs), and, be-
ing an ingredient in R&D, also takes place in (high-tech) companies. The upper aggregate level of
Research paradigm shifts , constitutes long-term shifts in global research philosophies. Research
paradigm shifts include scientific paradigm shifts (Kuhn, 1962) and technological paradigm shifts
(Dosi, 1982). These changes initiate radical, system changing science and technologies within a
timeframe of 30-50 years. They are sometimes referred to as the scientific or technological trajec-
tory (Dosi, 1982). They are often natural trajectories of technical progress: once a path has been
selected and established, the direction taken is towards the problem solving activity (Nelson,
1977). Along the trajectory, new global research communities are created15 and new (cross)-
disciplinary research paradigms will emerge. An example is the shift from more traditional bio-
technology, which focuses on the use of bacteria as means of production/products, to molecular
14
Whether what is described in sections III.3 and III.4 should be considered purely a global driver of industrial markets is
unclear. It can also be considered as part of the response of Science and Technology Infrastructures (the role of R&D and
Innovation) to emerging global issues (comment from the project leader).
15
A research community can be defined as: Large international groups of researchers that share common scientific inter-
ests, but are not institutionally linked. Researchers will have shared mental model and heuristics on a conceptual level,
but will be unaware of individual members.

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biotechnology, which uses these insights at the molecular level for production/products. Biotech-
nology is an example of a generic technology or research discipline. Unlike a research paradigm
shift, a discipline does not necessarily develop. Research paradigm shifts will affect society and
economy on a systemic level, opening up a wide range of new applications. New industrial sec-
tors can be created or current sectors transformed. Research paradigm shifts can be defined as:
Long term changes in research philosophy, which constitute cross disciplinary shifts in global
research communities, and even new research communities.
The literature provides some lists of enabling or emerging science and technologies. Perez
(1986) talks about the new technologies ; new energy sources, new materials and biotechnology.
Recent research focuses on converging technologies: nanotechnology, biotechnology, ICT and
cognitive sciences (e.g. IPTS, 2005) These technologies converge, thereby creating new inter-
disciplinary research themes. In a recent publication, the UN identified the so-called platform
technologies:16 ICTs, biotechnologies, nanotechnology, and low cost materials (UN, 2005). Most
of the research focuses on identifying the most promising sciences and technologies, referring to
them as frontier or key science and technologies. Here, we attempt to identify all relevant scien-
tific and technological paradigm shifts on the broad societal level.
ICT, biotechnology and nanotechnology, although frequently used terms, their meaning may be
problematic. These are umbrella concepts that have much overlap and little focus. For example,
there is overlap between nanotechnology and biotechnology. The field of genetic engineering
could almost be seen as a part of nanotechnology. As a result, these concepts are more like re-
search disciplines than advances in science and technology. Therefore in this report we try to
identify their real meanings.
3.3.1. Advanced medical sciences
Important technologies such as biotechnology, nanotechnology, ICT and material sciences have
been successfully introduced into healthcare products with one major aim: to improve healthcare
delivery. Despite increased interest in cost-benefit assessment techniques, the pace of introduc-
tion of new technologies is very slow, and there will be a significant increase in the number of
new technologies available in the coming decade (Institute for the Future, 2003a). These devel-
opments in the new technologies highlight a number of opportunities for the future such as ge-
nomics, new prosthetics techniques and the use of new biomaterials, that will dramatically im-
prove life conditions. Telecoms will permit remote monitoring of patients from a centralized facil-
ity. Integration of ICT, medical imaging and robotics will allow remote delivery of healthcare, im-
age processing, virtual reality, storage analysis and interpretation, robot-assisted surgery, image-
guided surgery and conform radiotherapy. The development of medical decision support systems
will be an essential complement to evidence-based medicine, providing information, analysis or
options to assist in diagnostic, therapeutic and prescription decisions (Braun et al., 2003).
3.3.2. Advanced process technology
Ultimately the goal of advanced process technology is to develop a process pathway or a series
of reactions that converts relatively abundant, but poorly differentiated raw materials and feed-
stock into desirable products for society, at the lowest possible cost (American Chemical Society,
2001). Major research paradigms that are having a great influence on new scientific insights and
enabling technologies in this field are developments in materials science, new theoretical knowl-
edge on materials and processes, cognitive science and developments in ICT. Related emerging
and driving developments in this field include theoretical modelling of materials and processes,
advanced catalysis, novel reactor concepts, advanced separation, novel solvents and alternative
16
The UN nominates them as platform technologies as their benefits are suggested as being available to poor countries
that often lack adequate infrastructure (electricity, transport, telecoms).

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media, functional coatings, advanced sensors, ubiquitous networks and computational intelli-
gence (Butter et al, 2006).
3.3.3. Cognitive sciences
The field of cognitive science consists of an interdisciplinary study of the structures of the human
mind. These structures include the sensory/perceptual apparatus, such as vision, audition, olfac-
tion; internal mental processes such as language, thinking, reasoning and problem solving; motor
control and the organization of skilled behaviour such as speech and musical performance;
memory; consciousness; attention; and many other aspects of the mind. All of these subfields are
clearly intertwined. The disciplines involved include psychology, biology, neuroscience, philoso-
phy, anthropology, linguistics, sociology, and computer science. Cognitive science has great po-
tential for applications in the medical and psychiatric realm, for sensory and motor prostheses, for
normal, remedial, and compensatory education, for cognitive, communicative, and decision-
making tools. The impact on individual, social, and cultural practices and self-understanding, with
implications for the political, economic, and ethical realms, cannot be underestimated. Finally, the
stimulation that cognitive science brings to its core contributing disciplines, and to the general
advancement of scientific and cultural ideas, is considerable (Andler, 2005).
3.3.4. Intelligent mechatronics
Intelligent mechatronics refers to a new generation of robotics, that can be very small in size, and
have the capacity to learn (performing still simple operations). Intelligent mechatronics is centred
on mechanics, electronics and computing whose combination makes possible the generation of
simpler, more economical, reliable and versatile systems. This hybrid world between ICT and
mechanical systems has been stimulated by advanced developments in ICT. New developments
in micro/nano manufacturing, embedded systems, advanced sensors and biomechanics, con-
nected to better control systems and system modelling are providing the motivation for increasing
the intelligence in mechatronics, and further developing the miniaturization of mechanical sys-
tems. The great benefit of these technological developments lies in being able to manipulate re-
motely (or intervene) in situations where this was previously not possible. For example, use of
mechatronics to conduct chirurgic operations within the human body by introducing micro-robots.
Similar applications can be found in defence equipment, submarines and equipment for use in
hazardous environments.
3.3.5. Molecular biotechnology
Molecular biotechnology is a collection of technologies able to manipulate the structure and func-
tion of biological systems on a molecular scale into forms not found in nature. The discovery of
the sequencing of the human genome at the end of 2000 heralded a revolutionary new scientific
age. The availability of the complete human gene map opens up enormous possibilities still re-
quiring the pooling of research efforts on a very large scale. The development of genomics (study
of all the genes in a living organism) enables the genetic manipulation of molecules or transgenic
organisms, which can completely change the ability to customize therapies based on individual
genomics; prevent, diagnose, and treat all types of diseases rather than relying on rescue ther-
apy; and provide breakthroughs in agricultural production and food safety (Anton et al., 2001).
3.3.6. Nano-engineering
Nanotechnology deals with the manipulation of atoms or molecules to produce materials, elec-
tronics, devices and new technologies. It involves nano-scale construction, atom by atom and
molecule by molecule, of new devices with extraordinary properties. The principle underlying
nanotechnology is simple: instead of reducing matter to arrive at the smallest possible particle,

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the smallest possible particle is extracted from matter. For thousands of years, humans have ex-
tracted materials from the ground, modified, heated, subjected them to pressure, assembled
them, etc. All these procedures use a great deal of energy and, at the same time, generate a
great deal of waste. Current industrial production is based on this manufacturing principle. How-
ever, nanotechnology uses the individual atoms directly and, through their manipulation and
through the application of assembly processes, groups of atoms are formed that can be used to
manufacture nano-materials or nano-machines. Nanotechnologies, inasmuch as they are a driver
of economic competitiveness, represent not only a major technical and industrial challenge, but
also an immense intellectual, cultural and educational challenge (Anton et al., 2001).
3.3.7. New energy technologies
Energy technology is important at both European and national levels. Based on the develop-
ments in oil prices, and the threat of climate change, this research paradigm is increasing in im-
portance. New technologies in the field of e.g. renewable energy (solar energy, biomass conver-
sion), fuel cells, energy storage, catalysis, high power electricity systems are creating momentum
for the development of new transport engines, domestic energy systems, centralized energy gen-
eration, etc.
3.3.8. Novel materials
Materials are widely used in our society. Packaging of food to providing the information carrier for
computer hard disks, all these functions are enabled by various materials, with various character-
istics. Materials can be considered the enabler for many technological innovations. Materials
technology is a very broad domain that covers many subjects and materials technologies such as
processing techniques, analytical techniques, materials design, and cost/benefit tradeoffs in in-
dustrial production of materials. In general, materials technology concentrates on the develop-
ment of certain materials with specific properties such as low weight, high strength, and efficient
biodegradability (Foresight Programme, 2000). Important drivers for these novel materials are
pharmaceutics, food conservation, nanotechnology, micro system technology, sustainable energy
and transport and space technology.
3.3.9. Ubiquitous computing
As a result of the advances in electronics that produced computers and new telecommunication
systems, our economy has changed dramatically. Ubiquitous computing describes a state in
which computer-based devices become so cheap, seamlessly interoperable and easy to use that
they will find application across a broad swathe of everyday activities. The implications of these
changes for policies on technology, employment and competitiveness will be profound (Institute
for the Future, 2003b). Examples of research themes are artificial intelligence, advanced comput-
ing, human interfaces, ubiquitous networks, telematics, digitization and intelligent electronic de-
vices.
3.4. Supply of new economic multipliers: innovation waves
Innovation waves represent societal aims or major technological trends in specific domains, in-
volving a number of industries, delivering a massive wave of innovative developments in a bid to
achieve particular goals and take advantage of technological potential. Innovation waves can
create or transform whole sectors. The societal aims can be sustainability or safety, while techno-
logical opportunities include ICT or nanotechnology. Basic societal functions can be addressed
by specific sectors, such as transport, health care, agriculture, energy and food. Innovation
waves have an impact on large parts of the international economy and require trans-national

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networks of organizations for their diffusion. Similar to Kondratiev waves, innovation waves, can
extend for 50 to 60 years.
Lists of major developments within industry are scarce. Schumpeter took up the ideas of Nikolai
Kondratiev, hypothesizing the existence of very long-run macroeconomic and price cycles, origi-
nally estimated to last 50-54 years. According to innovation studies, the Kondratiev waves arise
from the bunching of basic innovations that launch technological revolutions, which, in turn, cre-
ate leading industrial or commercial sectors. Most theorists agree with the Schumpeter-Freeman-
Perez techno-economic paradigm shifts; so far five waves since the industrial revolution, and
sixth to come (Freeman, 1997):
1. The Industrial Revolution (1770s to 1840s)

2. The Age of Steam and Railways (1830s to 1890s)
3. The Age of Steel, Electricity and Heavy Engineering (1880s and 1940s)
4. The Age of Oil, the Automobile and Mass Production (1930s 1980s)
5. The Age of Information and Telecommunications (1970s to )
The even numbered Kondratiev waves represent applications of the core technological break-
throughs established in the preceding odd numbered Kondratievs. Therefore, the sixth, currently
being debated, is expected to be the knowledge based economy in a globalized world, but there
is as yet no consensus. Kondratiev waves focus on the most prominent innovation, which intro-
duces completely new sectors. In general, innovation studies mainly focus on technological de-
velopment, innovation and diffusion in a few leading and fast-growing sectors. After all, these ma-
jor technological paradigms along with their fast-growing sectors drive economic growth. How-
ever, innovation is not confined to only a few key sectors forging ahead and driving the economy
(Bruland and Mowery, 2005). In the Netherlands, for example, the government has nominated
some sectors as transition themes: sustainable agriculture, sustainable energy and sustainable
mobility.
Those identified in the literature include: economic and environmental industrial processes; ef-
fects-based security operations; efficient and effective healthcare; high tech product manufactur-
ing; Information economy; Network economy; new business concepts; refocusing government
and citizenship (new governance concepts); safe and healthy food; smart consumer goods; smart
housing; sustainable agriculture; sustainable building and constructions; sustainable energy;
sustainable regions, cities, and rural areas and sustainable transport. Annex 3.2.3 provides an
overview and short description of innovation waves. A brief description of each trend is given be-
low.
3.4.1. Economic and environmental industrial processes
This trend focuses on industrial processes, such as chemical and food processing. New conver-
sion concepts, separation methods, modelling, advanced use sensors for monitoring and control
have led to efficiency improvements, and waste reductions. Reaction and process design (or in-
dustrial process technology) refers to the design and development of new processes - the fastest,
cheapest, cleanest etc. It includes the development, scale-up and design of chemical manufactur-
ing facilities (National Institute of Standards and Technology, 1998).
3.4.2. Effect based security operations
Within the military objectives have changed (Joggaby, 2005a). Historically, warfare was focused
on territorial conquest, attrition and annihilation of another country. Nowadays, terrorism and na-
tional security are more important than the threat of a war. Currently, destruction is the means
rather than the end of conflict, and the focus is on the effectiveness of security operations. These
so called effects-based operations are a technology-enabled force employment concept, which

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subordinates destruction to achieving only desired physical and psychological effects (Joggaby,
2005b). The focus on desired effects and the actions required to achieve them, implies a thor-
oughly considered, planned, executed, and assessed security operation. Unwanted side effects
from the application of specific security means are avoided as much as possible at all levels of
conflict.
3.4.3. Efficient and effective health care
The medical health system is coming under increasing pressure, as a result of the ageing popula-
tion, a lack of qualified personnel, better informed and more involved citizens; and increased
medical treatment possibilities. Genetics and new ICT developments are converging to generate
new treatments. Also new emerging diseases and the potential global spread of disease (due to
increased air travel) have increased the need for a change in healthcare. Hospitals and general
practitioners are under pressure to improve the efficiency and effectiveness of healthcare, leading
to changes in the meso/ macro system of health care delivery (Institute for the Future, 2003a).
3.4.4. High tech product manufacturing
This trend focuses on the manufacture of products. The use of the new ICT in the manufacturing
industry has resulted in high-tech manufacturing. It enables miniaturization of manufacturing
processes, increased production speeds, higher quality, reduction in costs and increased cus-
tomization of production (Roveda et al., 2003).
3.4.5. Information economy
The 2000 Lisbon European Council referred to the development of an information society as a
fast way forward towards a competitive and dynamic knowledge-based economy, capable of sus-
tainable economic growth, with more and better jobs and greater social cohesion. ICTs create
new methods of production, trade and communications. This sector has become the second larg-
est in the Union's economy and employs more than 2 m. people in Europe. To maximize the ef-
fort in this field, both economically and socially, the future generation of technology will be more
integrated into the environment and more accessible, facilitating a multitude of services and ap-
plications. The ultimate aim is to introduce more user-friendly technologies in all areas of life: per-
sonal security and privacy, teaching and training, access for the elderly and the disabled, tele-
working, electronic commerce and administration, on-line health (e-health), intelligent transport,
etc. (Prest, 2001).
3.4.6. Refocusing government, new governance concepts
Since the late 1990s the concepts of government and governance have been dramatically trans-
formed. These changes have been due to increasing pressures and expectations that govern-
ance should reflect modern methods of efficiency and effectiveness, and be more accountable.
Furthermore, trends towards globalization, privatization and liberalization have given way to a
new system of governance that is characterized by the state having less power to enforce gov-
ernance schemes (Montalvo, 2006; Shylendra, 2006). Many claim that ICT could enable both
efficiency and democracy to be satisfied more cheaply and easily than previously envisaged, and
that the application of ICT enables government to reduce the trade-off that traditionally has ex-
isted been between these two goals. New forms of governance are thus emerging, with profound
consequences for the way citizenship is understood and exercised. Underlying innovation themes
are e-government and deregulation (Millard, 2003).
3.4.9. Safe and healthy food

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The primary function of food in the human diet is to provide energy and nutrients. Food also has
the secondary function of giving sensory satisfaction based on its flavour, taste, colour and tex-
ture. Recently, public interest in food has shifted towards safety and health, partly as a result of
animal diseases and the risk that they could affect consumers. In addition certain foods have
been identified as having the capacity to modulate physiological systems (immune, endocrine,
nervous, circulatory and digestive). Research has also shown that a variety of food components,
currently classified as non-nutrients, promote a biological activity that can modulate physiological
functions in the body (Plaami et al., 2001). Related innovation themes are functional foods, eco-
logical foods, food monitoring and food preservation.
3.4.10. Sustainability
Since 1987 sustainability of the developments related to current schemes of consumption and
exploitation of natural resources has been questioned (Brundtland, 1987). The acknowledgement
that current trends are not sustainable in the longer term suggests that technological stocks need
to be radically modified. It has been argued that new technologies might bring the benefit of de-
coupling economic growth from environmental degradation while at the same time becoming
economic multipliers (Montalvo 2003, EU COM 2004). This assertion has found echoes in eco-
nomic sectors such agriculture, construction, transport and energy. For example in agriculture,
animal diseases have had a global impact on human health, making citizens more aware of ani-
mal welfare and increasing interest in the topic of food quality. Simultaneously, the industrializa-
tion of agriculture has had an impact on the environment. Therefore, agriculture is being pushed
to achieve a more sustainable character through the application of precision farming, less toxic
and more ecological production processes (Marsch, 2001). Furthermore, there is a trend towards
optimizing agriculture by means of bio- and nanotechnologies.
In the case of the construction sector, houses, office blocks, bridges and other constructions are
changing. Driven by demand for sustainability and customer individuality, as well as develop-
ments in materials, ICT and mechatronics, innovations are being initiated in the processes and
actual constructions. The design of buildings is highly computerized and will enable more partici-
pation from users. New materials will allow faster and cheaper construction, and enable passive
buildings where energy efficiency is optimized (Foresight Programme, 2001).
It is well recognized that the energy system, currently based on fossil fuels, must become more
sustainable in the long term. These fossil fuels are slowly depleting, while demand for energy is
growing; in addition fossil fuels produce environmental problems such as climate change. The
innovation domain of sustainable energy includes generation, transport and use of energy in a
manner that is globally reliable, safe, affordable, low-emission and efficient. The main focus is on
technological development and integration of renewable sources in all aspects of energy supply
(storage, distribution, use).
Finally, current transport demand and its associated technologies have a major effect on air
quality (23% of total green house gas emissions) (OECD, 2002; WBCSD, 2005). This has
prompted governments and technology developers to commit to developing new technologies to
reduce environmental pollution create new markets for cleaner means of transport. The rhetoric
on sustainable transport has gained momentum, but the market is not expected to take off until
around 2020 when the technologies are mature and are complying with the more stringent regu-
lations being proposed (ERTRAC, 2004). New innovations also aim at reducing manufacturing
costs, increasing quality and safety, reducing environmental impacts (from both manufacturing
and use) and increasing traffic efficiency (The Royal Academy of Engineering, 2005).

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IV. Institutional side
4.1. Increasing globalization in a context of innovation and rationalization
Since the 1980s, the world economy has become increasingly connected and integrated; lower
transport costs and the diffusion of ICTs have enabled a reduction in the concept of distance ,
and, in addition, gross trade, FDI, capital flows and technology transfer have risen significantly.
These trends should accelerate in the coming decades.
While increased globalization can be considered to be a widespread phenomenon, some indica-

tors show that present and future trends are characterized by unbalanced globalization (see
Stiglitz, 2002; ILO, 2004). In particular, trade and FDI are mostly concentrated on the developed
world; emerging economies such as China and India are rapidly taking-off; other parts of the
world are either stagnating (Latin America, with some national exceptions) or even declining in
terms of world trade (Sub-Saharan Africa, with the exception of South Africa). According to the
recent and expected trends in economic growth (see Table 4), these tendencies will be confirmed
in the near future.
Table 4: Global trends in trade FDI, GDP growth

% of world export 1980
Expected average an-

GDP (annual average
nual GDP growth (%)

Trade balance %
% of world export
% of world export
(annual average
% of FDI inflows
% of FDI inflows
GDP growth (%)
GDP growth (%)

(1980-2000)
(2000-2004)
1985-1995 )
2006-2010
2000-2004)
1990
2004
2004
USA 11.10 11.26 9.12 24.18 14.80 -3.87 91 10.6 3.2

Brazil 0.99 0.90 1.07 0.96 2.80 0.80 52 9.2 3.7
Mexico 0.88 1.16 2.11 2.48 2.56 -1.92 69 6.5 4.2
European 38.48 43.23 37.45 35.20 16.00 1.71* 56* 5.2* 2.1*
Union (15)
Russian Fed- - - 2.02 0.70 1.80 13.69 9 26.6 4.8
eration (1995-
2000)
Japan 6.41 8.23 6.30 0.35 1.20 1.24 5.5 1.9 70
China 0.89 1.78 6.39 6.42 9.35 2.64 39.4 7.0 536
Hong Kong 0.97 2.35 2.89 2.24 5.25 5.99 14.2 4.8 189
India 1.42 0.51 0.80 0.25 0.82 -0.69 27.1 5.5 200
* = European Monetary Union
Sources:
% of world export UNCTAD, Handbook of Statistics 2005;
% of FDI inflows - UNCTAD, World Investment Report 2005;
Trade balance % GDP and GDP growth: World Development Indicators - World Bank 2005.
Expected GDP Growth: International Financial Statistics January 2005 and projections after 2004 are from Global Insight (formerly DRI-WEFA).
As Table 4 shows, in the last two decades the main emerging economies have taken substantial
world market shares from the developed nations, while China (including Hong Kong) has recently
become the main recipient of world FDI. Taking into account the spectacular past and present
GDP growth of the developing economies (especially China and India) and expected short term
trends , it is very likely that further globalization will bring about a further concentration of trade
and activities in a selected group of emerging economies.
4.2 Intellectual property rights
With regard to future trends in the globalization of innovative activity, IPR will play an important
role. On the one hand, patents and IPR are institutional devices to make inventions and/or inno-
vations appropriable, and to avoid free riding and under-provision of innovation activity at the

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level of the firm, sector, national and international system. On the other hand, open science and
open innovation (for example the open source software OSS movement; see Hertel et al.,
2003) are increasingly diffusing throughout the world. In the coming decades there would appear
to be two main global drivers:
1) The trade-off between open science (to make scientific results and inventions publicly
available) and protected/patented commercial applications (see Dasgupta and David,
1994; Murray and Stern, 2005). Finding the right balance between appropriability and dif-
fusion - in terms of legislation and private/public incentives - will be one of the major chal-
lenges in the next few decades.
2) The increasing diffusion of IPR and patenting in the emerging economies, and their in-
creasing role in dedicated international organizations such as WIPO and WTO (see Alik-
han, 2000). As Table IV.3 shows, patenting activity in the emerging economies is boom-
ing and this is a clear signal of an increasing protection of IPR in those economies.
Table 5: Number of patent applications

Resident type Patent applications Patent applications Rate of growth
1996 2002 1996-2002
USA Non residents
111,536 183,398 64%
Residents
111,883 198,339 77%
Brazil Non residents 29,451 95,225 233%
Residents 2,655 6,521 146%
Mexico Non residents 30,305 94,116 211%
Residents 389 627 61%
European Non residents
Monetary Union 838,660 2,448,271 192%
Residents
99,022 129,155 30%
Russian Non residents 28,149 96,315 242%
Federation Residents 18,138 24,049 33%
Japan Non residents 60,390 115,411 91%
Residents 340,861 371,495 9%
China Non residents 41,016 140,910 244%
Residents 11,698 40,346 245%
Hong Kong Non residents 2,059 9,018 338%
(China) Residents 41 112 173%
India Non residents 6,632 91,704 1,282%
Residents 1,660 220 -87%
Source: World Bank, World Development Indicators 2005.
Finally, an important feature of current trends in globalization concerns the shift from a national to
a regional, international and technological competition. In general, increased global competition is
moving from tangible to intangible goods and services, while the actors involved are increasingly
regions rather than nations.
Indeed, in a context of increasing globalization, the geographic concentration of populations, ex-

ternal and network externalities and agglomeration economies is making regions rather than na-
tions the main actors in global competition and the main drivers of economic growth (see Lundvall

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et al., 2002). This trend will continue probably for another 20 years, although it might be partially
countered by a filtering out of activities away from the more congested areas in developed coun-
try cities.
As Table 6 shows, innovation activities such as patents are even more geographically concen-
trated than the levels and rates of change in GDP. In fact, innovation is particularly affected by
agglomeration economies, locally bounded spillovers and the regional institutional framework.
Accordingly, scholars are increasingly discussing the crucial role of regional innovation systems,
together with the more traditional concept of national innovation systems (see Breschi and Lis-
soni, 2001).
Table 6: Geographic concentration in key OECD countries*
GDP GDP PATENTS SKILLS

GROWTH (TERTIARY EDU-
CATION)
AUSTRALIA 35% 37% 79% 70%
CANADA 41% 43% 44% 69%
FRANCE 38% 45% 52% 36%
GERMANY 35% 43% 46% 24%
ITALY 39% 43% 54% 18%
JAPAN 42% 82% 83% 37%
KOREA 43% 57% 73% 31%
MEXICO 40% 39% n.a. 62%
TURKEY 55% 63% n.a 58%
UK 37% 57% 46% 33%
USA 39% 44% 65% 57%
*(weights of the 10% of the regions within a country, year 2001)
Source: OECD, Regions at a Glance 2005.
Concerning the process of globalization and the easier communication enabled by the diffusion of
ICT, and geographical proximity, a distinction needs to be made between information, which con-
sists of codified data that can be easily stored and retrieved, and knowledge, which includes tacit
knowledge, know-how, and skills that can be transmitted only through learning and experience.
While the process of globalization has been fostered by falling costs in the transmission of codi-
fied data through ICT, tacit knowledge that is embedded in people and organizations requires
companies to locate their activities in proximity to the sources of knowledge. Geographic prox-
imity thus becomes essential to gain access to knowledge of markets, even more important in a
global economy where a broad range of idiosyncratic regional markets exists (Geyer et al 2003).
Proximity also allows firms to gain access to new technological knowledge in the form of spill-
overs from other companies or public institutions (Audretsch and Thurik, 2000). New technologi-
cal knowledge is not fully appropriable by its producers; new knowledge spills over and creates
benefits at no additional cost (or minimum cost) to organizations other than the knowledge crea-
tors. Knowledge spillovers often occur through employee mobility or informal communica-
tion/exchanges within a community of researchers from companies, universities and public re-
search institutes. Knowledge spillovers among individuals and organizations that carry out re-
search in related areas are regarded as a key source of technological breakthroughs (the case of
semiconductors and Silicon Valley is most often cited in this respect). These spillovers are diffi-
cult to diffuse across space and tend to be localized within geographical clusters (Audretsch and
Thurik, 2000). These factors have implications for firms decision making processes in relation to
their innovative activities. The decisions of companies to invest in R&D and then where to locate
these R&D activities are shaped by the proximity to other company activities and to technology
poles and incubators, which provide access to specialized R&D knowledge and results (Euro-
pean Commission, 2005).

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4.3. International outsourcing and the labour markets
According to the Heckscher-Ohlin theorem, rich, developed countries should outsource through
both trade specialization and FDI labour intensive and unskilled activities to developing coun-
tries where unskilled labour is cheaper. Although this has been happening, the emerging econo-
mies are increasingly catching-up in terms of education, skills and technological absorptive ca-
pacity (see Ghose, 2003; Lall, 2004).
As mentioned above, international outsourcing also involves higher value added activities and
international competition is no longer North-South/knowledge intensive-labour intensive goods,
but is much more comprehensive and intra- rather than inter-industry. This trend will increase
appreciably in the next two decades (see ILO, 2005).
Accordingly, the international division of labour between firms and within transnational corpora-
tions is more complex than it was only ten or 15 years ago, with new industrialized countries and
emerging economies deeply involved in R&D, ICT diffusion, and the development of new prod-
ucts and services (see Wood, 2001; ILO, 2001).
These changes are obviously challenging the labour markets of the developed world. In particu-
lar, increasing globalization, international outsourcing and technological/organizational changes
are challenging European labour markets in terms of employment levels, skill-bias, sectoral mo-
bility and regulatory frameworks. As can be seen from Table 7 the main developed countries
have shown a remarkable increase in the percentage of skilled labour (see also OECD, 1996,
1998).
Table 7. White-collar workers in manufacturing employment in the G-7 countries
0 5 10 15 20 25 30 35 40 45
Canada 1981-1991//1996-2000
France 1982-1990//1990-1999
Germany 1980*-1990*//1999-2002
Italy 1981-1991//1997-2002
Japan 1980-1990//1997**-2003**
UK 1981-1991//1991-1999
US 1983-1993//1998-2001
Notes and sources:

Shares (percentage values) Blue indicates the first period.
For each country, the two pairs of bars refer to the initial and final year of the two periods reported on the left.
The source of data reported in the first period is OECD (1998), for the second period Piva et al., 2005.
Data are not comparable between countries, while within countries the two pairs of values are comparable .
* data for Germany refer to West Germany for the 1980-1990 period and to the whole of Germany for the 1999-2002 pe-
riod; the inclusion of East Germany contributes to reducing the skill incidence in manufacturing employment.
** 1997-2003 data for Japan also include the construction sector, which explains the reduction in skill incidence in the last
period with respect to the previous one
Globalization of economic activities and outsourcing are without doubt responsible for the trends
towards up skilling in the workforces of developed countries. The main reactions to these trends
in terms of labour markets have been increasing wage and income dispersion in most of the de-
veloped countries (see Freeman, 1995; Feenstra, 2000; Cornia, 2004 and Table 8) and decreas-
ing protection of workers (see OECD, 1994; CEPR, 1995). Indeed, it is more than a decade since

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wage moderation and labour market flexibility were considered as necessary adjustments to in-
creased competition resulting from globalization and the diffusion of technological progress.
Table 8: Income inequality in the G7 countries (Gini index)

Gini Index Gini Index Gini Index
mid-1980s mid-1990s 2000
Canada 28.7 28.3 30.1
France 27.6 27.8 27.3
Germany - 28.3 27.7
Italy 30.6 34.8 34.7
Japan 27.8 29.5 31.4
United Kingdom 28.6 31.2 32.6
United States 33.8 36.1 35.7
Source: OECD, OECD Factbook 2006: Economic, Environmental and Social Statistics
However, in the last two decades the occupations that have been negatively affected by these
drivers have mainly been unskilled jobs in traditional manufacturing sectors as a result of more
outsourcing of unskilled activities to the developing world.
In the coming decades, given the trends described above, most categories of workers with the
exception of specialists and workers employed in sheltered sectors such as non tradeable public
and private sectors will be affected. In this context, the risk of a rush to the bottom (lower wages
and lower labour protection) between the developed and developing world is increasing and
spreading around the different economic sectors and occupations.
4.4. The role of organizational change
Together with increasing globalization and outsourcing of economic activities, another big revolu-
tion is underway in both the developed and developing countries: lean production (see Piva et
al., 2005).17
Decentralization and delayering; collective working in teams and quality circles; multi-tasking
workers and job rotation are increasingly common features of national and transnational firms
corporate governance (see Brynjolfsson and Hitt, 2000; Hitt and Brynjolfsson, 2002). In the next
two decades we can forecast a deepening of new organizational practices in the developed coun-
tries and an extensive diffusion of these same practices in the developing world.
This means that R&D alone will be insufficient to pursue productivity gains and international com-
petitiveness. A vast theoretical and empirical literature is showing how the European productivity
slowdown and the so-called Solow paradox (Solow, 1987) is due to the lack of organizational
changes necessary to make new technologies profitable. In other words, technological and or-
ganizational changes are strictly complementary and super-additive, thus productivity gains can
only be obtained through their simultaneous adoption.
In addition, there is a third aspect, which concerns skills and human resource management
(HRM). Innovation, re-organization and skills constitute what is referred to as the productivity tri-
angle (see Caroli, 2001), able to sustain competitiveness and to face the challenges from the
emerging economies.
In terms of policy prescriptions, this argument suggests that innovation policies should be cou-
pled with re-organizational strategies and HRM at the level of firms. Indeed, the lack of comple-
17
First introduced in Japan, lean production is the organizational model based on just in time, total quality management
and flattening hierarchy as efficient ways to match new technologies and obtain the required flexibility both in process and
product innovation (see Womack et al., 1990), The Machine that Changed the World, Macmillan, London).

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mentary manpower strategies increases the likelihood of redundancy among those workers that
may be particularly exposed to the threats of globalization and skill-biased organizational and
technological changes. Hence, policy makers should support holistic strategies at the level of the
firm (on-the-job training aimed at transferring updated capabilities to workers), and promote edu-
cation and off-the-job training.
The literature suggests that ICTs and other pervasive general-purpose technologies (GPTs) are
applicable across a wide range of functions and tasks (see Bresnahan and Trajtenberg, 1995;
Freeman and Louçã, 2001) and so workers are better off with a general rather than vocational
education, because their skills are in this case less likely to be rendered obsolete by globalization
and technological progress (see Bresnahan (1999) and Bresnahan et al. (2002), Maurin and
Thesmar, 2004).
4.5. Conclusion
As the above sections have shown, the interaction between globalization, technological progress
and organizational change proves to be knowledge-biased for all levels of the workforce. As far
as labour markets in the developed world are concerned, global competition and outsourcing
would seem to imply either an increase in unemployment or an increase in income inequality and
labour market deregulation (see Section 2). A possible alternative to these trends might be
achieved through greater competitiveness derived from innovation and increased productivity. In
particular, economic policy should encourage product innovation in high-tech sectors and in those
sectors characterized by higher income and demand elasticities (such as ICT services; see
Freeman and Soete, 1994; Torrisi, 1998; Vivarelli, 1995, 2006).
At the same time, technological and organizational change are imposing increasing demands on
knowledge-based workers and combining the three angles of innovation, organization and HRM
(see Section 3) seems the only way to efficiently compete with emerging economies in the long-
run (as opposed to short-term responses such as decreasing wages, increasing wage dispersion
and increased labour flexibility, see Section 2). In this framework, the concept of a learning soci-
ety (see Lundvall, 1992; Lundvall and Johnson, 1994; Lundvall et al., 2002) should shape the
18
evolution of economic and education policies.
To sum up, the only feasible alternative to the race to the bottom strategy to face the competi-
tion from emerging economies appears to be an efficient combination of technological and organ-
izational innovation with adequate education and training policies,. both at the national and re-
gional level.
18
A learning society is a socio-economic system able to match the challenges posed by the diffusion of the ICTs in terms
of supply of skills, education and life-long training (see Lundvall, 2001).

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V. Emerging economies
The majority of children s toys carry the label Made in China. China is responsible for some
70% of the world s toy production (Shenkar 2005). In 1843, Daniel Webster, US Secretary of
State in the John Tyler administration wrote that the great and well-known amount of imports of
the production of China into the United States are not likely to be diminished (Shenkar 2005, p.
19
72) . Prescient words. Currently, China is taking on the world and the world seems to have little
choice but to deal with this reality so long as China continues its dizzying pace of economic de-
velopment. Like India and Russia, it is an arriviste power.
In January-February 2006 at the Davos World Economic Forum, discussions on China figured
prominently. But it was India that seemed to be everywhere, an India that was intent on brand-
ing itself as an attractive destination for foreign investment, as an emerging manufacturing hub
and as a credible partner for world business. In an effort to showcase its strengths and opportuni-
ties in front of world business and the political elite, Indian business and government leaders had
committed some two years of effort, and more than $4 m,, to an elaborate marketing and PR
campaign India Everywhere to ensure that the India story receive attention at this summit
(Knowledge@Wharton, 2006; Wolf, 2006). China, on the other hand, was relatively invisible in
terms of its public relations efforts.
This section addresses the key drivers for economic progress in India and China, these being the
two countries that occupy centre stage among the Emergent Economies. They have become
the focus of global attention because India is on the growth turnpike (Kelkar 2004) and China is
a funny looking tiger (Economist 1996), and have experienced the fastest growing economies in
the last 20 years.
Since the opening of China to foreign investment in the mid 1980s, and its embarkation on eco-
nomic reforms, China has taken the lead over India. Its economic growth has averaged just under
10% per year; India s, despite it active program of reforms in 1991,was about 6% per year for the
same period (Wolf, 2006),. It is however, important to note that the economic-political environ-
ments of these two countries are distinctly different. China in many ways is still shackled to com-
munism, whereas India is the world s largest democracy. Therefore, to contrast and compare re-
cent economic performance in India and China is to portray the two countries in some zero-sum
game, that is, to ask which of the two countries is going to lose the contest. Rather than sur-
mising whether India will outpace China, it is more constructive to examine the drivers of each
country s economic growth.
It is on this premise this next part of the report investigates the impressive performance of India
and China.
5.1 India
India embarked on an ambitious reform programme following the country s balance of payments
crisis in 1991. There was a marked willingness to begin an effective shedding of its hitherto dirig-
isme economy and to introduce industrial and trade liberalization, and financial deregulation.
Policies conducive to privatization and FDI were introduced, along with improvements to India s
regulatory systems. These reforms helped to accelerate the country s hitherto dismal rate of
growth, once described as Hindu when referring to its low rates of growth in the three decades
after its independence from Great Britain in 1947. These reforms built upon the reforms of the
1980s, about which much has already been written (Desai 1999), but these reforms were fledg-
ling compared to the 1990s measures.
India s real GDP growth accelerated in 2003/2004 to its highest level in over a decade. At 8.2%,
real GDP growth was double that recorded in 2002/2003, when India suffered its worst drought
for over 15 years. This remarkable stellar recovery in activity was spearheaded by agriculture
19
Citing From instructions by Daniel Webster to Caleb Cushing, his emissary to China, whose mission resulted in the
Treaty of Wanghia, signed on July 3, 1844. 'Annals of American History.'

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where growth reached 9.1% in 1996. Industry grew by 6.7% and services grew by 8.7% (IMF
2005).
The drivers for India s growth are categorized as (1) social; (2) economic; and (3) institutional.
5.1.1 Social Drivers

Social drivers, unlike economic or structural reforms, do not usually feature largely as factors for
economic growth. But the social dimension helps to underpin or sustain growth and thus needs to
be considered alongside other drivers of economic growth. Economic development results from
the interaction of growth opportunities with the right fundamentals or pre-existing capabilities
(Kochhar et. al, 2006). These fundamentals are diverse and include human capital. Of course the
sheer population size of a country is not a necessary condition for economic growth, but it could
be a sufficient condition that works in conjunction with other drivers, for a country to develop and
grow.
5.1.1.1. Demography
Much has been written about the greying of the world s population, which has given rise to a
near universal pensions crisis. India is not exempt, but is in a better demographic situation than
China, which also has a huge population. An average of 13 m. people are expected to enter the
Indian labour force every year for the next four decades (Kochhar et al., 2006, IMF 2005). Fore-
casts of the number of Indian men and women over 60 years old in 2025 are 11.8 and 13.1%,
respectively. In China, the figures are: men 16.8 and women 19.8%, respectively. Furthermore,
the median age for India is forecast to be 33 years in 2025. For China, this is 39. Significantly, the
dependency ratio of the Indian population (the ratio of those above and below standard working
age to those of working age) is 16.2 and 20.5 for men and women, respectively; for China, this is
28.4 and 30.8 (Concepcion, 2000; Kelkar 2004). These comparative data signal that India will
have a larger and younger labour force a demographic dividend (Kelkar 2004, p. 20), which
invariably is required for sustainable economic growth.
5.1.1.2. Life expectancy

Associated with their demography is life expectancy in India, which has increased from 55 to 63
years. The infant mortality rate has dropped from 109 to 70 per thousand live births (Fischer,
2002). This trend helps to sustain India s demographic advantage in providing human capital and
a viable work force, at least over the next 20 years.
5.1.1.3. Education: Improved literacy rate and the wide use of English
India s literacy has risen from 45 to 68% for men and from 20 to 45% for women (Fischer 2002).
With more investment in higher education and professional training, such as engineering, com-
puter science and software programming, and biochemistry, this high level of human capital will
continue to underpin India s economic growth. The IT explosion has apparently increased the
attractions of higher education. There is anecdotal evidence about the demand for English lan-
guage schools in backward states, such as Bihar and the agricultural hinterland of Punjab. This
demand is based on the belief that a command of the English language provides a gateway to
better employment opportunities largely because the use of English is widely acknowledged to be
an important factor in engaging with the worldwide economic community and using the Internet.
English is the language of international business and its use lowers transaction costs in interact-
ing with the global economy. The ability to communicate effectively with the global economy,
among other factors, provides opportunities for job creation. Other observers have provided sys-
tematic evidence from Mumbai on how the increased returns from education are bringing about
an increased enrolment of women in schools and upsetting the traditional caste system (Munshi
and Rosenzweig, 2003). However, because its population is so huge, India s population will con-
tinue to have generally low levels of education.

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India s remarkable growth in the last decade or so has been mainly due to its stock of highly edu-
cated human capital. Incomes will likely rise with continued economic growth and this in turn may
provide a disincentive for labour emigration, a pattern that India experienced in the 1970s (partly
because of the stagnant state of the Indian economy referred to above). The more high skilled
labour that remains within India, the greater the spillover benefits to the Indian economy (Rodrik
and Subramaniam, 2004a, p. 8; 2004b; Kochhar et al. 2006). Retention and skills training re-
mains a priority for the Indian Government.
5.1.2 Economic Drivers

Much has been written about the effective package of reforms that India undertook in the 1990s,
following the 1991 exchange crisis, which saw India s shift toward neoliberal, pro-business and
pro-market economic reform. Yet much has also been written on the greater significance of In-
dia s progress from the reforms undertaken in the 1980s (Desai, 1999; Kochhar 2004). Arguably,
if the starting level is low, any progress from that level will be impressive. However, it is not the
purpose here to engage in this debate; it is accepted that the reforms undertaken in the mid- to
late 1980s paved the way for India s accelerated growth. The point that should be emphasized is
that growth is arguably unsustainable in the absence of ongoing economic and institutional meas-
ures directed at overall economic growth. In other words, reforms must be systematic, if not sys-
temic see Table 9.
This section on economic drivers focuses mainly on the global IT outsourcing trend that helped to
drive India s economic growth and whose international trade has been boosted by this global de-
mand for IT-related services. Services, in particular in the IT sector as the following discussion
will show, continue to remain a central feature of India s growth and international trade.
Table 9 India: Composition of GDP (Per Cent)

1980 1990 2000
Agriculture 38.6 31.3 24.9
Industry 24.2 27.6 26.9
Manufacturing 16.3 17.2 15.8
Services 37.2 41.1 48.2
Source: World Bank, Basic Indicators, as adapted from Panagariya, 2004, p. 35.
5.1.2.1. Global IT boom and the foreign demand for outsourcing

The growth of services picked up sharply in the 1980s but accelerated in the 1990s, at an aver-
age rate of 7.5% per annum (Panagariya 2004; Kelkar 2004; Kocchar 2005). Its growth outpaced
that of industry. Today, India is a byword for the provision of IT-enabled and professional ser-
vices, such as software programming, software engineering, business process outsourcing, fi-
nancial services, health services and call centres etc.. Export-oriented services production ranges
from high volume production of low-end services such as accounting and payroll management to
services that require highly specialized and high wage staff, such as research and development.
For example, research laboratories set up in India by foreign companies have filed for more than
1,000 patents with the US Patent and Trademark Office (Kelkar 2004).
Business services, communication, IT-services banking and hotels and restaurants were mainly
responsible for the acceleration in services growth. Business services grew the fastest, with
growth averaging nearly 20% in the 1990s. However, it must be noted that business services was
growing from a very low base (IMF 2005). As pointed out above, the growth in services was pro-
pelled by foreign demand, although domestic demand has also grown. The impact of domestic
demand, however, is less outstanding than the effect of increased foreign demand. For instance,

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the export market registered an average growth rate of 42% and the domestic market 16% (IMF
2005) between 1998-2003.
The dramatic growth in these areas, particularly in IT-related services, is largely attributable to the
nexus between the economic reforms that the country undertook to stimulate the services sector
and the worldwide demand for IT and telecommunications services, coupled with the accelerating
demand for IT-related services outsourcing. It must be remembered that growth in services is not
unique to India; there is an extant literature explaining why services grow rapidly in mature
economies. Where India, perhaps differs from this pattern is the rate of growth in its service sec-
tor as a percentage of GDP. For instance, average annual growth rates in the services sector
went from 6.9% during 1981-1991 to 8.1% for the period 1991-2001 (Panagariya 2004).
Certainly technological advances particularly in IT and telecommunications have played an im-
portant role. As noted above the confluence between economic reforms and the global IT boom
that began in the late 1990s and continues to the present day provided opportunities for India. It
would be useful to ponder what would have been the state of India s growth in the IT services
sector in the absence of the worldwide demand for IT-enabled services and outsourcing. None-
theless, for India the timing was opportune and the IT sector recorded the most impressive
growth, at an annual rate of 28% between 1998 and 2003, and turnover estimated at US$17 bil-
lion in 2003 (IMF 2005). Indian exports in these services grew at an average of 15% per year in
the 1990s compared with 9% in the 1980s, and at21% in the second half of the 1990s. Cumula-
tively, service exports increased four-fold in the 1990s and constituted US$25 billion in 2002
35% of total exports of which about one third came from software exports (IMF 2005).
In the Indian context, IT services encompasses ITS (systems integration, packaged software in-
stallation and support, application outsourcing, custom application development, testing, etc),
hardware development and maintenance, and ITES (call centres, payment services, human re-
sources management systems, finance, business process outsourcing, etc). ITES exports grew
at an average annual rate of 62% in 2001-2003. The share of ITES and ITS exports increased
from 35% in 1998 to more than 60% in 2003, compared with the domestic market for ITS and
ITES which decreased by 20% in 2003 (IMF 2005, Gordon and Gupta, 2004). Table 13 presents
the composition of the IT sector in India.
Table 13 Composition of the IT Sector in India, 1998, 2004.

1998 1998 2004 2004
Composition US$ million Percentage US$ million Percentage
IT& ITES exports 1759 35 12,200 63
IT domestic 2096 42 3780 20
Hardware domestic 1152 23 3370 17
Source: IMF 2005, p. 17
Associated with the growth in the IT sector was the changing composition and mode of IT exports
over the period 1998 to 2004. In 1993-94, nearly 62% of all IT exports from India were conducted
onsite (at the client s premises). By 2002-2004, off-shoring, or outsourcing by foreign customers,
dominated the mode of delivery of software exports, accounting for almost 58% of total exports.
For India, the growth in IT exports has been remarkable. From a global perspective, however,
India accounts for a minor share of the total global spending on ITES less than 2%.
It is also worth noting that while outsourcing has provided increased employment opportunities,
its overall contribution to total employment remains modest. According to the Nation Association
of Software and Service Companies (NASSCOM), the ITES segment provided additional em-
ployment to 74,400 people in 2003-2004; the total number employed in this segment was
245,500 by March 2004. Despite the NASSCOM-McKinsey report s forecast of an additional 1 m.
jobs in this segment, it still constitutes a small contribution, given that India has to generate jobs

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for about 100 m. new entrants in the next decade (IMF 2005; Gordon and Gupta 2004). A poten-
tially dampening factor for further generation of employment in the IT sector could lie in the grow-
ing furore caused by organized labour in foreign countries, such as the US, over the issue of IT
outsourcing and the loss of domestic jobs. The jury is still out on the backlash and the effects of
this increasingly contentious issue on India. Does the modest overall growth in employment in the
Indian services sector help to underscore the need for industry and agriculture to grow rapidly?
Could Europe derive any implications from this by questioning the real role of the IT sector in
overall job creation?
5.1.3 Institutional Drivers

The quality of institutions is well recognized as contributing to successful development. High qual-
ity or well-functioning institutions, among other things, lower transaction costs, provide good gov-
ernance and ensure trust and credibility. The following sections discuss India s existing, reformed
and new institutions. It begins with the institutional reforms at the central and levels, which are
then followed by the sweeping changes of trade liberalization and privatization.
5.1.3.1. Central level

Institutions, for the purposes of this report, are defined as a set of norms, practices and proce-
dures rules of the game, the legislative, the judiciary and the rule of law, regulations, and or-
ganizations/regimes. For instance, democracy, the press, regulatory bodies, the bureaucracy,
redistributive mechanisms, market stabilization and pro-business measures are examples of insti-
tutions. Already noted above, a joint reading of the economic and institutional drivers arguably
provides a better grasp of the impact of the drivers for India s growth. As the discussion on Eco-
nomic Drivers above has shown, economic reform was very much a part of India s existing and
new institutional landscape. Indeed, the existing institutions of democracy, the rule of law, etc,
provided the bedrock on which India s development since its independence in 1947 was founded.
Since then new institutions have been introduced and others, deemed incompatible with its post
1991 reform package, abandoned or reformed. Institutions reflect the past and present but they
are also constituted by change.
As noted above, a key fundamental in the case of India is the presence of established institutions.
It is a democratic state, which functions under the rule of law. But this is not to say that non-
democratic states cannot grow fast; witness China. In fact, one could argue perversely that de-
mocratic states can sometimes find it more problematic to institute change. However, in the case
of India, its long-standing democratic institutions have in large part contributed to its political sta-
bility, an important factor for FDI.
In the case of new regulatory bodies, India is continuing to develop supervisory and prudential
institutions to ensure proper governance in the financial sector. In a show of its commitment, In-
dia has submitted to the scrutiny of Financial Sector Stability Assessment, which is a diagnostic
tool that draws on the knowledge of experts from national and international institutions, led by the
IMF and the World Bank (Fischer 2002). In liberalizing its insurance sector, it established an In-
surance Regulatory and Development Authority. According to the World Bank s Governance in-
dicators India ranks above China, in voice and accountability (Government s efforts in trans-
parency) and government effectiveness (Wolf, 2006; Dahlman and Utz 2005). Another institu-
tional advantage is a well-developed private sector that continues to animate business develop-
ment opportunities.
5.1.3.2. State level

A less widely researched issue is policy decentralization reform and its effect on India s growth.
rd
India s democracy is more representative than participatory. In recognition of this, the 73 and
74th amendments to the Constitution of India, which became law in 1993, represented a major

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step toward decentralization. From then, it became mandatory for each state to constitute local
self-government institutions (Narayana 2005; Kelkar 2004; Kochhar 2006).
A major objective of this measure was to remedy the disadvantaged position of certain groups
(castes, women) in the state electoral and decision-making processes. To achieve this, new insti-
tutions had to be developed. According to experts, the loosening of central control over economic
decisions catalysed states into undertaking economic measures, including those designed to at-
tract private sector investment. According to Kochhar (1996), many states economic perform-
ance was closely tied to state policies and their new institutions, facilitated nonetheless by de-
regulation measures and the relaxation of protectionist controls undertaken at central level. This
of course led to stark divergences in growth rates between the states. But as Kochhar (2006)
suggests, laggard states can still reform and perhaps the precedent set by Western Europe,
which offered incentives (through the European Commission) for laggard European countries to
reform, can be a lesson. The external pull set reforms into motion, so much so that some of the
former laggards like Ireland and Spain are now Europe s locomotives (Kochhar, 2006, p. 43).
But institutions can also inhibit progress; a refusal to dispense with institutions that are no longer
relevant can thwart change. India seemingly suffers from this problem even as it creates new in-
stitutions to spur the country to greater growth. For instance, dealing with its bureaucracy to set
up new businesses is still considered to be difficult and time consuming. Its continuing ban on exit
and retrenchment of workers remains a stumbling block to more flexible labour policies that aim
at increasing productivity and constraining costs, and privatization needs to proceed faster.
5.1.3.3. Deregulation and privatization of industry

In July 1991, the minority government of P.V. Narasimha Rao announced sweeping (by India s
standards) liberalization measures and opened up an economy that hitherto had been rather in-
sular. These measures dismantled import controls, lowered customs duties, devalued the cur-
rency and, with the exception of except the rail transportation and nuclear energy sectors, se-
lected for security and strategic reasons, broke public sector monopolies.
The 1990s reforms saw a rapid deregulation of industry, with only five sectors requiring industrial
licensing down from a list of 18 at the start of the reforms. These were retained for health and
safety, and environmental reasons and included(a) arms and ammunition, military aircraft and
warships, and items of defence equipment; (b) nuclear substances; (c) narcotics and psychotro-
pic substances and hazardous chemicals; (d) distillation and brewing of alcoholic drinks; and (e)
cigarettes/cigars and manufactured tobacco substitutes (Panagariya, 2004).
Entry restrictions on MRTP firms (firms subject to the Monopolies and Restrictive Trade Practices
Act had an asset limit) were abolished, which allowed mergers, acquisition, amalgamation and
takeovers to be conducted more freely. New regulations for controlling and regulating monopolis-
tic, restrictive and unfair trade practices were instituted to replace entry restrictions.
Privatization was also a major theme of the reforms but has progressed only gradually. There are
still 276 public sector companies at central level, which observers regard as untenable (Kelkar
2004, p. 11). However, central and state governments recognize the link between privatization
and productivity and are continuing to privatize these companies, albeit at a leisurely pace. For
instance, of the total of 919 state companies, 33 have been privatized and 69 have recently been
shut down (Kelkar 2005, p. 11).
With regard to FDI, the previous threshold of 40% on foreign equity investment was abolished
and replaced by a threshold of 51%. Since January 2006, India allows 51% foreign investment in
the retail industry, thus clearing the way for companies such as Reebok and Nike to move be-
yond franchise agreements in India. In eight categories, including mining services, electricity gen-
eration and transmission, and construction of roads, bridges, ports, harbours and runways, the
automatic approval for equity investment is now 74%. Furthermore, automatic approval for FDI of
up to 100% is applied to all manufacturing activities, with certain exceptions, such as acquiring an
existing Indian company and in industries where sectoral policies apply, for example, telecoms
and insurance. These require special conditions. FDI in defence production significantly, is now
allowed up to 26% equity, subject to licensing terms (Panagariya, 2004; IMF 2005).

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5.1.3.4. Trade Liberalization; Globalization
Trade liberalization reforms were reflected in (1) merchandise trade; and (2) services. Merchan-
dise trade liberalization was undertaken mainly through tariff reform. Trade in services was liber-
alized mainly through institutional reforms, which prominently allowed FDI and foreign equity in a
broad range of service sectors.
5.1.3.5. Merchandize Trade Liberalization

Tariff rates rose substantially from the 1980s. Tariff revenue as a proportion of imports rose from
20% in 1980-81 to 44% in 1989-1990. In 1990-1991, the highest tariff rate was a shocking 355%
and the average of all tariff rates was 113%. These tariffs thus became barriers to imports when
licensing was removed (see above). As a core plank of the 1991 reforms was to liberalize the
economy and to make India more business-friendly, the Indian Government was forced to lower
tariffs. The tariff structure was eventually rationalized through a reduction in the number of tariff
bands. The top rate fell to 85% in 1993-1994 and 50% in 1995-1996. In 2003-2004, the top rate
fell to 25% (Panagariya 2004).
The July 1991 reforms abolished import licensing on most intermediate inputs and capital goods.
About 30% of all tariffs, however, were made up of consumer goods and these remained subject
to licensing. However in 2000 India s trading partners successfully took India to the World Trade
Organization (WTO), which led it eventually on 1 April, 2001, to free all consumer goods from
licensing, with a few exceptions. By 2004, India could be described as having really liberalized
its trade practices, especially in the light of its past prohibitive tariff structure.
5.1.3.6. Liberalization of Trade in Services

Liberalization of merchandise trade was accompanied by liberalization of trade in services in the
1991 reforms. Service sectors were traditionally subject to Government intervention, for instance
in insurance, banking and telecommunications. In 1991, the Indian Parliament passed the Insur-
ance Regulator and Development Authority Bill, established an Insurance Regulatory and Devel-
opment Authority and opened the sector to private entrants and foreign investors.
The financial sector has undergone significant changes. Private banks are now permitted and FDI
in these banks is also permitted, up to a limit of 74% equity. Furthermore, foreign banks may also
open a specified number of branches annually. Currently, there are approximately more than 25
foreign banks with full banking licences and about 150 foreign branches are operating in India.
India s BSE and NSE stock exchanges are reputedly the third and sixth largest stock exchanges
in the world (Kelkar 2004, p. 11). Equity derivatives trading was launched in July 2000, and in
2004 had a daily turnover of US$4 bn. India s derivatives trading has been lauded as the world s
most successful launch and foreign brokers such as JP Morgan Chase are extending their pres-
ence in reaction to the remarkable growth of this segment of the financial sector (Sarkar 2003). In
sum, it is plausible that stock exchanges are key to modernizing and growing the financial sector
as well as being the building blocks required to improve transparency and competition. (In India,
non-transparent transactions are proscribed.)
The telecommunications sector was a public monopoly until 1994. A new National Telecommuni-
cations Policy in 1994 liberalized the sector, allowing the private sector to provide mobile, basic
and value-added services. Foreign investors were granted entry into the sector. In 1999 the New
Telecom Policy was promulgated and extended the provision of telecommunication services to
include satellite services and paging. FDI in these services is, however, limited to 49%, although
up to 100% of foreign investment is allowed under certain conditions for Internet service provid-
ers, infrastructure providers, email and voice mail providers (Panagariya 2004; Gordon and
Gupta 2003).
As a result of its telecommunications liberalization measures, India now boasts a teledensity of
7%, the target for 2005 which was achieved in 2003. The forecast of teledensity for 2006 is 17%.

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Furthermore, there are about 40 million cell phone subscribers and subscription is growing at a
rate of 2 m. a month (Kelkar 2004). For a country that up till the late 1980s experienced immense
difficulties with telecommunications services (it was a public monopoly), this is remarkable pro-
gress. Interestingly, India is the only market where CDMA and GSM, the two main mobile tech-
nologies, are locked in grim competition, (Kelkar 2004, p. 7), of course to the benefit of custom-
ers who are lured by attractive subscription incentives.
One hundred per cent of foreign investment is also allowed for software companies and almost all
areas of electronics. Similarly, 100% of foreign investment is allowed in IT businesses set up ex-
clusively for exports (Panagariya 2004). For instance, since January 2006, India has permitted
51% foreign investment in the retail industry, which cleared the way for international companies
such as Reebok and Nike to move beyond franchise agreements in India.
The infrastructure sector has been opened to 100% foreign equity. The construction of roads,
ports, airports, harbours can now involve 100% of foreign capital. Domestic air transport has also
been significantly liberalized; foreign equity up to 40% and investment by non-resident Indians up
to 100% are permitted in this sector. The rail sector remains firmly in the hands of the state.
Regarding the energy sector, FDI is allowed in the generation, transmission and distribution of
electricity. Building upon the experience of liberalization of the telecommunications sector, the
Government aims to do the same in the energy sector by introducing competition through the pri-
vate and public sectors. But despite its intention, electricity provision remains a problem for India
and even private providers continue to have to be financially rescued by Central Government.
Table 10 highlights the growth of the service sector compared to the other main sectors over a
period of about 50 years.
Table 10 Sectoral Growth Rates 1951-2000

Sector
Average Growth (in% per annum)
1951-1980 1981-1990 1991-2000
Industry 5.3 6.8 5.8
Services 4.5 6.6 7.5
GDP 3.5 5.8 5.8
Source: IMF Staff calculations using the Central Statistical Organization data, as cited in IMF 2005, p. 11.
Table 11 encapsulates the impact trade liberalization on the Indian economy post-1991.
Table 11 Impact of Trade Liberalization

1990 2000
Ratio of total exports of good and 7.3 14.0
services to GDP
Increase of imports 9.9 16.6
Ration of total goods and services 17.2 30.6
trade to GDP
Source: Adapted from Panagariya 2004, p. 26.
Liberalization has contributed greatly to India s globalization. As noted above, the unilateral re-
moval of several trade barriers, assisted by its WTO obligations and the reduction in protection-

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ism have contributed significantly to India s international trade and growth. Gross trade flows
grew three-fold over the period 1991-2001. Table 12 shows the impact of this phenomenon on
India s growth.
Table 12 Growth of India s Trade Flows, 1991-2001

1991 2001
Trade (in US$ billion) 56.7 155.5
Percentage of GDP 21.3 33.1
Source: Adapted from Kelkar 2004, p. 4
5.2. China
China has emerged as a production hub for global products, and much more than toys or socks.
It manufactures products that are still being produced in the US and Europe, such as home appli-
ances, automobiles and a wide range of components. China is also becoming a player in tech-
nology intensive products, such as flat screen televisions, chips and military aircraft. Its new
standards in mobile phones and video compression standards (the Enhanced Versatile Disk
EVD) are challenging the DVD. China is a major player in capital-intensive sectors, such as
automobiles and commercial aircraft assembly.
Chinese disposable incomes are rising and with them come a taste for stylish products, including
imported goods. Average annual GDP growth between 1980-2002 was 9.5%. Per capita GDP
growth rose from about US$300 in 1980 to US$1,000 in 2002. An estimated 200-400 m. people
have been lifted out of poverty since 1980. According to the World Bank, China accounted for the
lion s share of global poverty reduction during the last two decades (Herd 2005; Tao 2003). As
C.K. Prahalad argues, there is even fortune at the Bottom of the Pyramid, the bottom being the
poor, of which there are hundreds of millions in China (Prahalad 2005). The capitalistic aspira-
tions of millions of Chinese and the ambitions of the Chinese Government to make the country
the powerhouse of Asia requires, among other reasons, have induced a concentration on special-
ized capital goods, components and materials to produce a wide range of sophisticated and less
sophisticated goods to satisfy the country s population. .
China s economic growth has averaged just less than 10% a year over the past 25 years. The EU
runs a collective merchandise trade deficit of about US$45 bn., although the UK is responsible for
most of this deficit. Furthermore, China is beginning to challenge Europe s strategic and political
influential industries, such as the auto industry (Shenkar 2005). The labour-intensive industries in
Europe, such as the textile, apparel and shoe industries are already facing huge competition from
China. There are signs that Europe s furniture industry is going to be the next sector to come up
against competition from China. However, the EU has the lower price low labour New Member
States, which may counteract this threat to an extent (Business Week 2004, p.1)
The drivers of China s economic growth can also be defined as (1) social; (2) economic; and (3)
institutional.
5.2.1. Social drivers

5.2.1.1. Reforming the Educational System
A Chinese official described the country s human resource base as humanware (Shenkar 2005,
p. 72) and as a key factor in China s growth. In 2000, China had 459 R&D performing scientists
and engineers for every million of its people, equivalent to about 10% the US ratio. Chinese sci-
ence and engineering students represented 43% of the total in tertiary education versus 19% in
the US (Shenkar 2000). But this figure belies the fact that the standard of education in China is
low and students still lack the ability to apply what they have learnt.

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In an effort to remedy this, China has employed two strategies (1) reform of the educational sys-
tem; (2) encouraging the return of the Turtles. 20
5.2.1.2. Educational system

The educational reform is a systemic attempt to improve its infrastructure. First the authorities
have instituted a policy of raising the educational qualifications of young people. It has launched a
programme to provide all children with at least nine years of education, especially aimed at chil-
dren in rural areas of the country. This reform is being overseen by a high-level committee, with a
working group dedicated to science and education, chaired by the Chinese premier.
Higher education has also been dramatically reformed, a significant feature of which includes the
overhaul of the curriculum. It has radically departed from the past when generalism was advo-
cated and under the new curriculum, there is more focus on inter-disciplinarity and there are re-
quirements for various fields of study in courses dealing with business, management and indus-
try. The new curriculum involves the use of non-Chinese textbooks, that is, translations of foreign
textbooks, especially those on science, technology, law and management. Exchange pro-
grammes have been instituted for students and faculty.
By 2000, gross enrolment in local universities had reached 11%, double that for 1990. Signifi-
cantly, students are being encouraged to study abroad and fellowships/scholarships are provided
for this purpose. By 2000, Chinese students were attending universities in more than 100 coun-
tries, but the majority were in the US Also in 2000, China had more than 45,000 foreign students
from 164 countries (Shenkar 2005). Although, the number of Chinese students enrolled in Sci-
ence and Engineering in the US declined follow in the Tiananmen Square protests in 1989 and
the promulgation of the Chinese Student Protection Act the numbers have increased again. How-
ever, after the events of September 11th, US student visas have become increasingly difficult to
obtain and Britain, in particular, has seen a commensurate rise in Chinese students. Owing to the
outcry and lobbying of the Deans in several leading US universities, including Harvard, the Bush
Administration has once again relaxed student visa entry requirements. Chinese students con-
tinue to form the highest number of foreign students in the US to be awarded doctoral degrees
(NSF 2006). See Table 14 for Chinese recipients of S&E doctorates in the US
Table 14. US-trained Chinese S&E doctoral recipients and the return of the Turtles
Chinese S&E Doctorates Plan to stay % Definite plans to stay %
1992-95 1996-99 2000-03 1992-95 1996-99 2000-03 1992-95 1996-99 2000-03
10,256 10,658 10.089 95.5 92.7 92.5 46.9 58.6 63.6
Source: Adapted from National Science Foundation (2006) S&E Indicators 2006.
China s top 100 universities and research institutions are eligible for special funding and research
initiatives. These universities have also benefited greatly from multinationals that want to show
China that they are good corporate citizens, but at the same time are, naturally, training a new
cadre of skilled and educated graduates whom they can eventually employ.
5.2.1.2. Return of the Turtles

The Chinese authorities are luring foreign-trained graduates back to China. Incentives such as
the National Science Fund for Distinguished Young Scholars, the One Hundred Talent Program
and the Cheung Kong Scholar Program (which allows scholars to hold joint appointments in for-
eign and domestic institutions), are all targeted at graduates and senior scientists who have
stayed abroad. The underlying rationale for giving incentives to Chinese graduates to return to
20
The term turtle denotes the tendency of this specie to return to its birthplace. This term has been aptly used by
Shenkar (2005, p. 75) to categorize returning Chinese graduates.

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China is obvious: they bring their technological know-how and their international experience, both
of which are essential for the global marketplace. Table above also shows, however, how difficult
it is to attract foreign-trained students back. The question remains how long will new doctoral
graduates continue to remain in the US.
China s educational reforms have produced results. Data show that China s share of scientific
publication rose from 0.63% in 1986 to 1.83% in 1997 and 3.54% in 2001. Articles from China-
based scholars in the prestigious Science and Nature journals rose from 11 in 1986 to 93 in
th
2001. In materials science, China ranked 4 in the world in 2001, with a 1.6% citation rate (ver-
th
sus 5.5% in the US); in engineering, China occupied 9 position, with 1.5% citation rate (versus
th
5.6% in the US). In nano-science, China s share rose from 5.5% in 1995 to 11.2% in 2001, 7 in
the world, but with a negligible citation rate (Shenkar 2005, p. 76).
5.2.2. Economic drivers

External trade and FDI are central sources of China s growth. FDI inflow was more than US$50
bn in 2002; 4% of GDP (Tao, 2003). Exports grew by about 15% a year between 1980-2002
(Herd 2005; Tao 2003). In contrast to countries with abundant natural resources and comparative
advantage in agricultural and primary goods, China has an advantage in labour-intensive manu-
factured goods. A huge working population that has migrated from the countryside to the cities in
search of employment and a higher standard of living, helps to support this advantage. For in-
stance, China s advantage in textiles and clothing, as mentioned above, will be especially felt fol-
lowing the termination of the Multi-fibres Agreement in 2005, thereby intensifying competition in
this sector. Member States such as Spain and Italy, which have a fairly thriving textile and ap-
parel industry, particularly in luxury textiles and clothing, will likely experience great challenges to
maintain their traditional industries. According to Business Week, Chinese exports of bedroom
furniture to the US have shut down 59 US plants employing 15,500 workers since 2001. Prices
for US made furniture continue to plummet in an effort to counteract the influx of Chinese made
furniture (BusinessWeek 2004).
China is also developing its technology-intensive capability (see below). What is stunning about
China is that for the first time we have a huge poor country that can compete both (labour and
knowledge-intensive) with very low wages and in high tech (BusinessWeek 2004).
FDI warrants special attention in the case of China because of the unprecedented and massive
inflows. For the purposes of this report, we will consider FDI as a main economic driver behind
China s growth and development.
5.2.2.1. Foreign direct investment
There are mainly two types of FDI: (1) market-oriented; and (2) export-oriented. In terms of mar-
ket-oriented FDI, the most important determinant is the size and growth of the host country. Ex-
port-oriented FDI mainly pursues cost competitiveness. China is perceived to have all the right
attributes, thus attracting massive inflows of FDI, which are touted as being the major driver of
China s growth. These inflows, of course, have been facilitated by direct measures, such as re-
duced barriers to FDI and preferential policies. The Chinese authorities consider FDI to be central
to the introduction of new technologies, knowledge and know-how, and capital.
The preferential policy for attracting FDI involves tax concessions, reduced corporate tax rates
(cf. Ireland), tax holidays, and no tariffs on imported equipment and construction materials. From
nearly zero FDI in 1980, by 2003 China had about 6% of the global stock of FDI (UN World In-
vestment Report 2004).
Between 1992 and 1998, FDI inflows were about US$40 bn on average and about 4% of GDP
(IMF 2002). The main sources of FDI in the 1990s were Hong Kong and Taiwan. Since then the
US, the EU and Japan have also become big investors, although Hong Kong, Taiwan and Singa-
pore, areas with a large Chinese Diaspora, account for over 50% (IMF 2002). Between early
2003 and the first quarter of 2004, China accounted for the bulk of world FDI. China received
about 39% of these flows to Asia, with India receiving 13%, which amounted to approximately

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US$60 bn (Burton, 2004, 2003). FDI in China is now well over US$400 bn (IMF 2002). Table 15
below presents available data on inflows of FDI into China for 1979-1999.
Table 15 FDI inflows into China (in current prices)

Years FDI inflow (US$ million Annual average (US$ Annual rate of increase
million) (%)
1979-1983 1,802 360 55.4
1984-1991 21,546 2,693 27.2
1992-1999 282,653 35,331 12.1
Source: Adapted from OECD 2000, p. 5
Wholly foreign owned enterprises constitute most of China s FDI 50.7% of the total (OECD
2000). China s phenomenal FDI growth has, not surprisingly, raised the country s GDP (through
creation of jobs), and productivity and provided an important source of capital. Its improved pro-
ductivity growth is particularly noticeable in foreign-funded enterprises. As noted above, labour
productivity is about twice as high as that in state-owned enterprises. According to the US Con-
ference Board, the productivity of private industry has grown an astounding 17% in five years
(Business Week 2004). FDI has also created job opportunities and added to the transformation
and increased performance of China s industrial structure. China s trade growth during the reform
period has grown by about 4.5 times that of world trade growth, and foreign-funded companies
have played a key role. For instance, their share of exports has risen from about 1% in 1986 to
45-50% in 2000 (IMF 2002; OECD 2000).
To sum up, FDI has had an enormous impact on China s growth. Its benefits can be summarized
as:
o international trade
o productivity and increased technology transfer
o GDP (and higher wages)
o upgrading of skills
o modified industrial structure; increased industrial performance
o opportunities for new entrants into China s industry; accelerated diversification of owner-
ship patterns.
While China s international trade is still concentrated in labour-intensive sectors (toys, apparels,
sports goods, furniture, etc. it is clearly developing comparative advantage in new sectors includ-
ing computer equipment, consumer electronics, electrical apparatus, telecommunications equip-
ment and household electrical appliances. For instance, the Shanghai-based TV manufacturer
SVA Group, has a joint venture with Japan s NEC Corp to manufacture flat panels, the first Chi-
nese plant to make these products. Through the US company 3Com Corp, China is also design-
ing and manufacturing networking gear, a high-tech product for the US market. Outside Beijing,
US giant SMI Corp has opened a chip plant fabricating 12-inch silicon wafers that experts claim
are just two generations behind Intel. Four more of these wafer plants opened in 2006, with sev-
eral more planned (Business Week 2004). The country s new comparative advantages are still
evolving.
5.2.3. Institutional drivers

As discussed above in the section on India, strong institutions, which define the rules of the game
in society, are critical building blocks for sustained long-run growth. By the same token, w institu-
tions can have an adverse effect. China is what the Economist describes as a funny-looking ti-
ger (Economist 1996), compared to the other Asian tigers (Taiwan, South Korea). It certainly had
strong institutions under the Maoist and post-Maoist period. But ironically they were weak eco-

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nomic institutions for growth as they were not targeted at the development of a market economy.
These strong institutions, however, are being reformed to bring China to a more liberal economy
and to integrate it into today s globalized economy.
According to World Bank data, in 1993 China underwent the most remarkable transformation of
its broad economic institutions, starting from a weak base level (Johnson, Ostry and Subrama-
niam (2006). Therefore, it could be argued that there is only one significant institutional driver for
China s growth the changing attitude of the central government, itself an institution. However, it
cannot be said of China that the economy is all that matters; growth can survive any politic up-
heaval (Economist 1996, p. 9). Witness its continuing censorship of Internet content; Google s
submission to China s demands for censorship. In other words, in China ideology can still retain
sway over the way the country evolves.
However, for the purposes of this study, while China s central government is the primary driving
force of economic reform, several institutions have been either reformed or introduced, one nota-
ble example being a dedicated agency for the privatization of state owned enterprises. These
enterprises were previously a stronghold of Government and had a stranglehold on the economy.
In its exercise of institutional changes, China has followed a principle of pragmatism with the
aim of balancing the pace of reform with social stability (Child and Tse 2001), even as it contin-
ues to deal simultaneously with globalization, transition and development. The introduction of key
institutional changes, however has been achieved in piecemeal fashion, reflecting the tension
between socialist and market-oriented principles, to the former of which many still adhere.
China launched its Economic Reforms and Open Door Policy in 1978. The reforms reflected Chi-
nese characteristics, such as pursuing gradual state sector reform while simultaneously allowing
and encouraging the development of the private sector. This of course has been a rather slow
process and there are multiple challenges for state owned enterprises, such as continuing exces-
sive state involvement in management. However, strategic restructuring of the state-owned
economy and the reform of state-owned enterprises has helped to increase the vitality of enter-
prises in China. In its current trade liberalization and foreign exchange reforms, China has clearly
departed from the measures adopted in the 1980s.
5.2.3.1. Liberalization
The initial set of economic reforms in the late 1970s produced very moderate economic growth.
Adhering still to a system of planned foreign trade (a handful of foreign companies allowed into
the country dealt in a narrow range of products), China exported significant quantities of capital-
intensive rather than labour-intensive goods. This impaired the growth of external trade. On the
import side in the early years, China maintained an exceedingly complex and highly restrictive
system of controls, which included high tariffs, quotas, licensing requirements and restrictions on
the range of goods that Chinese companies were allowed to trade. In 1995, these tariffs were
lowed dramatically (Lardy 2003).
The early 1990s saw China embark on meaningful liberalization and deregulation measures as
it pursued a so-called export promotion development strategy (OECD 2000). The country s fast-
est growing exports were and continue to be labour-intensive textiles, footwear, apparel and
toys. Between 1980 and 1998, exports of these items rose more than ten-fold, from US$4.3 bil-
lion to US$53.5 bn. However, as noted above, this situation is changing; for instance, China has
displaced the EU, Mexico and Japan by becoming the largest supplier of high consumer electron-
ics, computers and other IT-related products to the US.
Trade as a share of GDP rose from 13% in 1980 to 50% in 2002. The share of all imports subject
to licensing requirements fell from a peak of 46% in the late 1980s to less than 4% of all com-
modities by 2001 (Lardy 2003).
Table 16 below presents the growth of China s Asian import trade, as an indication of its interna-
tional trade. The escalation of imports from Korea and particularly Taiwan is notable, given the
former s traditional antagonism and the latter s ongoing political tensions with China.

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Table 16 Import trade with Asian countries (share % of National exports going to China)
Country 19901 1995 2000 2001 2002
Japan 2.1 5.0 6.5 7.7 9.6
Malaysia 2.1 2.7 3.1 4.3 5.6
Thailand 1.2 2.9 4.1 4.4 5.2
Korea 0.9 7.3 10.7 12.1 14.6
Taiwan 0.0 0.3 2.8 3.9 7.6
Source: Tao 2003
Import substitution lists have also been abolished since the 1990s and tens of thousands of Chi-
nese firms have been authorized to engage in foreign trade transactions. International external
trade also grew remarkably, as illustrated in Table .
Table 17 China s Export Share of G3 Markets (imports from China divided by total imports)
G3 Market 1980 1990 2000 2001 2002
Japan 3.1 5.1 14.5 16.6 18.3
US 0.5 3.2 8.6 9.3 11.1
Europe 0.7 2.0 6.2 6.7 7.4
Source: Tao 2003 (power point presentation).
Liberalization measures entailed a restructuring of the Chinese economy, most marked in the
shift from agriculture to other sectors. This was, in great part a direct effect of the massive inflow
of FDI, itself a result of liberalization (see below). Table 18 provides a snap shot of China s
growth to 2000.
Table 18 China: Composition of GDP (Per Cent)

1980 1990 2000
Industry 48.5 41.6 50.9
Manufacturing 40.5 32.9 34.5
Services 21.4 31.3 33.2
Source: World Bank, Basic Indicators, adapted from Panagayira, 2004, p. 35.
5.2.3.2. Privatization and deregulation

Momentum towards a freer economy has continued with China s entry into the World Trade Or-
ganization. Associated with liberalization and the restructuring of the Chinese economy is the pri-
vatization of state owned enterprises. The share of the State sector in the economy is currently
less than 30% of GDP, versus more than half in 1990. The private sector accounts for more than
60% of China s GDP, two-thirds of industrial value-added, from less than one-third in the late
1970s.
Between 1995-2002 the number of people employed by state owned enterprises declined by a
third or 38 m. Although in the 1980s and early 1990s the share of manufactured goods produced

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in the state sector shrank, with a concomitant increase in the private sector and foreign compa-
nies, the employment in state-owned manufacturing establishments increased by more than 15m,
reaching a peak of 35 m in 1992 (Lardy 2003, p. 11). However by the end of 2002, state owned
establishments employed less than 10 m as a result of management and worker buyouts. Privati-
zation of state owned enterprises is also resulting in employees being laid off. Employment con-
tracts are more flexible, which led to the retrenchment of about 14 m in the industrial sector be-
tween 1998-2003 (OECD 2005).
Productivity in the business sector has increased. For instance, the private sector was responsi-
ble for about 57% of the value added produced by the non-farm business sector in 1993 (OECD
2005).
Returns on assets (defined as pre-tax profits divided by the sum of the depreciated value of fixed
assets plus working capital) from state-owned manufacturing companies, which had declined
continuously for 20 years and reached an all time low in 1998, are not increasing. By 2002, re-
turns were 9.1% compared to 5.0% in 1998 (Lardy 2003, p. 13).
Price controls on agricultural products and other items have been abolished. Privatization and
deregulation has helped to increase productivity. Profit incentives and reduced state intervention
(although as noted above, this aspect continues to be a key challenge for China), has contributed
to greater productivity. Profit incentives have affected the private capital market as factory owners
and small producers devote more of their firms own revenues to improving business perform-
ance (Hu and Khan 1997). Reform of state owned enterprises is also underpinning the pursuit of
greater profits, as privately owned establishments can now decide their own fates and profit-
seeking behaviour by firms is a well-accepted axiom of economic theory.
Deregulation has been introduced in several sectors, such as infrastructure, public utilities (tele-
communications and power equipment) and financial services. Table 19 below captures these
trends and shows the inexorable drive of China toward a freer economy.
Table 19 Share of transactions conducted at market prices (per cent of transaction volume)
1978 1985 1991 1995 1999 2003
Producer
goods
Market prices 0 13 46 78 86 87.3
State guided 0 23 18 6 4 2.7
State fixed 100 64 36 16 10 10
Retails sales
Market prices 3 34 89 89 95 96.1
State guided 0 19 10 2 1 1.3
Sate fixed 97 47 21 9 4 2.6
Source: OECD 2005
5.2.3.3. R&D Expenditures and Developing Research Capabilities

The Maoist regime, especially after the lost decade of the Cultural Revolution, for the most part
had stifled technological development, although it s the basic capabilities to undertake industrial
application, especially in heavy industries still existed. China had developed considerable skill in
utilizing and adapting older technologies, and these became the foundations for the country s
modernization.

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When reforms started in 1979, Government recognized that China lagged behind the developed
countries, and especially the four Asian tigers Singapore, Taiwan, Malaysia and South Korea.
Thus, it initiated attempts to upgrade technology capability by importing technology.
Between 1978 and 2002 there were about 1,917 R&D policies developed or co-developed by
various departments. These increased to 1,361 between 1991 and 2002. Table 20 presents the
growth of R&D policies, and indicates the awareness of the importance of R&D policies for eco-
nomic development.21
Table 20 Number of R&D Policies from 1978 to 2002

Period 1978-1985 1986-1990 1991-1995 1996-2002
Average Number of Policies per year 21.00 76.60 94.80 126.71
Source: Feng and von Tunzelmann 200522
By 1999, China s R&D expenditure had more than tripled since 1991. S&T and R&D, as a per-
centage of GDP, rose from 1.8% and 0.7%, respectively in 1991 to 1.57% and 0.83% in 1999.
Basic research expenditure remained low (5%) compared to applied research (25%) and experi-
mental research (70%) (Shenkar 2005, Feng and von Tunzelmann 2005). Table 21 depicts the
growth of R&D in relation to GDP. The expenditures growth shows a remarkable momentum, to a
near 10-fold increase during the ten years between 1991 and 2002.
Table 21 Ratio of R&D Expenditure to GDP, 1991-2002 (percentage)

Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
R&D Intensity 0.74 0.74 0.72 0.65 0.60 0.60 0.68 0.70 0.83 1.00 1.07 1.23
Expenditure* 15.9 19.80 24.80 30.63 34.87 40.45 50.92 55.11 67.89 89.57 104.25 129.76
Deflated ex- 14.94 17.20 18.79 19.35 19.49 21.35 26.68 29.58 37.31 48.72 56.04 69.43
penditure
* Chinese currency, billion, current values. Deflated values are in 1990 prices, with GDP deflator calculated by the
authors.
Sources: Feng and von Tunzelmann 2005. 23
A central plank of the development of research capabilities was for China to conduct its own re-
search. The Chinese authorities believed that this could be achieved through the establishment of
R&D centres in China. There are currently several foreign firms with China-based R&D centres,
including IBM (the Chinese firm Lenovo has acquired IBM s PC unit), Oracle, Hewlett Packard,
Sun Microsystems, 3Com Corp, Nokia, etc. US affiliates in China are among the most R&D in-
tensive overseas operations. In 2000, China was host to the eleventh largest share of for over-
seas R&D expenditure by US firms, up from thirtieth place in 1994. These firms spent US$7 m on
st
R&D in China in 1994, which increased to half a billion dollars in 2000. China is in 1 position in
terms of R&D investments by US affiliates (Shenkar 2005).
In a survey conducted by Industry Week and the Cleveland-based Manufacturing Performance
Institute, 54% of Chinese companies cited innovation as a top priority, compared to only 26% of
US respondents. The survey also found that Chinese companies spend more on working training
21
The details (content) of the policies are not available, but suffice it to say that the marked increase in the number of
policies more than signals the role of policies in economic development.
22
Citing ZhongGuo Jishu, Chuangxin ZhengCe, YanJin FenXi (2002) An Analysis of the Transition of China s Technology
Innovation Policy:1978-2002, pp.44-47
23
Citing ZhongGuo KeJi, TongJi Nianjian (2002), China Statistical Yearbook on Science and Technology 2002, p.437;
ZhongGuo TongJi Nianjian (2003) China Statistical Yearbook 2003, p.749.

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and enterprise management software than US companies (BusinessWeek 2004). More innova-
tion, increasingly better quality goods, coupled with the so called China Price (BusinessWeek
2004) suggest that the industrialized economies may need to revisit their business plans.
Table 22 provides a snapshot of the 19 new or reformed ministries responsible for R&D policies.
The large number of actors explains why policies and institutional reform are slow to occur.
Table 22 Main Policy Actors in China

Ministry of Science and Technology
Ministry of Finance
State Administration of Taxation
The State Council
National Development and Reform Commission24
Ministry of Education
State Economic and Trade Commission
Ministry of Commerce
General Office of the State Council
General Administration of Customs
National Peoples Congress
Ministry of Personnel
The State Commission for Restructuring the Economic Systems
Ministry of the Information Industry
The Economic Commission
The State Commission of Science and Technology for National Defence Industry
State Patent Bureau of China
State Intellectual Property Office
State Copyright Bureau
The related institutions in local governments
The research institutes
The agencies & service institutes
The universities
The enterprises (SOE, SME, UOE, FDI, etc.)
Source: Feng and von Tunzelmann 2005, p. 30
5.2.3.4. Laws
Another major institutional driver has been the introduction of new laws. A company law permits
private individuals to own limited liability corporations. Competition laws have not only been im-
plemented, but also rigorously enforced in an attempt to unify the internal market. China has also
amended a series of laws, regulation and provisions, such as Equity Joint-Venture Law and Con-
tract Law. The Joint-Venture Law forbids nationalization except under special circumstances. To
date, there has been no incidence of China expropriating foreign investment. Therefore, invest-
ment risk is significantly reducing. The Contract Law was effected in 1999 to protect FDI by as-
serting the legal rights of all parties while allowing them to determine their own solutions for dis-
pute resolution and breach of contract. This Law clearly was aimed at attracting foreign invest-
ment.
At the end of 2001, the Chinese authorities drafted a law for the promotion of small and medium
sized enterprises (SMEs). This came into effect at the beginning of 2003. A central element of
this law was for the provision of central funds to help the creation of SMEs, to train their person-
nel and to foster their role in international trade. The law also set out to establish a credit-rating
system for the SMEs. In 2003, more than 20,000 employees of SMEs were trained in manage-
ment. A credit system has been set up for over 4,000 SMEs in five major cities and about 10,000
24
The National Development and Reform Commission grew out of the State Development Planning Commission (SDPC)
and the State Commission for Restructuring the Economic System (renamed the State Council Office for Restructuring
the Economic System in the early 1990s) in 2003.

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SMEs have been created in six major cities. One thousand credit guarantee organizations have
been also established for SMEs, which has facilitated easier borrowing. These measures in com-
bination have helped to increase employment in SMEs by 580,000 and to increase sales reve-
nues by more than US$13 bn in 2003 (Feng and von Tunzelmann 2005).
Poor enforcement of Intellectual Property (IP) in China has been, and continues to be a constant
complaining of foreign companies. It is widely argued and accepted that illegal appropriation of IP
is a significant deterrent to FDI. Piracy and counterfeiting is a thriving industry in China and it is
ironic that despite this situation, foreign companies continue to flood into China. Furthermore,
despite introduction of IP laws, China has done very little to enforce them. However, with China s
entry into the World Trade Organization and its domestic companies starting to recognize the
value of their home-grown IP, the Chinese authorities are beginning to take IP enforcement more
seriously. To instil confidence that China is (finally) intent on protecting IP, it has created a spe-
cial court to prosecute product-piracy cases, amid demands for Beijing to step up action against
rampant illegal copying of movies, music, software and other goods. The Supreme Court has
named a Judicial Court of Intellectual Property to handle such cases nationwide. In 2005, China's
courts convicted 741 people in 505 criminal product piracy cases. The courts handled 16,453 civil
cases of violations of IPR in 2005, more than 20% more than in 2004 (PatNews, 2006). This is
indeed a positive institutional move, but there is abundant anecdotal evidence that central gov-
ernment itself is guilty of unauthorized use and duplication of software. China s performance in IP
enforcement warrants continual monitoring and study.
5.2.3.5. Decentralization
There has been growing decentralization of authority to lower level governmental units, including
provincial, city and village governments. These lower level governments, as in India, are allowed
to formulate their own policies to attract investment and govern business activities under their
jurisdiction, but within a general framework set by central government. Although beset with prob-
lems, decentralization nonetheless has resulted in the growth of collective enterprises referred to
as Township and Village Enterprises (TVEs). These are owned and operated by village and
township municipal governments and have contributed to some extent to the growth of the Chi-
nese economy (Childs and Tse 2001). While several TVEs are low-tech, poorly managed and
even wasteful, observers anticipate that they will play an increasing role in China, particularly as
they begin to attract FDI and learn more effective management processes.
5.2.3.6. Financial
China s banking structure is still state dominated, despite the presence of several banking institu-
tions (joint-stock banks, city commercial banks and credit cooperatives, foreign banks). The bank-
ing sector is still centrally controlled. A major problem facing the banking system is the size of
non-performing loans; observers and Chinese banking supervisors, worry that a continuing trend
in non-performing loans, coupled with poor corporate governance, lack of internal controls and
risk management skills, and prohibitive tax policies for the banks (Luo 2003), will eventually crip-
ple the banking system. Measures to tackle these problems, with the aim of reshaping and stabi-
lizing the banking sector, included the setting up of a separate securities in 1992 and insurance
regulator in 1998. In April 2003, the China Banking Regulation Commission (CBRC) was estab-
lished, with a clear mandate to restructure the sector, to improve enforcement and supervision
and to advance cooperation among the three regulatory supervisors (securities, insurance and
CBRC).
To foster the growth of the securities market, in 2002/3 China instituted the Chinese Securities
Investment Fund, which regulates fund managers and fund custodians. The State Council and
the China Securities Regulatory Commission have drawn up additional laws. In December 2004,
the total net assets of the country s 114 securities firms were about US$6.3 billion, not too insig-
nificant for a country with only about 14 years history in the securities market. From two single
stock exchanges, the Shanghai Exchange and the Shenzhen Exchange established in 1990,

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China now boasts about 1,400, with a total capital stock value of US$140 bn and total capital
value of US$150 bn (Knowledge@Wharton 2006).
These are concrete institutional measures designed to develop the financial sector. But clearly
China needs to continue to overhaul this sector, as it integrates further into the globalized econ-
omy. This remains a primary challenge.
5.3 Conclusion
We attempt to draw some conclusions about the latest developments in the emerging economies
of China and India. India has undertaken sterling measures in its attempt to move from a regional
economic power to that of a world economic powerhouse but still faces some challenges . The
economic momentum of the early part of the 1990s has not been maintained and the average
growth rate of 7% per year in the early years to 1997 has not been maintained (Wolf
2006).Exogenous factors such as droughts, high energy prices and recent earthquakes have
been partly responsible for the slowdown. Nonetheless, expert observers caution India against
complacency. To understand India s , or any other country s growth it is necessary to understand
its ongoing problems as they have the potential to sideline progressive growth. These problems
are not the subject of this report, however. India still faces a catalogue of challenges. They in-
clude deregulation of its labour markets, revitalization of agricultural growth and increased infra-
structure investment. There is also a call for India to privatize and deregulate beyond what has
already been achieved.
With regard to China, we can expect that it will continue on its path of growth, but it too faces
several challenges. China has a declining fertility rate and a fast ageing population. This may re-
sult in labour force problems . The majority of its population still suffers from poverty, and the in-
come gap is growing. The country also faces a critical shortage of skilled and experienced work-
ers, despite its concerted effort to improve the educational and skills level of the population.
China s socio-economic challenges require non-ideological state intervention in the market to
deal with the practical problems that the market alone may not be able to solve. China needs to
reform its financial system as this has the greatest potential in the near future to trigger system
disintegration (New Statesman 2005, p. 26). There are other challenges but they are beyond the
remit of this report. A comprehensive understanding of these challenges will not only provide bet-
ter insights into China s growth but more importantly, its future growth. China, as its history has
shown, has experienced policy reversals.

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TASK TWO
World markets trends: Implications for European Indus-

try Competitiveness
I. Introduction
For Task one the research team explored and identified the global trends likely to shape the be-
haviour and structure of European market economic activities in the medium term future. Task
two aims to analyse the implications of the findings from Task 1 for European industry, particu-
larly in relation to competitiveness. The terms of reference for this study referred to several
themes related to competitiveness, including:
Macro economic implications;

Structural and organizational changes in industrial activities;
Scale and sectoral composition;
Research, technological development and related requirements;
Human resources, skills, labour market conditions;
Localization of economic activities, infrastructure;
Framing conditions for investment attractiveness.
Because each of these themes is broad and not well defined a brief methodological discussion is
required. In addition, as there are a large number of issues identified in Task one, pinpointing
their consequences for the themes to be studied in Task two is problematic. Two aspects merit a
brief discussion in this context. These are our understanding of competitiveness in the context of
this study and the general heuristics being adopted in the accomplishment of this task.
1.1 Competitive process focus

First in relation to the themes listed and competitiveness, we need to clarify what is competitive-
ness? For the purposes of this study we define competitiveness as an index used to compare the
capability and performance of a firm, an industry, an industry cluster, a nation or region in selling
and supplying goods and/or services to a market - local, regional, or global. A region or a nations
competitiveness is generally assessed in terms of its capability to maintain a position of surplus in
the international trade balance (Ezaela-Harrison, 2005). Typical measures used are trade per-
formance and exchange rate indexes, relative labour cost, GDP growth rate per capita, and pro-
ductivity and total factor productivity growth. Despite this seemingly straightforward definition, the
concept of competitiveness has always been controversial (Lall, 2001).
Disagreements arise over its measurement, the indexes used, and whether the results reported
are supported by the measurements recorded. According to Hämäläinen (2003: p. 3) the litera-
ture in the field covers three broad areas depending on the focus, i.e. inputs or resources for
competitiveness (e.g., Zanakis and Becerra-Fernandez, 2005), efficiency of the organizational
process (e.g., Vena, 2006) or competitive performance (e.g., Lall, 2001). Depending on the focus
chosen, and use of categories such as micro-macro, firm-national, input-output (resources-
performance) we can define competitiveness and therefore the perceived performance of nations

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and policy mixes to enhance competitiveness in various ways. The three categories mentioned
above are indicative of where the sources of disagreement concerning the definition of competi-
tiveness, lie.
In addition, there is controversy over what determines national competitiveness. For example, the
now classic work of Porter (1990) argued that conditions (skilled labour, infrastructure, and raw
materials), domestic market demand, industrial organization and structure, and firm strategy,
structure and level of competition were what determined the performance of nations. Ezaela-
Harrison (2005) maintains that competitiveness is related to R&D investment levels, productivity
trends, trade balance, level of education of labour force, etc., while Hämäläinen (2003) empiri-
cally tested for national competitiveness based on seven interrelated factors. These factors were
resources, technologies, organizational efficiency, product markets characteristics, external busi-
ness activities, institutional framework and government activities. Despite these disagreements
about what determines competitiveness, there is implicit agreement that national competitiveness
can be maintained, improved or lost over time. Thus, national performance is dependent on the
ability of governments to design and implement appropriate policies and framework conditions.
The role of government is to implement the necessary and sufficient conditions for firms to par-
ticipate in the international competitive process.
In the context of the above we can now turn to an examination of the themes provided in the
terms of reference for this study. As the study aims to identify implications at European level all
these themes clearly refer to the macro level. The competitive process, in terms of firms or re-
gions, can be classified as: inputs required to be competitive, efficiency in the management of
inputs and resources, and performance resulting from the first two items. Given the prospective
nature of the study we have emphasized inputs, and taken as the guiding principle the need of
preparedness or readiness for the future.
Thus the main question in Task two is: what are the implications and challenges for Europe of the
necessary conditions related to the themes listed above? In order to investigate this question we
need to look at the factors affecting competitiveness and their effects on inputs for global com-
petitiveness .
1.2 Note on Methodology

We describe the approach and heuristics adopted in tackling Task two. Exploring the implications
of global market trends for European industry was assumed to involve a degree of deductive rea-
soning. This assumption is related to the nature of the task itself looking at the future. Explora-
tion of the implications of world trends for the competitiveness of the EU industry is to a large ex-
tent influenced by: a) the very incomplete knowledge about functional relations between trends
identified, competitiveness and future surprises; b) the lack of a generally agreed framework to
explain the relationship of factors affecting the world system; and c) the fact that the actors in-
volved in the study have cognitive limitations and methodological preferences. The implications
for Europe in the light of global trends is unavoidably affected by the assumptions made, the in-
clusion and selection of critical variables (trends), and the implications and challenges inferred in
the different themes. The implications derived from this study should be seen as a partial version
of a global model that necessarily should be debated, and complemented with expertise more
closely related to the specific trends identified.
Given the open character and high level of aggregation of the themes proposed in the terms of
reference for this study (assumed to be determinants of European competitiveness) the partici-
pants in this study used the following heuristics to draw implications for EU industry. First, deseg-
regation or definition of the main traits that delineate the boundaries of the themes selected. This
desegregation is aimed at making explicit what is likely to be affected by global trends within each
theme. This highlights the level of complexity in forecasting all possible impacts on the themes
proposed. Next, the traits identified were taken as indexes that would produce an aggregated

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impact. The selection of these traits or indexes was related to the experience of the authors in
relation to a specific theme, and also on what were assumed to be the main features defining its
boundaries. Last, the main features identified were compared with the list of global trends identi-
fied in Task one of this study to find potential relationships and implications. In this last point a
determinant factor for the exclusion or inclusion of a trend in the final analysis was if the authors
considered that R&D and Innovation had a role to play in facing the identified challenge.
For example, in the case of the theme Localization of economic activities the most frequently
used terms in the literature on this subject and its definition are: international subcontracting, out-
sourcing, off-shoring, labour cost, availability of skilled labour, fiscal regime (level of taxation and
repatriation of profits), degree of labour unionization, general labour age bracket, regulations
(health, safety, environment), easiness to open and close down business establishments, avail-
able infrastructure, internal market consumption, etc. Not until the theme is defined and disaggre-
gated can the potential implications of global trends be made explicit. A case of a trend excluded
was for example poverty eradication, as we thought that there are other public policies were likely
to play a more important role and it appear to have little to do with the competitiveness of the EU
industry.
The rest of task two is structured as follows. Section II addresses the themes structural and or-
ganizational changes in scale of industrial activities and sectoral composition; Section III explores
implications for research, technological development and related requirements; Section IV looks
a the implications for human resources, skills, and labour market conditions; Section V explore
potential effects from the localization of economic activities; Section VI offers some insights on
the future of framing conditions for investment attraction (input and efficiency); Section VII looks
at the potential macro economic implications, and Section VIII summarizes the main implications
for European industry.

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II. Structural, organizational and sectoral composition
2.1 Introduction
This section discusses the implications of the trends identified in Task one in relation to demand,
supply and institutional factors for the structure, organization and sectoral composition of indus-
trial activities and the indicators that can be used to capture these aspects The definition of these
indicators will have some implications for European competitiveness. In general three areas of
industrial organization theory are drawn on: industry structure, industry dynamics, and sectoral
distribution. These are briefly discussed below.
Industry structure
The shape of the firm size distribution is a measure of the industry structure. This distribution is
positively skewed as a result of the presence of several small firms and only a few large firms,
across industry sectors. Small and large firms play different but complementary roles in the inno-
vation system. Small and medium-sized firms (SMEs) are vital sources of innovation, which
through the Schumpeterian process of dynamic competition, threaten the market positions and
even the existence of large and established firms. Recently, however, the attention of scholars
and policy makers has shifted from consideration of the role of SMEs to focusing on the role of
entrepreneurs and new firms. Small firms often take the decision to occupy a market niche and
remain small, while new firms are more likely to produce technological breakthroughs and un-
dergo rapid growth. Firm age seems to matter more than firm size in terms of competitiveness
and economic growth. However, both new and small firms face a number of obstacles that
threaten their survival, such as lack of resources and scarcity of established relationships, and
problems involved in accessing capital and labour markets. In addition, public policies are often
negatively biased towards new and small firms (OECD, 2005).
Large firms, on the other hand, are involved in large-scale R&D projects; the preponderance of
R&D expenditure (EC, 2005) and patenting activity (DTI, 2005) is accounted for by a few leading
firms. Large firms complement small firms in innovation activities, often promoting entrepreneurial
activity through partnership and corporate venturing. The relative contribution of small and large
firms to innovation varies across industry sectors and is shaped by the nature of the technology
regime (Marsili, 2001). Section 2.3 discusses the implications of general trends in industry struc-
ture, emphasizing the role of new and small firms vis-à-vis large and established firms. These
issues are important for public policy because the relevance and impact of various types of policy
measures may vary according to the size (and age) of the target population of firms (OECD,
2005).
Industry dynamics
Firm size distribution is a static measure of the structure of market competition. In order to cap-
ture the dynamic aspects of market competition, it is necessary to examine how firm size distribu-
tion evolves over time. The industry structure is changed by the entry of new firms and/or the di-
versification of production by existing firms. The creation of new firms or new divisions of existing
firms is a pervasive phenomenon across the industrial system. Industries are generally character-
ized by significant entry rates, even in presence of strong structural entry barriers (Geroski,
1995). It is also well known that the majority new firms die few years after formation; but those
that survive contribute to a large share of job creation and economic growth. In addition, industry
structure evolves as consequence of the market share volatility in existing firms. For example, it

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has been shown that there is generally high stability in the hierarchy of top R&D investors, al-
though some entries and exits do occur in the top of the distribution (EC, 2005).
Sectoral distribution
In terms of innovative activities, the sectoral distribution can be expressed as the share of R&D
expenditure by sector in the economy. A measure of the concentration of this distribution cap-
tures the degree of a country s R&D specialization. This is important because it influences the
overall intensity of R&D expenditure at the national level. For example, their small presence of
EU firms in R&D intensive sectors (R&D investment/sales ratio > 5%) accounts for the lower R&D
intensity of EU companies compared to US companies (EC, 2005). In particular, the innovative
capacity of the industrial system depends on the proportion of investments in areas of high tech-
nological opportunity (as expressed by the intensity of R&D expenditure) or the proportion of in-
vestment in fast growing technologies (for example, measured by growth in patenting).
Structural changes in the economy will generate changes in the industry distribution of R&D ac-
tivities. These variations reflect the differential rates of growth in R&D expenditure across indus-
trial sectors. They are caused by differences in the rate of technological change across industrial
sectors, but also by the emergence of new technologies that lead to the creation of new indus-
tries.
Section 2.2 provides a discussion of the effects of demographic changes on these dimensions.
Section 2.3 explores the effects of technological and economic change from the supply side per-
spective. Section 2.4 discusses potential effects on EU industry from the institutional point of
view. In discussing the effects of these drivers of change, emphasis is placed on the implications
and challenges for innovative activities.
2.2 Demographic change

The ageing population, and as baby-boomer generation approaches retirement age, has impli-
cations for industry structure and dynamics. Both demand and supply conditions are affected. On
the demand side, the aging population is prompting changes in market demand, and an in-
creased concern over health care, which creates opportunity for new businesses (Eckhardt and
Shane, 2003). On the supply side, demographic changes are affecting the supply of potential en-
trepreneurs, and therefore the creation of new firms. Generally, entrepreneurs emerge some-
where between the ages of 25 and 40 (Evans and Leighton, 1989). In addition, early retirement
can be the motivation for self-employment. Early retirees are seen as the potential next genera-
tion of entrepreneurs (Singh and DeNoble, 2003). These older entrepreneurs, who have been
employed for many years, differ from other entrepreneurs and tend to be less risk averse. They
bring the experience accumulated in their previous employment to the new firms and thus repre-
sent valuable resources and capabilities (Singh and DeNoble, 2003).
Thus, it can be seen that an ageing population transforms the nature of market demands, creates
opportunities for new businesses and increases the number of potential entrepreneurs. The ex-
perience of late entrepreneurs can contribute significantly to the survival and performance of new
firms. The challenge for the EU industry is to match new market opportunities arising from the
changing nature of market demands, and the new supply of entrepreneurial skills and human
capital, with new business propositions, products and services.

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2.3 Supply side
2.3.1 Globalization
Globalization can have major effects on whether opportunities are created for new or established
firms, and therefore its net effects on market structure and dynamics are difficult to predict. In in-
creasing the integration of markets, globalization allows established firms to better exploit scale
economies, and thus raises the barriers to entry of new firms and increases market concentration
(Verheul et al., 2001). In addition, increased international competition and pressure to reduce
costs may threaten the survival of small and young firms, which generally lack resources and
have more liabilities. On the other hand, globalization opens up new and unexploited local mar-
kets and increases the variety in customers needs and preferences. This transformation leads to
more market niches and greater opportunities for new and specialist firms thereby reducing entry
barriers and decreasing market concentration (Verheul et al., 2001).
Globalization and the increased use of outsourcing by manufacturing and service firms has direct
effects on the productivity of industry sectors. However, the direction and extent of these effects
has not been studied in depth (Olsen, 2006). Several studies have focused on the negative ef-
fects of outsourcing on wages and labour skills, while other studies have tried to establish
whether positive effects on productivity can be observed. In particular, it has been argued that
contracting out by manufacturing firms to foreign providers of service activities, a phenomenon
that began in the 1980s in customer services and extended to engineering and software devel-
opment, increases productivity. However, empirical studies of the existence of a positive effect
have not found sufficient evidence to support these claims. Indeed, the effect on productivity of
outsourcing seems to be conditional on the industrial sector (Olsen, 2006).
The implications of globalization for EU industry will vary. it could enhance the competitive posi-
tion of established firms, through enabling them to exploit scale economies in larger markets and
a broader supply chain. However, increasing variety in demand, will create new market niches
that offer opportunities to entrepreneurial firms. At the same time, increased competition from the
emerging countries may threaten the survival of new and small firms with limited resources.
2.3.2 The service economy
There is a trend towards a service economy, which has implications for the structure and dynam-
ics of industry and the sectoral composition of the overall economy. First of all, the increasing
presence of service activities in the economy creates opportunities for new firm creation. The
service sector is generally characterized by lower capital intensity than the manufacturing sector.
Consistent with the view that capital intensity may represent a possible source of structural entry
barriers (Geroski, 1995), average firm size is generally lower in services than in manufacturing
firms (Verheul et al., 2001). A service economy thus implies lower entry barriers.
In addition, manufacturing and services have become more integrated because of the increasing
inclusion of service activities in production processes and the coupling of services and manufac-
tured content in firms offerings. As a result, established firms need to develop new capabilities in
the coordination and integration of different types of activities in the context of fairly complex sys-
tems ( integrated solutions ). This trend may have implications for the industry structure that are
quite different: the need for coordination by the firm of different and interdependent activities may
require large scale and therefore increase concentration in the industry.
The emergence of a service economy helps to enhance industry competitiveness through (i) the
creation of new firms and lower structural entry barriers related to lower capital requirements and
(ii) the innovation of established firms that can diversify their market offering by integrating manu-
facturing and service activities.

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2.3.3 The entrepreneurial economy
The creation of new firms has become increasingly important for policy makers at national and
international levels (Brandt, 2004). New firms are a key source of new (and radically new) ideas,
with the potential to enhance the dynamism and competitiveness of the economy. In particular,
new firms contribute significantly to new job creation and productivity increase across industrial
sectors, although the establishment of new firms is more likely in some sectors than in others.
For example, there is a large presence of new firms in the information and communication tech-
nologies (ICT) sector. Because of the positive effect of entrepreneurship on productivity and eco-
nomic growth, national governments and the EU have introduced a broad range of policies.
These policies aim to lower structural barriers to new firm creation and reduce the liabilities for
new firms, especially in the early start-up stage. These policies include changes to licensing regu-
lations (Brandt, 2004).
Entrepreneurial activity is commonly regarded as a source of competitiveness and economic

growth. The challenge for government is to design public policies that reduce structural barriers to
entry and reduce the liabilities of new firms in the early stages of formation. The role of industry is
to create a favourable environment for the creation of new firms, for example, through established
firms venturing activity (e.g. joint-ventures, spin-offs, technology incubators, etc). There is a cru-
cial role for policy in encouraging entrepreneurship; according to recent study, in 2003 only 47%
of Europeans indicated that they preferred self-employment to being employed (Eurobarometer
Flash 146, 2003).
2.3.4 Open Innovation
Open innovation identifies a new approach to innovation that has been adopted by a number of
leading firms (Chesbrough, 2003). While the old closed innovation model involved the exploita-
tion of firms in-house capabilities and R&D activities, in the new open model firms rely on a
broad range of external (and internal) sources of ideas in the development of new products and
processes. Innovative firms acquire new ideas from competitors, users, suppliers, universities,
and other institutions; they bring knowledge from the outside to their organization. At the same
time, firms have become more open to transferring their own knowledge to the outside, through
technology licensing, partnering and venturing (Chesbrough, 2003). The model of open innova-
tion affects the organization and structure of industrial activities. First, the boundaries of firms be-
come more permeable as technologies are transferred in both directions, from external sources
to the firm, and from the firm to external actors that may commercialize it. Second, large firms are
part of a broad network of collaboration and knowledge transfer that create opportunities for inno-
vation and growth for small and new firms. Thirdly, large organizations are becoming important
sources of new firm creation. Increasingly, they are promoting corporate venturing and nurturing
the spin-off of new firms, for example by setting up their own technology incubators.
The new model of open innovation has been adopted by leading firms such as Philips, to organ-
ize their innovative activities and increase innovative performance. This model also favours the
creation and success of entrepreneurial firms, which can benefit from strong relationships in in-
novative activities with the established firms. The challenge for government and industry is to in-
crease the commitment of businesses and institutions to open innovation, collaboration and
knowledge transfer.

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2.3.5 Supply of new inventions: new research paradigms
The effect of technological advances on industry structure and dynamics is not clear-cut and is
shaped by the nature of the technology involved (Marsili, 2001). Advances in production tech-
nologies, such as ICT or nanotechnology, that are pervasive and can be applied across a wide
range of industrial activities, work to reduce entry barriers and have a positive influence on the
creation of new firms (Patel and Pavitt, 1994; Verheul et al., 2001). These technologies tend to
reduce the costs of capital goods, lower minimum efficient scales and facilitate the specialization
of new firms along the supply chain (Verheul et al., 2001). In particular, information technologies
(IT) have reduced the costs of communication between organizations. As a consequence, carry-
ing out and coordinating transactions through the market is becoming relatively cheaper, with the
effect of reducing firm size and diversification (Verheul et al., 2001).
New technologies that involve high degrees of novelty are often better exploited by new firms
than by established firms. Established firms have long term relationships with their existing cus-
tomer base that prevent them from recognizing and exploiting business opportunities that emerge
out of radically new technologies (Christensen, 1997). New firms often have the enthusiasm and
flexibility required to meet the challenges of new and emerging technologies that established
firms do not. Technological advances can lower entry barriers in an industry and reduce market
concentration.
However, they have the opposite effect on industry structure and dynamics. Technological ad-
vances that require higher intensity of R&D expenditure in the form of sunk costs, increase the
barriers to entry and threaten the survival of firms (Sutton, 1998). Market concentration and firm
size can thus increase with the introduction of new technology.
The emergence of new technologies, by changing the distribution of R&D activities across indus-
trial sectors, has an impact on the overall level of R&D intensity. Concentration of investment in
emerging and fast growing technologies is required to enhance the general level of innovative
activities. This effect varies across sectors. For example, the smaller presence of EU companies
in high technology sectors, accounts for the lower overall level of R&D intensity in the EU com-
pared to the US.
The implications of technological change on industry structure and dynamics are shaped by the
nature of the technology. New research paradigms that destroy or disrupt the technological capa-
bilities of established firms, create opportunities that are more likely to be identified and exploited
by new firms. In contrast, technological advances of a more incremental nature strengthen the
capabilities and competitive advantage of established firms, and increase the barriers to entry
and the sunk costs of R&D.
2.4 Institutional side
2.4.1 Intellectual property rights
The extent to which intellectual property rights (IPR) can be effectively used and enforced to pro-
tect innovation has an influence on the structure and dynamics of industries. In particular it affects
the role of new and small firms in the innovation process in different ways. First, the possibility to
license technology from universities or established firms creates opportunities for potential entre-
preneurs to create new firms without sustaining high development costs. IPR in combination with
the diffusion of information technologies (see Task one report, Section III.3.2) create the condi-
tions for the emergence and operation of markets for technology (see Task one report, Section
III.2.1). These markets take the form of websites in which researchers and companies exchange
solutions to technical problems. They contribute to the formation of a community of researchers
that exchange knowledge and span the boundaries of individual organizations. These internet
based R&D communities are part of the new information economy (see Task one report, Section
III.4.5) and contribute to the wide diffusion and distribution of knowledge.

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Markets for technology and strong patent regimes, facilitate the division of innovative labour be-
tween research oriented small firms and development oriented large firms (Arora and Gam-
bardella, 1994). By increasing the opportunities for new firms to specialize in research activities,
these factors are expected to have a positive effect on innovation and entrepreneurship in the
industrial system.
Furthermore, in the new open innovation model (see Task one report, Section III.2.1) in which
firms need to establish a network of relationships with external parties, new firms are especially
subject to what has been termed the paradox of disclosure (Gans and Stern, 2003). New and
small firms face a trade-off between the need to disclose their ideas when engaging in potential
collaborations, and the risk that their ideas will be imitated by their partners, which are often also
their potential direct competitors. A strong patent regime may help new and small firms to solve
this paradox by providing them with more bargaining power in their negotiations with large and
established third parties (Gans and Stern, 2003). A strong patent regime creates conditions that
facilitate the exchange of ideas between established and new firms, through market mechanisms
or collaborations.
The challenge for government and industry is to favour the creation, through an effective IPR re-
gime, of a market for technology that provides both new and established firms with alternative
means to commercialize their ideas and gain economic returns from innovation.
2.4.2 Organizational change
It was observed that a new trend towards an open model in the production and dissemination of
knowledge is emerging. Leading innovative firms benefit from the technology they create not only
by commercializing it in the form of new products or processes, but from the use that other entre-
preneurs or organizations make of it. This new model of commercialization of innovation requires
new managerial practices and organizational arrangements. For example, large firms strive to
introduce incentives and practices that promote creativity and entrepreneurial behaviour in their
employees. They also need to introduce new practices to scan and combine the several external
sources of ideas they may draw upon (an example is the new connect and develop approach
introduced by Procter & Gamble, as opposed to the traditional research and develop approach).
In this perspective, the economic benefits of innovation derive as much from organizational as
from technological change. This can be seen as part of a more general trend in which organiza-
tional change and human resource management (HRM) play a greater role in sustaining competi-
tiveness and economic performance (see Task one report, Section IV.4).
Organizational change is a key source of renewal and helps established firms to build a competi-
tive advantage. The challenge for industrial firms is to develop new managerial practices that en-
hance both internal capabilities (by mobilizing available skills and human capital) and external
capabilities (by drawing on external collaborations and social capital).

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III. Research, technological development and related re-
quirements
3.1 Introduction
This paper discusses the implications of the key drivers identified in Task one for research and
technological development activities (RTD). It addresses some of the ways in which the demand
factors identified in the first stage of the study relate to research and development (R&D) activi-
ties. Drawing mainly on published studies and the result of foresight exercises, the paper as-
sesses the nature of these influences (what general areas of research they push, and whether
they affect the way in which research will be conducted through, for instance, changes to the
regulatory environment).
It should be noted, however, that the effects of the drivers identified in Task one for the develop-
ment of RTD capabilities are unlikely to be unequivocal. This is because the goals of R&D activi-
ties can be multiple whether funded from private or public sources. It is still common to look at the
effects of research in a linear way, as leading to new knowledge, which can then be applied to
technological development and eventually result in new products and processes improving pro-
ductivity, economic competitiveness and improved quality of life. However, in reality the relation-
ships between R&D activities and their socio-economic environment are seldom linear and un-
ambiguous. For instance, increased competitiveness can be at the expense of social improve-
ments (due to the more intense use of natural and labour resources), or can take place in the ab-
sence of productivity improvements (by introducing new products or designs while leaving factor
productivity unaffected). Consequently, research policy agendas will be subject to social debate
and are likely to be redrawn as the results of research activities are fed back into the decision
process, and political balances shift. Similarly, private industry strategies will have to adapt to
complex and changing market and social conditions.
Several of the drivers identified in Task one interact and, depending on the shape of this interac-
tion, either stimulate or act as a barrier to R&D activity in different industrial sectors. Further a
single demand driver will typically affect several sectors. There is no neat and easy way of map-
ping industrial sectors against technological fields. In addition, many key technologies affect sev-
eral industrial sectors and draw knowledge from different fields of scientific activity. The horizontal
nature of some key cross-cutting technologies tends to be underestimated when using demand-
led criteria for the identification of key R&D fields. In this section all drivers and challenges identi-
fied are on the demand side.
3.2 Climate change, environmental degradation and over-exploitation of

natural resources
Task one identified three major and interrelated global challenges: climate change, environmental
degradation and over-exploitation of natural resources. Underlying them, there is a common con-
cern about the long-term sustainability of current patterns of economic growth. This is not a new
concern: the limits to growth debate of the mid 1970s revolved around concerns that the growth
in resource consumption brought about by rapid economic growth could not be sustained by lim-
ited natural resources. Then, as now, the debate moved towards the potential role of technologi-
cal change to overcome such limits by means of more efficient use of resources.
The current debate differs in the mounting evidence of climate change and its relationship with
specific forms of energy consumption. Climate change could trigger significant environmental

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disasters in the not too distant future, which could compound the scarcity of some natural re-
sources initially prompted by economic growth in specific regions. For instance, water shortages
are likely to become more acute in regions where economic development has been supported by
tourism based on favourable weather conditions, and involving intensive use of water re-
sources.
There are several obvious research themes that are being impelled by these challenges.
Research on the nature, patterns, causes and effects of climate change.

RTD on alternative sources of energy, particularly renewable sources and sources that
do not generate CO2 emissions. This work is not limited only to the development of new
technologies, but also includes the development of policy strategies to support their de-
ployment. Socio-economic, institutional and legal issues play an important role in the dif-
fusion and uptake of new forms of energy.
Energy efficiency and conservation, including RTD into more efficient vehicle engines
(see below), energy saving and conservation technologies for residential and industrial
buildings, etc. Important developments are taking place in the field of bioclimatic architec-
ture for domestic buildings and the diffusion of high efficiency and decentralized renew-
able energy systems. Again, changes in energy consumption patterns involve the use of
new technologies and also establishment of supporting institutional and legal frame-
works. It has been argued that energy options must be supported by appropriate energy
policies favouring the introduction of energy efficient technologies and the provision of
fiscal and economic incentives (OPTI 2001).
New technologies for water treatment and use.
The drivers of technological efforts in these directions are contingent upon political decisions and
are the subject of considerable social debate. For instance, pursuing more efficient air transport
systems will not receive the support of conservationist groups, who see air transport as inherently
wasteful and contributing to emissions of greenhouse gases. The patterns of technological devel-
opment to be followed within the fields mentioned above are contingent upon political decisions.
Similarly some of the stressors on environmental conditions are related to other drivers. For in-
stance, ageing populations in developed, rich countries have increased the demand for second
and retirement homes in regions with better (warmer and drier) weather conditions, thus in-
creasing the demand for air travel and water often in regions already suffering water shortages.
Again, many will argue that this model of development is inherently unsustainable.
Many of the industrial sectors directly affected by the changes discussed here are well developed
in Europe and are areas of relative technological and commercial advantage. The commercial
aircraft industry in Europe has been developed to compete with the US giant, Boeing. The poten-
tial industrial effects of restrictive environmental policies on air travel need to be assessed care-
fully. Aerospace industries tend to be concentrated geographically and any downturn in the indus-
try is likely to have profound regional effects. However, European firms have also developed
strong capabilities in t renewable energy technologies. Industries such as wind turbines are well
developed, and further support for technological development in these fields is likely to place the
industry in a strong international position in an area with clear growth prospects.
3.3 Ageing population and changing health care concerns

Ageing populations are inducing research activities in a variety of directions. It is driving medical
research into the types of diseases that are more common among old people in the rich industri-
alized countries (for instance Alzheimers and Parkinsons disease). It has been pointed out that
the research effort invested in tackling these diseases is much larger than the investment ad-
dressed to fight diseases that are prevalent in poor countries, and are affecting much larger

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populations.25 The effect of an ageing population on medical research priorities is therefore not a
given but the result, again, of public and private policy decisions.
The relationship between medical research priorities and ageing populations is one of mutual in-
fluence. Research priorities are affected by demographic change, but demographic change is, to
some extent, the result of medical progress. For instance experts estimate that scientific ad-
vances in human genetics will increase life expectancy. Not only will the percentage of the popu-
lation aged over 65 increase, but within this group the percentage of over 80s, will also increase.
The increased life expectancy of older people has made projections on the size of older popula-
tions made only 15 years ago, obsolete (House of Lords 2003).
Another area where technological development could respond to the needs of an ageing popula-
tion is the field of technologies and services related to telecare : the monitoring and provision of
health needs at home from remote sites. Demographic trends will lead to an increase in the num-
ber of people with chronic illnesses and mobility constraints, for whom telemedicine applications
could deliver higher quality homecare services. e-Health strategies are being developed (for in-
stance, in the UK) as a response to the problem of an ageing population. The telecare systems
being developed are linked to intelligent home technologies and smart buildings and rely on
the intensive implementation of ICTs for specialized applications. The barriers to the application
of ICTs in telecare application are often of an institutional rather than a technological nature.
Ageing populations have many other impacts. Some of these impacts were reviewed in Section
2.2. and include changes in the nature of entrepreneurship and market demands. As argued
above, the challenge for EU industry is to develop new products and services to match the new
market opportunities that are developing as a result of demographic changes. For instance, there
is an emerging need for new forms of access to educational and commercial demands from older
citizens. Industry must develop and deliver new products to fulfil these needs; as is the case with
telecare, one of the main goals must be remote delivery of new services to populations that may
have reduced mobility.
3.4 Changing diets and healthier food

New daily life habits, developments in the agro-food industries, and changing demographic struc-
tures are having an influence on diet, and generating new health problems and research chal-
lenges. The growing popularity of prepared foods, their higher fat content, and the increasingly
sedentary nature of jobs and leisure pastimes is leading to widespread health problems related to
obesity. There is a demand for healthier foods that are attractive and competitive in the food retail
market. For instance, public agencies are currently promoting the consumption of fruit and vege-
tables. However, many fresh fruits do not travel well , and are expensive to move over long dis-
tances. This is leading to different but interrelated research areas:
The development of new fruit and vegetable varieties

New packaging technologies; including the development and use of more environmen-
tally friendly bio-compatible and bio-degradable materials. Some of these materials have
applications in other fields and their development is based on biotechnology and biomi-
metic processes (CMI International, 2000)
New food transport systems (including transport technologies, and logistics and distribu-
tion systems).
There are also concerns about the growth model that a system based on the global production
and distribution of fresh food entails. The energy costs of transporting fresh produce over long
distances is one of the arguments put forward in favour of the development of food production
and distribution systems based on local production and commercialization.
25
For instance, only about 1% of newly developed drugs are for tropical diseases.

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Food safety is an area of growing concern. There is a demand for better tracking and monitoring
of foods, and for research on the safety of new food products. Tracking and monitoring of food
sources can also be developed as a security technology to fight potential terrorist attacks on the
food chain (for instance the wilful spread of animal diseases). Further, as the European Commis-
sion proposal for the 7th Framework Programme notes.
Research into the safety of food and feed chains, diet related diseases, food choices and
the impact of food and nutrition on health will help to fight food related disorders (e.g.
obesity, allergies) and infectious diseases (e.g. transmissible spongiform encephalopa-
thy, avian-flu), while making important contributions to [ ] policies and regulations in the
area of public, animal and plant health and consumer protection. (Commission of the
European Communities 2005, 9).
This is yet another example of a research area being related to a complex set of diverse
policy objectives.
There is a complex set of interlinked industrial sectors involved in this area: from biotechnology-
based companies developing new seed varieties, to the food and the transport industries. The
food production chain involves very different types of companies with very different industrial dy-
namics. Especially important are the food production and packaging industries, where important
opportunities exist to develop and commercialize new technologies. This is a field that is made up
of both large and small industries, and where there is scope for policies to support new, science-
based companies. It must be noted that areas such as food packaging are seldom considered a
priority for technology policy priority, [and may evolved under the radar of S&T policy makers].
3.5 Increased demand for transport services

Several of the trends identified in Task one and discussed above point to an increased demand
for transport, both for goods and individuals. Increased international mobility emerges as a char-
acteristic of globalised patterns of production and service delivery, and emerging leisure activities
(international tourism, second homes). In addition, the transport sector accounts for some 12% of
all EU jobs and for 17% of EU GNP. However, as discussed above, there is an environmental
cost to increased international travel, and this is triggering debates about the future patterns of
technological development. The industries involved in the production of transport equipment are
being pressed to develop new, more energy-efficient means of transport.
There is a broad set of scientific and technological fields that are involved here, and several fore-
sight initiatives have identified strategic research areas. In land vehicles two parallel trends can
be identified (OPTI 2001):
1. The development of engines less dependent on oil fuels (hybrid vehicles, bio-fuels and
hydrogen);
2. Incremental efficiency improvements in the currently dominant engine technologies.
In aircraft lower fuel burn can be achieved through improvements in:
1. Aerodynamics;
2. Weight reduction through the use of lighter structural materials;
3. More fuel-efficient engines, including new combustion and injection systems.
There is also a need for more efficient use of the existing transport infrastructure. Advanced
forms of traffic management (from air traffic control to road management systems) are receiving
attention to reduce the waste created by air and road traffic congestion. For instance, Air Traffic
Management Systems allow the distance between aircraft to be reduced and would improve the
efficiency of air transport and reduce congestion. These need to be complemented by systems to

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improve airport performance through a range of technologies such as landing aids, and improved
meteorological forecasts (ACARE 2002,21).
Integrated approaches linking all transport modes (inter-modality) have been the focus of EU re-
search policy and are seen as essential for ensuring sustainable and efficient transport systems.
Inter-modal logistics would also reduce excessive dependency in Europe on road freight
(Georghiou, Aho, Cornu et al. 2006,9-10).
These areas are fields where industrial competences exist in Europe, and where t extensive re-
search and technology programmes are underway, at both European and national levels.
3.6 Epidemics and pandemics

Task one identified epidemics and pandemics as one of the health threats driving new research
activities, mainly based on current concerns about a possible flu pandemic resulting from a muta-
tion of the avian flu virus. Growing international travel increases the potential speed and range of
outbreaks of contagious diseases. There is an urgent need for the development and implementa-
tion of early means of detection (requiring advanced diagnostics), monitoring and control sys-
tems.
This is an area where changes in the security environment are also driving research. The spread
of epidemics has been considered as one of the scenarios open to potential bioterrorists. Given
that an attack of this type could occur without warning, and in any location, the monitoring of out-
breaks of diseases has also become a major concern for research.
Another emerging challenge is the spread of new antibiotic-resistant strains of bacteria. These
are posing complex research challenges for pharmaceutical companies and research establish-
ments, and are forcing changes in practices and processes in health care establishments.
These issues combine with other trends in the healthcare system that have been analysed in de-
tail, for instance, in the report on healthcare carried out as part of an Expert Group work on Key
Technologies for Europe (Braun 2005).
The main industrial sector involved in this field is the pharmaceutical industry. Some of the world
leaders in the industry are located in Europe: large multinationals with strong presence in all the
public policy environments relevant to the development of the industry. It is however a highly
regulated industry, where national and European regulations can affect the competitive standing
of local firms. In the development and implementation of new regulations, industrial considera-
tions need to be balanced with other public interest considerations.
3.7 Terrorism and pervasive insecurity

The emergence of new forms of terrorism explicitly designed to cause as many civilian casualties
as possible, as exemplified in the 9/11 attacks, has opened up a new type of security challenge.
One of the problems in this context is that the potential tools to carry out these types of attacks
are very varied, the potential targets are virtually everywhere, and the nature, objectives and tim-
ing of a potential attack are virtually unpredictable. This context leads to pervasive insecurity .
Broad programmes of research are being launched in several countries in a bid to confound
these new threats. Their scope is wide, as befits the vague and undefined nature of the threat.
They cover, among other areas:
Identification and mitigation of infrastructure vulnerabilities (ranging from IT to energy in-

frastructures, underground security, etc.) ;

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The development of regulations and control mechanisms to hamper the potential use of
biological and chemical agents in terrorist actions;
The development of technologies to treat the effects of a chemical, biological or radio-
logical attack (medical treatments, etc.);
The development of technologies to provide early warning of dispersed biological or
chemical attacks (unleashing of contagious diseases, poisoning of water resources, etc.);
The development of technologies to monitor and identify security threats in public places
(airport security, ).
Consequently, pervasive insecurity results in a broad range of research topics with security im-
plications, and emerging policy agendas to set up new regulations to monitor and control activi-
ties, facilities and products across a wide spectrum of activities. The extension of such regula-
tions is likely to affect the conduct of R&D activities and, by reducing access to facilities and in-
formation, may hamper scientific development. It is therefore important to develop appropriate
regulations and institutional arrangements to manage this higher level of supervision over re-
search activities.
An industry is developing around the development of protection systems against the perceived
new threats. Often the firms involved are closely related to defence research establishments and
companies, and face strong competition from US firms whose research and procurement pro-
grammes are much larger than in Europe, making the possibilities for technological development
far greater. There is a European presence in the US market, but it is a market where technology
controls and other restrictions may force companies to segment their operations along national
(or transatlantic) lines. In other words European firms with a strong presence in the US will organ-
ize their presence in the American market through subsidiaries operating as if they were US firms
and with the links with the parent firms limited to ownership structure. It is therefore important to
support the development of European technological capacities in this area. It is a new market
dominated by public sector customers, where procurement practices and regulations need to be
sufficiently flexible to encourage the entry of new firms and stimulate competition.

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IV. Human resources, skills, labour market conditions
4.1 Globalization and technological change employment impact

Increasing globalization and accelerated diffusion of ICTs have reopened the debate on the relation-
ship between technology and employment. The fear is that globalization (see Section III.2 of Task
one report), international outsourcing (see Section IV.3, Ibid.), and new technologies (see Section
III.3, Ibid.) might have weakened - or even eliminated - the positive correlation between growth and
employment, which was undoubtedly one of the main characteristics of the Fordist golden age (see
Noble, 1984; Aronowitz and DiFazio, 1994; Rifkin, 1995; Vivarelli, 2006). In some cases, this fear is
being translated into future scenarios where the end of work is forecast as a possible outcome of
the labour-saving relationship between globalization, technology and employment. On the whole, this
pessimistic literature is characterized by two common features, which can be summarized as follows.
On the one hand, the focus of the analysis is confined to the study of the direct labour-saving effect
of international outsourcing (see Sections IV.I and IV.3 of Task one report) and ICT process innova-
tions, and the empirical evidence discussed is often anecdotal: case-studies where dramatic de-
creases in employment have occurred are proposed as examples of the entire economy and the di-
rect labour-saving impact is proposed as the only consequence of technical change and globalization
(for a critique of this pessimistic approach, see ILO, 1996).
On the other hand, the methodology of the analysis underestimates the indirect effects of export-
led growth and the unpredictable job opportunities offered by new ICT products. From a static
viewpoint, it is very easy to point to the adverse impact of international outsourcing and labour-
saving innovation, but, from a dynamic perspective, all the compensatory effects of process inno-
vation and all the expansive impacts of product innovation and increasing competitiveness have
to be taken into account as well (see Pianta, 1995; Pianta, Evangelista, Perani, 1996). In a nut-
shell, we can point to the following counterbalancing forces that will compensate (at least to a
certain extent) the possible crowding out of European employment.
- The same ICT process innovations that displace workers in the user industries, create new jobs in
the capital sectors where the new machines are produced. In terms of global competition, outsourc-
ing of labour-intensive activities towards the emerging economies can be counterbalanced by an
increasing global demand for capital goods (machinery) produced in the advanced European
economies.
- Increasing global competition in ICT process innovations involves the displacement of workers; but
these innovations themselves lead to a decrease in the unit costs of production and - in a competitive
global market - this effect is translated into decreasing prices; in turn, decreasing prices stimulate a
26
new demand for products and hence additional production and employment.
- In a world where competitive convergence is not instantaneous, it is observed in the hiatus between
the decrease in costs due to technical progress and global outsourcing, and the consequent fall in
prices, extra-profits may be accumulated by innovative entrepreneurs. These profits may be invested
thus creating new activities and new jobs (see Vivarelli, 1995; Pianta, 2004).
-Technical change and global competition are not only accomplished by outsourcing and labour-
saving process innovation; they can result from the creation and commercialization of new products;
26
The compensation mechanism "via decrease in prices" was re-proposed both by neo-classical economists at the beginning
of this century and by modern theorists (for a summary, see Stoneman, 1983 chaps. 11 and 12; for a detailed analysis of the
hypotheses, procedures and conclusions of these models, see Vivarelli, 1995, chaps. 4 and 6; Petit, 1995; Spiezia and
Vivarelli, 2002).

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in this case, new economic branches develop and additional jobs are created (see also Section III.1).
In the current debate, various studies (Freeman, Clark and Soete, 1982; Freeman and Soete, 1987,
1994; Pianta and Vivarelli, 2000) agree that product innovations have a positive impact on employ-
ment since they open the way to the development of either entire new goods or differentiations of
mature goods (see Report Task One Section III.3 for a list of examples of supply of new products
27
from the diffusion of the new technological paradigm).
The challenge described in the last point is particularly important in terms of European competitive-
ness (see Section I.1 of Task One report): indeed, product innovation represents the high road to
international competitiveness as an alternative to cost-cutting process innovation, lower wages and
worsening labour market conditions (see Fagerberg, Guerrieri, Verspagen, 1999; Petit and Soete,
2001)28. From this point of view, the challenge posed by the emerging economies should be
faced not with a rush to the bottom in terms of labour-saving process innovation and cutting
wages, but rather through labour-friendly product innovation both in high-tech sectors and in the
innovative niches of traditional ones.
4.2 Employment and new technologies

Concerns about possible job losses due to globalization and ICT technologies are particularly
vivid within European manufacturing, where outsourcing in favour of the emergent economies
and labour-saving ICT process innovation seems to prevail.
Since the 1980s, it became clear that the compensation mechanism via new products (see the
last paragraph of the previous section) takes the form mainly of a compensation via new ser-
vices (see Report Task One Section III.1.4). Indeed, the ICT revolution has brought the fastest
employment growth rates in services and particularly in the software and information services:
We shall take the example of software employment to illustrate the general problem of assessing
the future potential impact of ICT on employment growth. Employment in software and informa-
tion services was one of the fastest growing categories in all OECD countries in the 1980s
(Freeman and Soete, 1994, p. 60).
However, even in manufacturing, new products developed in the 1980s and the following dec-
ades: home computers and hardware, network infrastructures for new ICT services (optical fibre
and ISDN), video recorders and DVD, mobile phones, etc. Thus, although the mechanism via
new products mainly operates via new services , European manufacturing is not immune to the
positive employment impact triggered by the global diffusion of new products.29
In the meantime, both in manufacturing and services, labour-saving technologies imply decreas-
ing prices and increasing demand, through the same process of globalization and international
competition. On the whole, the net impact of globalization and the diffusion of ICT on employment
depends on the balance between process and product (service) innovation, and on the effective-
ness of different compensation mechanisms via decreasing prices and new investments. Differ-
30
ent European national systems of innovation reveal different overall impacts according to the
sectoral composition of their economies, the different proportion of process and product innova-
tions, and the different effectiveness of the compensation mechanisms discussed above.
In this framework, the competitiveness challenge posed by the globalization of the ICTs and other
advanced technologies calls for a European economic policy able to strengthen the sectors that
are providers of the new technologies (such as telecommunications, biotech sectors, electronics
27
See Dosi (1982, 1988).
28
For a discussion of labour market flexibility and deteriorating labour market conditions as an example of European
short-term responses to globalization and technological change, see Vivarelli (2002).
29
It is also important to take into account the strong interdependence between services and manufacturing (see Section
III.1.4)
30
See Lundvall (1992).

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and nano-technologies and so on) and those that are users31 of the new technologies. Amongst
the latter, advanced services assume a crucial role as a focus for a targeted industrial policy.
4.3 Innovation, globalization and skills: challenges and possible solutions

While international competition, global outsourcing and technological change may have adverse
quantitative effects on European employment (see previous sections), they also have qualitative
32
effects on the composition of the employed. In particular, during the 1990s debate focused on
the so-called skill bias which seems to characterize the present era of globalization and ICT
33
revolution (see Sections IV.3 and IV.4 of Task One Report) . It is suggested that competition from
34
emerging economies, together with new technologies, implies a change in the relative ratio be-
tween skilled and unskilled workers with the demand for labour shifting in favour of the former.
This tendency in the labour market can imply either lower wages for the unskilled (this seems the
tendency in the US and the UK) or higher unemployment rates among the unskilled (this ten-
dency seems to prevail in continental Europe).
Moreover, the skill bias approach is also an interpretation of current trends in income distribution
and can be useful in explaining current forms of social exclusion (see Section II.1.9 and the fol-
lowing section, Ibid.).
From a theoretical point of view, a skill-bias can be represented by an asymmetric movement of

the isoquant towards the origin: this means that the same amount of output can be produced with
fewer workers and that this reduction in labour coefficients is more severe for the unskilled work-
ers (see Cooper and Clark, 1982, p. 108; Vivarelli, 1995 pp. 80-81). When globalization and tech-
nical change involve an increase in the average proportions of skilled and unskilled workers, even
assuming favourable demand conditions is not enough for assuring a return to full employment.
In fact, although increasing demand can potentially counterbalance productivity gains, structural
unemployment can occur as a consequence of the scarcity of skilled labour.35
In principle, there are two possible solutions. The first is to allow a wage adjustment which implies
a drop in the relative wages for unskilled workers; then unskilled labour becomes cheaper and
employers can move along the isoquant and decide to hire a larger proportion of unskilled work-
ers. This is what is currently happening in the US and also to an extent in the UK. However, there
are limits to the effectiveness of this solution. First, a reduction in wages can imply a decrease in
aggregate consumption and thus in effective demand; if this occurs, demand expansion is unable
to compensate for productivity gains from technical change and international outsourcing. Sec-
ond, the reaction of relative demand for labour to wage adjustments will be limited of the technol-
ogy is relatively rigid: if a given production process requires a fixed skilled/unskilled utilization ra-
31
For the role of learning by using in the diffusion of new technologies, see the classical contribution by Von Hippel
(1988).
32
See Section IV.3 and, in particular, figures reported in Table IV.5. in Report Task one.
33
For instance, Berman, Bound and Griliches (1994) found that about one-third of the shift in US manufacturing employ-
ment from production to non production workers can be accounted for by between industry shifts (which are in turn
caused by changes in the relative composition of trade flows in the 1980s); while most of the shift to nonproduction em-
ployment has occurred within the four-digit US manufacturing industries. This important residual can be related to skill
bias labour-saving technological change; in fact, this paper also shows that skill upgrading is positively correlated with
investment in computers and with R&D expenditure. (See also Wood, 1994; Machin, 1996; Machin and Van Reenen,
1998; Adams, 1999; Goux and Maurin, 2000; Caroli and Van Reenen, 2001; Greenan, 2003; Piva, and Vivarelli, 2004).
34
See Wood (1994, 1995).
35
For example, assume that current conditions imply full employment of both skilled and unskilled workers: for instance,
20 skilled workers and 100 unskilled workers are employed in a given economy. Then, a skill bias - due to a combination
of skill-biased technological change and international outsourcing of low-skilled activities - occurs: the same output can
now be produced with 10 skilled workers and 30 unskilled ones (the relative coefficient in the use of labour has increased
from 1/5 to 1/3 because of the skill bias). Now, even if an unlimited demand expansion is assumed (that is sustained eco-
nomic growth, see Section II.1.10), the economic expansion can lead to the full utilization of skilled labour (20) and to
under-utilization of the unskilled (60); as a consequence, 40 unskilled workers are unemployed. In other words, a limited
supply of skilled labour implies unemployment among unskilled workers.

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tio, wage adjustments will not make any difference. Third, unskilled workers may escape from
unemployment, but may be caught in an income trap leading to a working-poor situation.
The second solution is training to transform some of the unskilled workforce into skilled workers.36
Implementation of this solution is open to hindrances. Training may be inadequate or redundant
and in this case workfare only disguises unemployment (for example, as has occurred in some
of the Nordic countries, see Calmfors, 1994 and Lindbeck et al., 1994). Moreover, skill biased
technological change and globalization are fast and continuous phenomena; it is difficult to plan,
update and implement training to keep pace and, training programmes may be insufficient to pre-
vent high rates of unemployment among the unskilled.
Public provision of education and training is also not protected from possible government fail-
ures : for instance, employers skill requirements are often idiosyncratic and public authorities be
informed of them all in detail. Moreover, public training is often affected by bureaucratization, inef-
ficiency and short-term orientation (Booth and Snower, 1996). Hence, authorities should promote
the optimum interaction between public education and training, and the private demand for skills,
in order to maximize economic performance (Keep and Mayhew, 1988). However, in terms of
Porter s theory of national competitiveness (see Section I), the widespread diffusion of the skill
bias as a global trend requires for further investment in education and training as a means to
sustain long-term European competitiveness. Thus, the real policy challenge is to combine in-
creased education and training with the optimum interaction between the public education and
training system and the private demand for skills, in order to maximize the economic performance
and the competitive advantage of Europe (Keep and Mayhew, 1988).
3.4 Skill bias and increasing wage inequality

Overall, both theoretical considerations and empirical evidence suggest that the skill bias
resulting from a combination of technological change and globalization - plays an important role
in determining the level and the internal composition of unemployment. However, the impact of
the skill bias is partially absorbed by higher unemployment and a bigger wage gap between
skilled and unskilled workers.
In a seminal paper, Krueger (1993) focuses on the issue of whether employees who use com-
puters at work earn more as a result of applying their computer skills. This hypothesis is tested
through econometric estimates based on data from the 1984 and 1989 US Current Population
Survey (CPS). The main result is that workers who use computers receive roughly 10-15 percent
higher pay, other things being equal. In addition, because more highly educated workers are
more likely to use computers at work, the estimates imply that the proliferation of computers can
account for between one-third and one-half of the observed increase in the rate of return to edu-
37
cation between 1984 and 1989.
Empirical studies suggest that, at least in the US, the computer revolution has increased the
wage premium for better educated people; and conversely, less well educated workers face a
higher risk of being excluded (unemployment) or trapped in a working-poor situation.
However, recent studies on the impact of ICT upon wage differentials have cast some doubts on
the hypothesis that technical change is the main reason for wider wage differentials. For instance,
using German data, DiNardo and Pischke (1997) found that wage differentials are correlated with
the use of computers and also with the use of telephones, with sedentary occupations, and even
36
In the example in the previous footnote, it would be enough to train 10 unskilled workers to reach full employment (re-
taining the optimistic hypothesis of no demand constraints, 10 newly skilled workers can be combined with the remaining
30 unskilled).
37
In another paper, Dunne and Schmitz (1995) found that the share of production workers in plants using computer-
based equipment is smaller than that in plants without this type of equipment, although this difference is small (4%). In
addition, production workers in ICT plants earn a 14% wage premium compared with workers in more traditional plants.
See also Doms, Dunne and Trotske (1997).

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with the use of pens and pencils. This evidence suggests that the computer wage effect is not
robust to the inclusion of the worker s educational level or skill. In other words, a worker gets a
higher wage and uses a computer because he is more highly skilled and better educated, but
there is not any causal relationship between the use of a computer and wage differential.
Chennells and Van Reenen (1997) used data drawn from the British Workplace Industrial Rela-
tion Surveys (2000 plants) and concluded that simultaneous determination of technology and
earnings leads to the conclusion that higher earnings exert a positive influence on the probability
of introducing technical change, but that technical change per se has little direct influence on the
earnings of manual employees (p. 602).
Finally, Entorf and Kramarz (1997) based on longitudinal French data, found that computer-based
new technologies are used by already better paid, abler workers; yet, these workers appear to
become more productive after the introduction of ICT and so their wage differential increases by
an extra 1% per year.
On the whole, while the skill bias effect seems to be demonstrated in terms of workers displace-
ment, the bias in terms of wage differential seems to be less obvious than earlier studies on the
subject would suggest.
3.5 Innovation, organizational change and human resources manage-

ment
Together with employment, skills and wages another challenge of the current waves of techno-
logical progress and globalization concerns the organization of the workforce at the level of the
firm (see Section IV.4 of Task one report). Indeed, labour-saving and skill-biased innovation on
the one hand and international outsourcing and global competition on the other have been re-
sponsible for the final decline of Fordist production.
In general terms, organizational change is becoming increasingly important, and the significance
of the literature on the subject is increasing. There is a progressive shift from rigid, Taylorist, and
segmented organizations towards more flexible and holistic ones within firms (see Lindbeck and
Snower, 1996).
This phenomenon first appeared in the US and Japan and has since spread through Europe, al-
though with different intensities in different countries (see Aoki, 1986; Greenan and Guellec,
1994; O Connor and Lunati, 1999). Space precludes a thorough review of the vast literature,
which is based on Chandler (1962) and relates to organizational change and its impact on firms
structure and performance. Suffice to say that economic, management and sociological studies
on the subject seem to agree on certain trends:38
1. Decentralization and delayering: lean production is associated with new firm organiza-
tion, such as just-in-time, management of breakdowns and quality control, which in turn
imply both the decentralization of decision making and greater involvement, responsibility
and autonomy at the shopfloor level (see Brynjolfsson and Mendelson, 1993; Greenan,
39
1996; Bresnahan, 1999) .
2. Collective work: new working practices such as work teams and quality circles require a
collective effort from the workforce (see Osterman, 1994).
3. Multi-tasking: workers are required to perform a greater variety of tasks within a given oc-
cupation and to rotate among different jobs (see Greenan and Mairesse, 1999; Ich-
niowski and Shaw, 2003).
38
For a more detailed analysis, see Caroli (2001).
39
See also Brynjolfsson and Hitt (1998, 2000).

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Moreover, the recent literature reports that these organizational changes generally occur con-
comitantly, assuming the form of clusters of organizational innovations. For instance, Ichniowski
et al. (1997), demonstrate the complementarities between the introduction of teamwork, flexible
job assignment and intensive worker-management communication in US steel manufacturing (for
an empirical study using Italian data, see Cristini et al., 2003).
These important transformations call for a combination of reorganisational strategies with inter-
vention regarding HRM at the level of the firm, especially with regard to production workers.40
Indeed, the lack of complementary manpower strategies increases the likelihood of redundancy
among blue-collar workers, who may be particularly exposed to globalization and labour-saving
organizational and technological changes (see previous sections). For instance, according to the
empirical results in Wolff, 1995, motor skills seem to be affected by a long-term absolute decline
(see also Freeman and Soete, 1994).
In terms of HRM, a three angle strategy whereby organization, technology and skills are the
components of the triangle (see Caroli, 2001) may exist. In this framework, blue-collars are not
necessarily victims of an intrinsically labour-saving process of globalization and technological
change; but they are negatively affected by an inefficient mix of these phenomena with an organ-
izational change involving new working practices. If this is the case, HRM and education policies
may decisively mitigate the impact of globalization and technological change upon the most vul-
nerable workers.
Of course, a HRM strategy able to combine innovation, organizational change and skill-upgrading
will not only preserve European employment, but also be a pre-condition for greater European
competitiveness on the input side (see Section I.1), that is, it will to provide the European econ-
omy with the necessary resources to cope with globalization and increasing international compe-
tition.
40
See Section III.1.5

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V. Localization of economic activities
5.1 Introduction
Following the rise of the export oriented mode of industrial development, the attraction, retention
and off-shoring of economic activities has been on the policy agendas of national and regional
governments (Driscoll and Berhman, 1984; Gonzalez-Arechiga, 1990). In developing nations, this
export oriented industrialization model has become a substitute for the import substitution
model that prevailed in the period 1940-1980. In the industrialized nations this wave of interna-
tional subcontracting was known as liberalisation and deregulation of economic activities (Boyer
and Saillard, 2002). Pioneers of this push towards globalization were the Reagan and Thatcher
administrations in the US and the UK respectively. Studies on the factors that affected the reten-
tion and attraction of economic activities boomed in the eighties alongside the great waves of
global industrial restructuring via international subcontracting (Koido, 2000; Driscoll and Berh-
man, 1984).
In the early days international subcontracting of business operations, primarily in manufacturing,

was limited to the simpler processes involved in manufacturing activities. In these subcontracting
operations all the inputs required for production were sent to a cost centre and semi-finished or
final goods were returned to the originating firm. Minimal local input apart from cheap labour -
was added by the subcontractor. Today, this phenomenon is referred to as off-shoring (Bronfen-
brenner and Luce, 2004). Off-shoring involves both white and blue collar workers, and encom-
passes R&D, design of product and service marketing strategies and sophisticated medical inter-
ventions. Whole business operations in industry and services can be broken down into discrete
parts and distributed across the globe to where the best value can be achieved (La Londe, 2006).
The beginning of the process of international subcontracting and large waves of foreign direct
investments (FDI) can be traced back to the early sixties when two export platforms were estab-
lished in Taiwan and Northern Mexico (Gassert, 1984; Gonzalez-Arechiga and Barajas, 1989).
These were the first modern experiments in the international relocation of industrial activities.
Then, and now, the location of economic activities is determined by the perspective of the recipi-
41
ent (FDI) or donor (off-shoring) and are the same. The determinants of FDI and off-shoring
identified in the literature are: cost and availability of educated and skilled labour, degree of la-
bour unionization (deregulation of labour markets), fiscal incentives (tax exemptions), infrastruc-
ture, regulation enforcement (health, safety, environment), ease of setting up and closing down
business, social and government stability (Bernard et al., 2006; Faust, et al., 2004; Pennings and
Sleuwagen, 2000; Boyer and Saillard, 2002; Koido, 2000; Driscoll and Berhman, 1984). More
recently, attractiveness and level of internal market consumption is becoming important.
The logic behind the effect of these factors on retention (or attraction) of economic activities that
a nation will be more likely to retain and attract new economic activities in relative terms versus
its competitors if:
The cost of labour is lower;
The availability of educated and skilled labour is high;
The degree of labour unionization is low;
The deregulation of labour markets is high;
41
This topic is complemented in Section VII Attractiveness for FDI.

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The availability of critical raw materials is high and low cost and supplies are adequate
(e.g. oil, gas, water, minerals, etc.);
Fiscal incentives (tax exemptions) are high;
National infrastructures are available in the host country;
Lax enforcement of regulations (health, safety and environment);
It is not problematic to open and close down businesses;
There is social and government stability;
The nation s internal market consumption is strong;
National future markets spurred via innovation and regulation are very promising.
A nation is likely to lose its capacity to attract and retain economic activities if the factors outlined
are not present.
Although these factors are all important, the most significant seems to be low cost labour. A re-
cent study conducted in the US (Bernard et al., 2006) showed that
across industries plant survival and growth are disproportionately lower in industries with
higher exposure to imports from low-wage countries. Within industries, the higher the ex-
posure to low-wage countries, the bigger is the relative performance difference between
capital-intensive plants and labor-intensive plants in terms of survival and growth. Finally,
firms facing higher shares of imports from low-wage countries are more likely to switch
industries. When plants do switch, they jump towards industries that are on average less
exposed to low-wage countries and are more capital- and skill-intensive.
The conclusion of this study clearly indicates that R&D and innovation are important for
creating and sustaining knowledge intensive industries.
There is much to be gained by firms from off-shoring economic activities. In manufacturing and
services, cost reductions can amount to 50%. This allows firms to become more competitive, in-
creases profits and reduces prices. Firms are able to invest more in improving current products
and services and introducing innovations to create new jobs to replace those lost by the off-
shoring activity. This sounds desirable and logical but has no firm foundations.
When contrasting the factors affecting the attraction and retention of economic activities with the
global trends identified in Task one report, six factors were found to have direct relevance for the
42
location of economic activities. In order of appearance in the Task one Report these trends are:
population ageing, energy costs, mobility, environment, knowledge infrastructures and emerging
economies. The implications of these factors for the competitiveness of European industry are
described below.
5.2 Population ageing in Europe
The current trend in European industry and services towards off-shoring, is likely to continue if
EU labour markets do not become more flexible. The ageing of population presents special chal-
lenges in this respect.
42
Globalisation is not included here; the relation between the local and global in economic activities is at the core of
globalisation.

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In Europe the population pyramid is pro-
jected to start a sharp inversion after 2010;
by 2030 60 percent of the total population
will be aged over 60. RTD-info (2006) fore-
casts that in 2009 the downward and up-
ward curves representing, respectively the
older and younger working groups, will in-
tersect. It is expected that by 2050 there
will be 66 million workers aged 55-64 and
48 million aged 15-24. This trend is directly
Figure 7 Youngest (15-24) vs. oldest (55-64) related to the location of current and future
working age groups (EU 25: 1995-2030) economic activities. From the supply side
Source: EU Commission RTD info-49 perspective, as mentioned above, one of
the main factors affecting location of eco-
nomic activities is the cost and flexibility of labour. With fewer younger workers, who by definition
are more flexible and cheaper to employ than seniors the current conditions for attracting and
retaining business will be much more difficult. In addition:
Past trends of early retirement to improve employment figures or forced by business to
more senior workers when these become too expensive. Traditionally this problem of la-
bour cost has been shifted to the state, as the state would traditionally pay most part of
the pension and long health care. Industry must learn to operate with a workforce that is
in average less flexible and more expensive.
Increased life expectancy will have an effect on the cost of pensions, health care and
long term care. The amounts needed to cover pension payments will start to encroach on
resources needed in other areas of social policy, such as support for young parents in
order to increase birth rates.
There will be a risk of pension schemes being bankrupt as the numbers of tax payers
contributing to them is reduced as a result of the reduction in absolute numbers of work-
ers.
Immigration of young and highly specialized labour has been a short term solution for
some firms. Once immigrants become integrated within the host nation, their demo-
graphic pattern tends to mirror that of their adopted country.
The EU is depending on innovation to sustain new business. This implies some major challenges
for labour, and industrial policy. First, Europe must be able to compete for new markets with new
innovative products and services; Second, government intervention must create the appropriate
market and regulatory conditions to enable technology diffusion; Third, the labour force must be
flexible, allowing rapid and cost effective retraining of workers and the unemployed, enabling
them to be reallocated to new positions (created by the innovations). As the average age of
workers is forecast to rise from 2010, this implies an urgent need to improve the employability of
senior workers.
5.3 Energy
Oil prices rose to over $US70 dollars in the second quarter of 2006. The high cost of energy has
traditionally had a negative effect on industrial activities. It will have a negative impact in tradi-
tional energy intensive industries, e.g. pulp and paper, iron and steel, refineries, cement and con-
struction, transportation, etc.. So far the higher energy prices have not seriously affected the EU
economy in a major way. Given that access to basic inputs is a deciding factor in locating industry
activities, appropriate and effective energy policies will become very important to encourage
competition.

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5.4 Mobility and trade
The current trends in off-shoring of economic activities are enabled by a synergy between cheap
transportation and the application of IT. Currently there is a boom in both maritime and air trans-
port and mass smart micro parcelling via air and motorways. This latter method is supporting e-
commerce for companies such as e-bay and amazon, etc. The current trend towards off-shoring,
and its associated styles of production and consumption, can be sustained in the long run if en-
ergy prices remain relatively low, or if radical innovations in transportation technologies emerge.
The current concepts and scientific paradigms underlying transport technologies have prevailed
for over 200 years. The challenge for EU governments and industry is to underpin new (or old)
transportation science and its application in to exploitable products and services.
5.5 Off-shoring, trade and environment43
The relocation of economic activities and the associated environmental issues have occupied
scholars and policy-makers on trade and environment for more than 35 years. International con-
ventions (UNEP, UNFCCC, Kyoto Protocol, Basel, etc.) and a great deal of regulation have re-
sulted. The problems related to trade, the environment and competitiveness if economic activities
continue in Europe are complex, but can be summarized as:
Effects of freight transport on the environment;44
Need for enforcement of regulatory schemes that limit the environmental impacts of eco-
nomic activities in Europe;
Capacity of European industry and governments to promote innovation (R&D and diffu-
sion) in products and processes and cleaner technologies.
The effect of environmental regulation on the competitiveness of firms, sectors and countries has
been under debate for several years (for a review see Montalvo, 2002). The evidence from em-
pirical studies is not conclusive. Some authors are convinced of the negative impacts, while oth-
ers see no or even positive. Nevertheless, sectors that are energy intensive or are using less
resource efficient technologies that do not meet local environmental standards, are increasingly
adopting off-shoring. As environmental standards become more stringent in the west, it is inevita-
ble that industry seek out regions where regulation of all kinds (including safety and health) is
more lax).
In the literature on the environment and innovation it is frequently argued that environmentally
oriented innovations can spur business opportunities and create new markets while enabling sus-
tainability by increasing efficiency of resources. The rationale is that the current technological
stock presents fundamental anomalies in relation to the preservation of the first and second law
of thermodynamics. If this is the case then the renewal of the current technological stock provides
the opportunity to create a massive economic multiplier through innovation. Those countries that
take the lead may benefit from the creation of new markets. Currently Japan and the US (despite
the rhetoric of the Bush administration in the US) are investing more than Europe in R&D into
environmental technologies.45 The challenge for EU industry is to tap into these new inventions
43
The challenges posed by climate change, materials usage, waste and sustainability are included here.
44
Transportation (excluding air transport) accounts for 23% of the total green house gas production . This was briefly
touched on in the previous point.
45
The report of the Manvis (2005) project, presents a positive image of current European competitiveness in environ-
mental technologies. According to this report the US is seen as very innovative in consumer products, Japan is perceived
as very innovative in organizational and production technologies (lean production and logistics) and the EU has very
strong credentials and tradition in the environmental technologies sector. Whether this will change in the future is not
known. The fact that Europe is the first country in the world to have launched an Environmental Technologies Action Plan
(see COM 2004) is an encouraging sign.

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and to scale up in order to compete with current technologies (process and product). The role of
the EU will be to create an institutional setting that will encourage innovation.46
5.6 Knowledge infrastructures and innovation science
One of the trends identified in Task one is the increased role of governments in devising schemes
to support the production of science, technology and innovation (STI). One of the first conditions
necessary to attract and retain economic activities is the presence of a highly educated and
skilled labour force. Some of the most attractive regions for off-shoring have invested heavily in
higher education, training of scientists and technicians, and service provision.
The most recent innovation literature indicates that governments and firms have recognized the
new model of innovation. In the past, innovation was considered to be the result of scientific and
technological activities. Acknowledgement that innovation and change are economic multipliers,
means that professionals are managing innovation. Those countries best suited to managing and
exploiting innovation will be more likely to attract national and foreign investment. The challenge
for industry and the EU is to tap into the knowledge available and implement knowledge and insti-
tutional infrastructures that will enable innovation science to be optimized and exploited.
5.7 Emerging economies
Emerging economies are a special case and a major challenge for EU industry. In general,
economies such as China, India, Mexico, Brazil, etc., present serious competition. These coun-
tries generally encompass all the conditions listed in section 5.1 in this chapter, such as low cost
labour, poor regulation, etc. Competition from these countries is predominantly in less knowledge
and capital intensive sectors. With the new move towards smart off-shoring there is a conviction
that many white collar jobs will be lost to foreign locations. It is also argued that only parts of the
R&D innovation process will be outsourced allowing a greater focus on new areas of innovation
that could become profitable.
46
The first steps have been taken with the process to establish a new Programme Framework on Competitiveness and
Innovation (COM 2005). This Framework Programme puts strong emphasis on the role of eco-innovations to increase and
sustain competitiveness in the long term.

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VI. Investment attractiveness
6.1 Introduction
This section examines the role of foreign investment and the conditions that are conducive to the
attraction and retention of investment. Task one reported on factors that will shape the market
over the next 15 years, highlighting the roles of demand and supply, whose integration is largely
a result of economic and social factors, and institutions. The economic, social and institutional
environment largely dictates the inflow and outflow of foreign investment.
For the purposes of this report, investment will be analysed in terms of inward foreign investment
through capital inflows (including the establishment of subsidiaries, R&D facilities and joint ven-
tures (JV)), managerial and technical assistance, and technology transfer (TT), commercial and
marketing know-how. The composition of foreign investment, which the host country may benefit
from, depends in large part on its economic, social and institutional environment. Furthermore,
given an increasing worldwide trend towards liberalization, location choices for foreign investors
are increasing. Social, economic and institutional environments influence choices. (See the dis-
cussion of this issue in the sub-section on Decentralization in the Sections on India and China in
the Task one report.) Hence, a review of foreign investment will highlight the important local
drivers for foreign investment.
A better understanding of these factors and how they interact, will help in the formulation of effec-
tive strategies to attract investment; and show how investment policies in countries with similar
characteristics differ resulting in some countries being less attractive to foreign investment than
others. Foreign investment is sought to help economies grow and develop. The effects of foreign
investment will be reflected in consumption patterns and the existence of more sophisticated
consumers in the host country, and in the ability of host countries to develop and increase their
innovative capacity, improve their citizens quality of life, sustain economic growth, spur competi-
tiveness, and increase skills and knowledge.
Task one identified the acquisition of these benefits as global challenges. Foreign investment
could ameliorate some of the social disparities between the ten new Member States and the EU-
15. According to Goldman Sachs, by 2050, the non-Western G-20 major emerging market
economies from the developing world may account for 70 percent of total GDP from all the G-20
economies, compared to 17 percent in .47 This growth will be largely attributable to foreign in-
vestment (UNCTAD 2003, OECD 2005).
Most countries actively seek foreign investment in a bid to reap the favourable effects on income
generation from the inflow of capital, advanced technology, management skills, and marketing
and technical know-how. Foreign investment is not confined to manufacturing activities; it can
benefit services and resource-based industry, for example, it can be in the form of organizational
and managerial expertise. The OECD Initiative on Investment for Development 2003, for in-
stance, is am example of developed countries providing support for developing countries efforts
to attract more and better investment (OECD 2005). This Initiative is part of a continuing effort
designed to achieve the Millennium Development Goals (MDG), announced at the 2002 United
Nations Monterrey Consensus. An important component of the MDG is to help mobilize private
investment, both domestic and foreign, to achieve major development objectives.
It is also becoming increasingly evident that countries seeking such investment are better in-
formed about the importance of the right conditions to lure investors. However, this awareness is
not always translated into practice, sometimes because of political-socio-economic constraints or
rigid bureaucracy. It is not sufficient to put in place legislation and to wait for foreign investment to
flow in. These issues are the basis of the OECD Initiative s (see above) central project for the
Development of a Policy Framework for Investment, which includes a checklist of nine fundamen-
tal policy building blocks (see below).
47
See Global Shifts in Economic Power in the First Deliverable.

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The competition for international investment has increased as more countries undertake market-
based reforms. For example, China, and to a smaller extent India, have attracted foreign invest-
ment in the last few years, in the former case at quite spectacular levels. Although China is the
recipient of the most foreign investment to date, the proportion it receives from OECD countries is
small relative to its size. Thus, host countries must continue to be proactive in competing for for-
eign investment.
In this context it is interesting that Belgium received three times more foreign investment in 2003
than in 2002 ($US 31,345.5 m. against $US13,083 m.) (OECD 2004). Ireland received 10 times
more in investment in 2003 than it received in 1997 ($US 2,709.6m. against $US 25,463.2 m.)
(OECD 2004). Ireland ranked highest among the OECD countries for inward foreign investment
in the late 1990s (Nicoletti et al. 2003). Belgium s attractiveness can in part be attributed to the
European Commission s location in Brussels; foreign companies see being at the heart of Europe
beneficial for a number of reasons.48 Ireland s remarkable growth is attributable to new policies
that shaped its economic, social and institutional environment to be open to foreign investors and
enabling for business.49
Table 23 below presents global trends in FDI,50 highlighting the increase of foreign investment in
China, Hong Kong (part of China) and the Russian Federation. India captures much less than
China of the stock of foreign investment as pointed out in the Task One report, Section on India,
which highlighted that India should develop policies and regulatory changes that will attract in-
vestment.
Table 23. Global Trends in FDI

Country/Region % of FDI Inflows Annual Average 1985- % of FDI Inflows 2004
1995
U.S. 24.18 14.80
Brazil 0.96 2.80
Mexico 2.48 2.56
EU-15 35.20 16.00
Russian Federation 0.70 1.80
Japan 0.35 1.20
China 6.42 9.35
Hong Kong 2.24 5.25
India 0.25 0.82
Source: UNCTAD, World Investment Report, 2005; adapted from First Deliverable.
6.1.1 Determinants of investment

The determinants of investment can be categorized as pull factors and push factors (UNCTAD
1997, 2003). The pull factors relate to the economic and social environment (also referred to as
natural endowments ), the institutional structures and practices of the host country, and policies.
The push factors are dependent on the foreign investor s objectives: to take advantage of cheap
labour, or cheaper and better skilled labour than in the home country; or to take advantage of
technological developments in the host country.
48
It is beyond the scope of this report to discuss in detail the reasons for Belgium s attractiveness as a foreign investment
destination.
49
It is beyond the scope of this report to provide an in depth review of the factors that have contributed to Ireland s
growth.
50
The marked decrease in the US and the EU in 2004 reflects the decline that started in 2002 when there was overall
slow economic growth, which was reflected in falling stock market valuations, lower corporate profitability, slowdown in
corporate restructuring and near collapse of merger and acquisition activity, a main mode of foreign investment. FDI in-
flows declined in 16 of the 26 developed countries. Australia, Germany, Finland and Japan maintained higher foreign
investment inflows in 2002. See UNCTAD (2003). Global FDI began to grow again in 2004, with developing regions lead-
ing this recovery and inflows to developed countries continuing to decline. See UNCTAD (2005).

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6.2 Pull factors: Social and economic environment
The accumulation of economic and social policies and conditions in a host country is referred to
as the country s natural endowment (UNCTAD 1997). For the purposes of this report, natural en-
dowments include market size, rate of growth and dynamics (composition of the labour market,
business activity, innovation, consumption volume and patterns, demand for new and varied
product and service offerings, etc) and the existence of a skilled and/or cheap labour force in the
host market.
Natural endowments also include the physical infrastructure (for example, good road network and
reliable transportation facilities, communication networks, energy supply, and health care and
hospital services, etc.), accessibility and location of natural resources. The high price of com-
modities is a major factor in the influx of foreign investment in 2004 to developing countries rich in
minerals, oil and other natural resources (UNCTAD 2005).
Many examples of economic and social factors were discussed in the Task one report and thus
do not need to be re-rehearsed here. We can summarize by saying that social and economic
policies to improve literacy rates and educational standards, to produce and use new knowledge
(human resource development), to produce labour market -based reforms, provide tax incentives,
and incentives for innovation, to stimulate R&D investment and sustainable development, will all
contribute towards the establishment of a buoyant economy.
Labour market factors are likely to be significant for EU industry because of the diversity of labour
practices and the increasing mobility of its labour force. Also, policies and institutions that affect
the functioning of the labour market, can directly or indirectly impinge on foreign investment
transactions. Employment protection legislation, collective bargaining mechanisms and labour
income taxation are clearly driven by policy objectives. Research has shown that these aspects
of the labour market can have a negative effect on foreign investment decisions because they
may increase the cost of labour and influence the flexibility of the labour market (Nicolleti 2003).
Labour market arrangements are a significant factor in English speaking countries, Japan and
Portugal, but are less important for attracting foreign investment in other countries of Europe that
have less adaptable labour market legislation and whose practices may not be so attractive to
foreign investors.
The Task one report analysed the importance of economic and social policies and development
measures by reviewing the actions undertaken by India and China both to develop their econo-
mies and to attract foreign investment. While the existence of natural resources may not be within
the control of governments, policy makers are able to set in place measures that will enable ex-
ploitation of those that do exist.
However, the size and buoyancy of a market, the availability of cheap labour and an adequate
infrastructure are no longer enough attract inward investment. This is largely because of the in-
creasing competition for investment in a widely liberalizing world. Thus, institutional structures
and practices, and policies have an important role to play, as was extensively discussed in the
Task one report (and see below).
In light of the importance of the social and economic context for attracting foreign investment, it is
clear that Europe should develop policies that focus on improving the educational and skills base
(particularly in the case of the new member states) to enable them to undertake more local R&D
and innovation activities. A better educated and more highly skilled human resource base will be
attractive to potential investors. Proficiency in English, (recall the policies in some Indian states to
improve the standard of English in a bid to attract foreign investment) the widely accepted inter-
national language for commerce and business, should be a central element of the education cur-
riculum.
Market-based reform and labour market conditions will be important for Europe. The new Mem-
ber States will need to transform their previous employment practices to create an environment
that supports productivity, enables good performance and high quality output.

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6.3 Pull factors: Institutional structures, practices and policies
The purpose of this section is to emphasize the importance of institutional structures, practices
and policies for creating an investment promoting environment, which, experts argue, is central
to attracting the community of international investors (UNCTAD 1997, 2001, 2003; 2005, OECD
2005). The nine building blocks suggested by the OECD Initiative identify the policy issues inher-
ent in institutional structures, practices, and policies. These building blocks are investment policy,
investment promotion and facilitation, trade, tax and competition policy, corporate governance,
and general public governance, and human resource development (OECD 2005).
6.3.1 Institutional structures and practices

An investment promoting environment has many components. Of central importance are regula-
tions that do not curb competition; anti-competitive policies reduce the attractiveness for interna-
tional investors. In work conducted by the OECD, regulations feature prominently in terms of
amount of foreign investment (Nicoletti et. al 2003). Nicoletti et al. also found that countries that
initially enjoyed significant FDI suffered a decline as its regulations became more restrictive.
OECD research also shows that most European countries and the US regard openness (minimal
tariff and non-tariff barriers) in a potential host country as positively influencing investment deci-
sions, whereas restrictive border measures, such as are in place in Canada, Australia and to a
certain extent Japan, have depressed the flow of inward investment(Nicoletti 2003, p. 60).
A positive image is also important (UNCTAD 1997, 2001, 2003). This includes convincing the
investor community that the country will provide an attractive environment for business opera-
tions. The foundations on which image is built include institutions and their associated structures
and practices; the existence of the rule of law, an effective judiciary, political stability and good
governance.
According to UNCTAD, investment promotion agencies (IPA) are strategic structures designed to
promote investment. This is mainly because IPAs are concerned with projecting a positive image
through various channels, including the media, brochures, the press, trade fairs and trade mis-
sions, personnel targeting particular regions and industries and making personal contacts with
private firms, preparation of CDs and DVDs that demonstrate the readiness and openness of a
host country to foreign investment (UNCTAD 1997).
A good investment promotion regime involves institutional structures and practices that are wel-
coming to foreign and local investors. This gives investors confidence in the system; they do not
feel at risk from actions on the part of the host country, such as expropriation of investment as-
sets or misappropriation of IP. In other words, an investment regime needs to be predictable
(that is, stable and not subject to sudden changes and fluctuations in policy and practice), to be
business-enabling, and to be transparent in relation to issuance of the necessary permits and
licences. These structures and procedures will convince investors that they their investments will
be secure.
Investment facilitation activities are equally important. These include the provision of services for
prospective investors in order to facilitate start-up and to ensure that foreign investors continue .
These services could include a dedicated agency to deal with investment approvals, government
contacts, support for site visits, customs clearance, and referrals to local businesses that provide
legal and recruitment services. In Europe, transition economies such as Poland, the Czech Re-
public, Romania and Bulgaria have recently set up such facilities in a bid to attract foreign in-
vestment. Some European regions have launched an aggressive investment promotion and facili-
tation effort, for instance Catalonia through the agency CIDEM, to entice multinationals to their
region. Facilitation services help to translate investors interests into actual investments and thus
the structure that enables and provides these services is vital for ensuring investor interest and
satisfaction.
Political stability is very important to encourage foreign investment. This is particularly important
in countries once considered to be hostile to foreign investment. Political stability needs to be as-
sociated with a government that clearly supports foreign investment at all levels central, re-
gional and local. (See discussion on this issue in the Section on India.)

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Central to political stability is macroeconomic stability. For instance, China maintains restrictions
on currency convertibility that do not conform to the policies of most developed countries. How-
ever, foreign investors are confident that China does not intend to change its policy in the imme-
diate future, which endows a predictability in the investment regime in China. China allows con-
vertibility for transactions that relate to international trade in goods and for transactions that relate
to the repatriation of profits derived from foreign investments. Savers, however, are not allowed to
purchase financial assets denominated in foreign currencies, for example, Japanese shares or
US Treasury bills. Thus, China s restricted currency convertibility prevents foreign and Chinese
speculators from currency trading, which could expose the country to a potential currency col-
lapse and capital flight. This form of macroeconomic stability has not adversely affected China s
ability to attract foreign investment, as already noted in the Task one Report.51 India operates a
similar policy of restricted currency convertibility.
The importance of creating an investment friendly environment cannot be underestimated and
this is underpinned by political stability.
Europe needs to be alerted to these issues. In addition, several other measures need to be con-
sidered, such as the introduction of business-enabling measures including the removal of inap-
propriate tariff barriers, the introduction of transparent approval process for the issuance of per-
mits and licences and the avoidance of cumbersome bureaucratic procedures.
6.3.2 Policies and regulations

Policies and regulations are a principal aspect of institutional practices and structures. For exam-
ple, regulations for IPR enforcement are a direct outcome of the institutional environment. Rigor-
ous enforcement of IPR will not be possible if there is no history of such enforcement in the host
country or if there is no willingness on the part of the authorities to institute policies and practices
to uphold it. The integral role of policies in institutional structures can be seen in policies related
to administrative procedures for the repatriation of profits, dealing with expatriate personnel and
immigration matters, dividends and capital, etc. In other words, a host country s institutional envi-
ronment needs to be conducive to policy implementation and, if necessary, reform for it to be an
attractive destination for foreign investment.
In the war on terrorism, security features significantly. The plethora of legislation and policies that
are being adopted by many countries to safeguard homeland security is testimony to its para-
mount importance and institutional structures, practices and policies are fundamental. Security
has now become a factor that must be included in investment calculations; investors will not be
willing to invest in countries where their investment (including personnel) might be vulnerable to
terrorist activity.
Thus, pull factors for investment are provision of a risk-free, predictable and receptive social,
economic and institutional environment. It importantly to tempt foreign investors to make direct
investments rather to invest in the form of trade or licensing of technology and contracting out
management and marketing know-how (UNCTAD 2003).
51
The reasons for China s adoption of full currency convertibility are beyond the scope of this report. The example of re-
stricted currency convertibility used here merely serves to illustrate the importance of a stable and predictable macroeco-
nomic structure.

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52
Table illustrates the marked trend towards regulatory changes to attract foreign investment.
Table 24. National Regulatory Changes, 2000-2005
Item 2000 2001 2002 2003 2004
# of countries that introduced changes in their investment 69 71 70 82 102
regimes
# of regulatory changes, of which 150 208 248 244 271
More favourable to FDIa 147 194 236 220 235
Less favourable to FDIb 3 14 12 24 36
Source: UNCTAD, World Investment Report 2005, Overview, p. 9.
a
Includes liberalizing changes or changes aimed at strengthening market functioning, as well as increased incentives.
b
Includes changes aimed at increasing control, as well as reducing incentives.
The introduction of business-friendly policies and practices is a necessary but not sufficient condi-
tion to attract foreign investment; it is their enforcement that is paramount for investment promo-
tion. Ineffective or complex legislation and procedures that are difficult or impossible to enforce
will have a negative effect. Potential investors need to be assured that they can operate in a risk-
free, stable and predictable environment where the rule of law applies. Europe needs to ensure
that such an environment is pervasive across member states, where the property, whether intel-
lectual or physical (intangible and tangible) will be safe from misappropriation or destruction.
Europe needs to project an image of a region where investment will benefit foreign investors.
6.4 The push factors: policies of the investing country

Pus factors are as important as pull factors in determining foreign investment. The policies pur-
sued by the investing country are important. As most capital-surplus countries no longer impose
capital export controls and many promote outward foreign investment, their policies are acting as
a catalyst for foreign investment.
Transnational (or multinational) corporations are vigorous and aggressive in seeking out invest-
ment opportunities abroad in order to maintain their competitive edge, secure global markets,
gain access to new technologies and knowledge (see open innovation and networks in the Task
One report), cut costs (as evidenced in the increasing role of outsourcing in a variety of sectors),
and produce healthier returns in the form of dividends and profits to their shareholders.53
Cultural affinity is important in choosing a destination for investment. This is evident in the foreign
investment flows within the Asian region (for instance between Japan and China and among the
South East Asian countries, such as Singapore and Malaysia) and from the UK to the US. Asso-
ciated with this are the relations between the donor and receiving countries. Good relations are a
positive influence.. However, in the case of Canada and the US, which have been involved in fre-
quent trade disputes over the last 50 years or more this has not affected their rates of investment.
Both countries have engaged reciprocal foreign investment. Geographical proximity is an impor-
tant contributory and strategic factor in investors decision-making. Geographical proximity ex-
plains many patterns of inward foreign investment. Most European countries have received for-
eign investment from EU countries; Canada, Mexico and Ireland54 receive investment from the
US; and Asia-Pacific countries from Japan and the US (Nicoletti et al. 2003).
Furthermore, in choosing a destination, an investing corporation will prefer to locate its activities
close to a reliable supplier network Despite the widespread use of ICTs for a wide array of busi-
52
The changes that were less favourable to foreign investment occurred in some Latin American and African countries,
particularly in the area of natural resources.
53
Of course, as noted above, in an economic downturn, their foreign investment activities may decline, but this would not
curtail their constant search for competitive advantage and global markets.
54
This is partly explained by the historical ties between Ireland and the US Irish immigrants once formed a significant
proportion of the US population and ties continue to be remarkably strong between the two countries.

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ness activities, an extensive local supplier base (availability of raw materials, design and engi-
neering services, maintenance and repair of machines, etc.) is a key consideration for an inves-
tor. ICT complements, but cannot substitute for, a readily accessible supplier base. Furthermore,
as argued in the First Deliverable, proximity to other company activities is a factor in the decision
of companies to invest in R&D in a certain location as this may enable access to specialized R&D
55
knowledge (knowledge spillovers).
For reasons of proximity, the EU-15 may want to investigate the potential of the new Member
States. Proximity helps to reduce the costs of outsourcing and enables access to the supplier
base. The EU-15 could help the new Member States to formulate and implement investment
friendly and economic policies.
VII. Summary
The aim of task two of this study was to analyse the implications of the global trends identified in
Task 1 for the European industry in particular in relation to its competitiveness. The latter in par-
ticular to macro economic implications; structural and organizational changes in industrial activi-
ties; scale and sectoral composition; research, technological development and related require-
ments; human resources, skills, labour market conditions; localization of economic activities, in-
frastructure; and framing conditions for investment attractiveness. The exploration of these
themes required first to define what we understood by competitiveness and to find a focus in the
competitive process. Given the prospective nature of the study we focused on the front end of the
competitive process, thus, we saw the themes as inputs for preparedness for competition in the
future. Furthermore because of methodological rigour there was the need to define the bounda-
ries of the themes just mentioned above. That is to say, what was supposed to be affected by the
global trends identified? Most likely the study at the level of generality assumed carries some in-
consistencies and has left or underscored some important drivers, challenges and implications if
we regard the potential nth-reader of this report. Despite the limitations of the report some clear
implications were identified and we make an attempt to generalize and summarize it all below.
Regarding the structure, organization and sectoral composition of industrial activities in Europe
few global trends were considered with immediate relevance. These were: in the demand side
the aging of population; in the supply side globalization, the entrepreneurial economy, the service
economy, the open innovation, new technologies and new inventions; and in the institutional side
IPRs, and organizational change. The implications of these global drivers and challenges for EU
competitiveness were considered against three indicators: industry structure, industry dynamic
and sectoral distribution. The main implications found follow:
In the demand side, the massive growth of retired people expected already by 2010 especially
early retirees could be seen as the potential next generation of entrepreneurs . It is known that
individuals who become entrepreneurs late in their life after leaving their occupation have charac-
teristics that differ from other normal entrepreneurs . They tend to be less risk adverse. They
bring the experience accumulated in their previous job into the new firms and thus contribute to
build valuable resources and capabilities for the new organization. Further opportunities arise
with the creation of new markets (and social costs) related to care and long term health. The
challenge for the EU industry is to match new market opportunities originating in the changing
nature of market demands, new supply of entrepreneurial skills and human capital, with new
business propositions, products and services.
In the supply side, there are divergent implications of globalization for the EU industry. Interna-
tional trade can potentially enhance the competitive position of established firms if they manage
to exploit scale economies in larger markets and larger supply chains. By increasing variety in
demand, globalization creates new market niches that are to there to be occupied by entrepre-
neurial firms. However, increased competition from emerging countries may lower the chances of
55
See Section VI.4 on Globalization in the First Deliverable.

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survival of new and small firms that do not count with the necessary resources and institutional
support to scale up and take opportunities at the global level.
Closely related to the potential advent of a new wave of entrepreneurs mentioned above, there is
the acknowledgement of the need to promote entrepreneurial activities in Europe as this is com-
monly regarded as a source of competitiveness and economic growth. The challenge for gov-
ernment is to design public policies that reduce structural barriers to entry and the liabilities of
new firms in the stage of formation. The role for the industry is to create a favourable ground for
the creation of new firms, for example through the venturing activities of established firms (e.g.
joint-ventures, spin-offs, technology incubators, etc). There is a strong role for policy to promote
entrepreneurship, according to recent study only 47% of Europeans in 2003 indicated that they
prefer self-employment to being employed.
The implications of technological change on industry structure and dynamics are shaped by the
nature of technology. New research paradigms that destroy or disrupt the technological capabili-
ties of established firms, create opportunities that are more likely to be identified and exploited by
new firms. In contrast, technological advances of more incremental nature strengthen the capa-
bilities and competitive advantage of established firms, and increase barriers to entry eventually
in combination with sunk costs in R&D.
The new model of open innovation has been increasingly adopted by leading firms like Philips,
to organize their innovative activities and increase innovative performance. This model also fa-
vours the creation and success of entrepreneurial firms, which can benefit of strong relationships
in innovative activities with the established firms. The challenge for the government and the in-
dustry is to increase commitment of businesses and institutions to open innovation, collaborations
and knowledge transfer. For small firms to survive in the long term in the face of the new forms of
organization of innovation so called open innovation , the challenge for government and the in-
dustry is to favour the creation, through an effective IPR regime, of a market for technology that
provides both new and established firms with alternative means to commercialize their ideas and
gain economic returns from innovation. A further challenge related to the emerging trend towards
an open model in the production and dissemination of knowledge affects in different degrees
firms of different sizes related to organizational change. This new model of commercialization of
innovation requires new managerial practices and organizational arrangements. The challenge
for industrial firms is to develop new managerial practices that enhance both internal capabilities
(by mobilizing available skills and human capital) and external capabilities (by drawing on exter-
nal collaborations and social capital).
Concerning research, technological development and related requirements this draft has briefly
explored some of the research implications of the drivers and trends analysed in the first stage of
this project. It did not try to attempt an inclusive study of the research fields that these trends
suggest; many far-reaching and comprehensive foresight and technological forecast studies have
developed detailed analysis of demand trends and socio-economic conditions, existing techno-
logical and scientific capabilities and proposed detailed technological and scientific strategies.
Here we have just underlined some of the general fields of R&D activity derived from the initial
analysis of demand drivers. There are, however, some traits that can be identified even at this
level of generality.
First, and most important, all the drivers mentioned have a bearing on a variety of research disci-
plines, technologies, and industrial sectors. Similarly, most R&D areas impinge on several driv-
ers. Further, any of the technologies mentioned here will draw from knowledge from a variety of
research fields.56 It follows that, from a policy perspective, it is unadvisable to bound areas of
research, technological and innovation policies within single disciplines or user communities. Pol-
icy design and implementation, as well as policy analysis, has to be based on interdisciplinary,
and systemic approaches. Second, and related to the above, many of the areas of activity we
have described in this paper are no longer purely industrial. For many problems, solutions have
to offer a combination of novel products and different ways of organizing either their production,
or delivery, or maintenance. For instance, increased energy efficiency in transport depends, not
56
See for instance, the studies carried out in France every five years to identify key technologies (CMI International
2000).

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only on more efficient engine technologies (an industrial issue), but also on new traffic manage-
ment systems to counter congestion. The development and implementation of the latter may be
connected to services rather than industrial sectors.
Third, many of the scientific and technological development pointed out in this paper, and also in
many foresight studies, are of an incremental nature. Most of the areas mentioned are already
the subject of public R&D programmes and have focused policy initiatives for quite some time.
New capabilities have to build on existing scientific and industrial resources. Fourth, innovation is
not only a technical pursuit. Regulatory environments and other socio-economic conditions are
crucial to the deployment of many of the technologies discussed in this paper, and, at times, they
are even the main focus of change (like, for instance, the dispersion of technology controls to ad-
dress security concerns). Often, research on socio-economic issues will be necessary to support
the construction of adequate socio-economic conditions and institutional environments for the
application of technological solutions to social problems.
In the subject of human resources, skills, labour market conditions five dimensions defined the
boundaries of the theme. These where globalization and technological change employment im-
pact; employment and new technologies; Skill bias and increasing wage inequality; globalization
and skills: challenges and possible solutions; and Innovation, organizational change and human
resources management. The main implications on these dimensions in the face of global trends
and challenges identified in Task One report follow:
Globalization and technological change, specially the pervasive use of ICT, renewed the debate
concerning the relationship between technology and employment. The fear is that international out-
sourcing and new technologies have weakened the positive correlation between growth and em-
ployment. The problem here is the solving of the paradox of the apparent inverse relationship be-
tween the direct labour-saving effect of international outsourcing, the beneficial indirect effects of
export-led growth and the unpredictable job opportunities which can be opened by new innova-
tions. This challenge is particularly important in terms of European competitiveness. Indeed,
product innovation represents the high road to international competitiveness as an alternative to
cost-cutting process innovation, lower wages and worsening labour market conditions. From this
point of view, the challenge posed by the emerging economies should be faced not with a rush
to the bottom in terms of labour-saving process innovation and cutting wages, but rather through
labour-friendly product innovation both in high-tech sectors and in the innovative niches of the
traditional ones.
The net employment impact of globalization and the diffusion of new technologies depends on
the balance between process and product (service) innovation and on the effectiveness of differ-
ent compensation mechanisms via decreasing prices and via new investments. Against this
background, the competitiveness challenge posed by the globalization and advanced technolo-
gies demands European economic policy effort to strengthen both the providers of the new tech-
nologies (such as telecommunications, biotech sectors, electronics and nano-technologies and
so on) and those who are users of the new technologies. Amongst the latter, advanced services
assume a crucial role as a focus of a targeted industrial policy
The advent of strong competition from emerging economies, together with new technologies im-
plies a change in the relative ratio between skilled and unskilled workers with the demand for la-
bour shifting in favour of the former. This tendency in the labour market can imply either lower
wages for the unskilled or higher unemployment rates among the unskilled. Hence, authorities
should promote the best interaction between the public education and training system and the
private demand for skills, in order to maximize economic performance. However, the widespread
diffusion of the skill bias as a global trend asks for further investment in education and training
as a mean to sustain long-term European competitiveness. Thus, the real policy challenge is to
combine an increase in the amount of education and training with the best interaction between
the public education and training system and the private demand for skills, in order to maximize
the economic performance and the competitive advantage of Europe.
The last main challenge of the current waves of technological progress and globalization con-
cerns the organization of the workforce at the level of the firm. Empirical evidence suggest the
massive organizational changes at the firm level can be summarized in three concepts: decen-

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tralization and de-layering, collective work and multi-tasking. Blue collar workers lack of comple-
mentary manpower strategies increases the likelihood of redundancy when exposed to globaliza-
tion and labour-saving organizational and technological changes. Blue-collars are not necessarily
victims of an intrinsically labour-saving process of globalization and technological change; but
they are negatively affected by an inefficient mix of these phenomena with an organizational
change involving new working practices. If this is the case, HRM and education policies may de-
cisively mitigate the impact of globalization and technological change upon the most vulnerable
workers.
With respect to location of economic activities, according to general wisdom in the subject the
main factors affecting the retention and attraction of economic activities to a specific location
were the cost and availability of educated and skilled labour, degree of labour unionization (de-
regulation of labour markets), fiscal incentives (tax exceptions), infrastructures available, regula-
tions enforcement (health, safety, environment), easiness to open and close business, social and
government stability and internal market consumption. In relation to these factors the main drivers
and challenges found to have direct implications for Europe in the face of global change were
ageing of population; energy availability prices; mobility and trade; off-shoring, trade and envi-
ronment; knowledge infrastructures and innovation science; and emerging economies.
Off-shoring is a worry not only for Europe but as found in the literature for all economies. The first
implication for Europe here is to assess based on reliable statistics the kind and numbers of jobs
(especially white collar jobs). This represents a challenge taking into account the need to gather
data across all member states and in relation to international trade balance. Here the question is
how the trade balance is likely to behave in the long term. Some of the main implications for the
EU identified were. First, the aging of population is expected to speeding up after 2010 and
reaching a peak in 2050.This is likely to make a large proportion of the labour force relatively
more expensive and less flexible. Second, the steep trend of energy high prices in recent years is
likely to stay high with the advent of emerging economies that will to sustain high demand of fos-
sil fuels. In general this could have a strong negative effect on economic activities, most likely
reduce the far location of manufacturing dependent on cheap labour in the short term. In contrast
most likely to trigger innovation on alternative energy sources and transport systems. Third,
closely related to the latter point, the movement of merchandise in large hauling and small parcel-
ling the demand in transport services has rocketed in recent years. Increase in mobility demand
by increasing international trade. This trend is expected to remain and to increase depending on
energy prices, trade liberalization and its impact on environment.
Fourth, concerning regulation in diverse areas especially on environmental protection, safety and
health, experience has shown that intensive energy, and natural resources business are more
likely to flee to countries with cheaper sources of energy (e.g., oil and hydraulic). Fifth, In high
tech sectors we can expect an increase in competition based in knowledge structures and strug-
gles for the market underpinned by innovation science and technology ; Sixth, the trend of inter-
national collaboration and subcontracting of R&D and innovation in some instances called open
innovation brings challenges in relation of public investment and subsidies for R&D. If con-
ducted off-shore who benefits from it?
Last, emerging economies in appearance are doing better in setting the conditions to attract and
expand foreign direct investment. This must be assessed against the social cost incurred by the
host nations in order to learn from others experiences. Traditionally the off-shoring of industrial
activities has been costs based mainly in relation to unskilled labour. Recently this trend includes
all the spectrum of business operations from unskilled labour to smart outsourcing of R&D, man-
agement and marketing. It is not clear to what amounts the relative social cost of sustaining the
right conditions to foster economic activities. The challenge in the face of new forms of off-
shoring for Europe, given its diversity in many areas is to strike balance, set thresholds and limits
as to how far we can go in setting the conditions to retain and attract new investments. The first
impression is a deterioration of the welfare state. It is clear that if Europe opts not to follow the
models of emerging economies - where disparities of highest and average earners are huge -
there is a critical role for innovation, innovation science, where there are strong knowledge infra-

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structures to create and retain jobs and re-insert layoff workers (seniors in average) as well as
supporting institutional frameworks to ensure the returns of investment on R&D and innovation.
With regard to framing conditions for investment attractiveness, prospects for the growth of global
FDI flows are expected to rise if economic growth becomes more widespread. Further corporate
restructuring, the persistence of profit growth and the continuing pursuit of new markets is also
likely lead to more foreign investment. Furthermore, the continued need of firms to improve their
competitiveness through innovation and new markets, alongside the need to reduce costs and
access natural resources and strategic assets abroad, such as new technologies and knowledge,
will provide incentives for further FDI growth. For developed countries, in particular, improved
profitability of transnational companies will likely trigger greater merger and acquisition activity,
which in turn could push up the levels of FDI in developed countries. For Europe to remain com-
petitive it will require an effort to maintain and improve investment policy, investment promotion
and facilitation, trade, tax and competition policy, corporate governance, and general public gov-
ernance, and human resources development. The EU with an expanded number of Member
States who are developing countries, will want to draw in much needed foreign investment as
direct investment yields a greater economic benefit to the host country in terms of acquisition of
skills, knowledge and technologies, job creation, a higher standard of living, etc.
The introduction of business-friendly policies and practices is a necessary but insufficient condi-
tion to attract foreign investment. Instead, the enforcement of these policies forms the paramount
feature of investment promotion measures. It is not enough to have tomes of legislation and
procedures that have no teeth or worse still, that are so complicated as to make enforcement and
implementation difficult. Potential investors need to be assured that they can operate in a risk-
free, stable and predictable environment where the rule of law effectively applies. Europe needs
to ensure that such an environment is pervasive, where the property, whether intellectual or
physical (intangible and tangible) will be safe from misappropriation or destruction. Europe needs
to portray that it is a region where investment will appeal to the interests of foreign investors
through the advantages and benefits that they may reap.
As final remark, throughout this draft we have discussed what were considered to be the most
salient drivers and challenges for the EU industry in the medium term. Also we have learned that
a competitive position can be maintained, improved, or lost in the course of time depending on
new contingencies, resources available (including natural, human and knowledge), new tech-
nologies, the level organizational efficiencies, market characteristics, institutional frameworks and
government activities. All can be strongly affected by political decisions taken now. Political deci-
sions that in turn will affect thus not only long term competitiveness of the EU but also its social
well-being. In this report in the exploration of implications for the competitiveness of the EU indus-
try we have considered the front end of the competitive process, thus we have taken an input
perspective. Looking at the next task in this study, i.e., exploring the implications of the insights of
this report to the competitiveness of specific sectors, perhaps it is worth to consider sector com-
petitiveness in the light insights of this report against five dimensions that are the bottom line that
determine if a sector (or firm) can be competitive now and remain competitive in the future. A sec-
tor will be most competitive if what it offers - regarding processes, products or services - are
valuable, scarce, non imitable or imperfectly imitable, substitution free or quasi-free, and non-
separable form the system where embedded. Here we can clearly see the role of R&D and inno-
vation as new products, processes and services purport all these characteristics, at least for a
while, therefore the need for constant renewal.

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Conclusions and policy implications
1. Introduction
This exploratory study aimed: (i) to identify and analyse the main socio-economic and institutional
driving forces that are likely to shape world markets in the next 15 years; (ii) to trace the links be-
tween these driving forces and the likely evolution of European industry; (iii) to identify the chal-
lenges that the EU economy will face in the future. The achievement of these aims involved three
main tasks. First, identification of the main drivers affecting the shape of future markets over the
next 15 years; second, analysis of their implications for EU industry competitiveness; third, based
on tasks one and two, identification of industrial sectors of strategic interest to the EU.
Unlike other studies that have focused on one aspect of the demand-supply-institutions system,
this exploratory report is more comprehensive in that it defines the main elements of the system
in some detail. However, the amount of detail and the number of issues and variables involved
makes the report rather dense. In this section, we summarize and highlight the most relevant as-
pects identified in the report, concerning global trends and European competitiveness. This report
should, however, be seen as a first attempt to identify relationships between global trends and
drivers, current conditions, and policy implications for European competitiveness over the next 15
years. The draft of this report was put out for review by a number of experts and, despite the
huge amount of information it contains, the level of agreement and convergence in the comments
of these reviewers on what issues should be seen as the most relevant, was high. The reader is
explicitly invited to complement his/her own reading of previous sections of this report and the
conclusions presented below.
In this section we limit ourselves to summarizing patterns of trends and drivers in European in-
dustry competitiveness and to proposing some implications for policy derived from the patterns
identified, and the role that can be played by innovation. First, we cross referenced the drivers
and challenges identified in task one with the themes explored in task two and the sectors ana-
lysed in task three (presented in Annex one). The patterns that resulted are presented Table 25
and briefly discussed below.
2. European competitiveness: Patterns of drivers and challenges

The report identified many drivers and challenges which made the task of identifying those that
were the most important rather problematic. Table 25 presents a cross tabulation of drivers (de-
noted as trends in the rows) and their relevance for the five themes that are defined in this study
the future competitiveness of European industry and the three sectors selected for further
analysis in relation to challenges for their future global competitiveness (denoted as themes and
sectors in the columns). Due to the lack of discrimination between endogenous and exogenous
drivers, and the implicit interrelationships between the themes relating to competitiveness, the
57
patterns in the table are far from unequivocal. The table can be read in different ways depend-
ing on the perspective taken:
57
The relevance of the themes was computed by taking account of the frequency of each trend in the analyses conducted
in tasks two and three.

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Table 25. Patterns of challenges for industrial European competitiveness
Heath: Telemedicine
Structural, organiza-
Transport: Aeronau-
logical development
skills, labour market
Localization of eco-
Human resources,
Research, techno-
tional and sector
attractiveness
Environmental
Technologies:
Themes & Sectors
composition
Investment
conditions
activities
Trends
nomic
tics
Demand side
2.1 Global trends
2.1.1 Ageing population
2.1.2 Climate change
2.1.3 Epidemics and pandemics
2.1.4 Global shifts in economic power
2.1.5 Increasing pressure on health care
2.1.6. Over-exploitation of natural resources
2.1.7 Population growth
2.1.8. Pervasive globalization
2.1.9. Social equality
2.1.10. Sustained economic growth
2.1.11. Terrorism and pervasive insecurity
2.2 Consumption trends
2.2.1 Energy
2.2.2 Materials usage and waste
2.2.3 Water
2.2.4 Mobility
2.2.5 Urban concentration and consumption
Supply side
3.1 Innovation as source of competitive advantage
3.1.1 Increasing government support for STI
3.1.2. Increasing reliance on collaboration and Open Innovation
3.1.3. Increasing importance of Entrepreneurship
3.1.4. Growing role of the service sector
3.1.5. Interdependence of services and manufacturing
3.1.6. Increasing reliance on human resources for science and technology
3.2 Globalization
3.2.1. The emergence of markets for technology
3.2.3 More sophisticated use of customers as sources of innovation
3.2.4 Rise of innovation technologies (IvT)
3.2.5 The experience economy

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Table 25. Patterns of challenges for industrial European competitiveness (Continued)
Heath: Telemedicine
Structural, organiza-
Transport: Aeronau-
logical development
skills, labour market
Localization of eco-
Human resources,
Research, techno-
tional and sector
attractiveness
Environmental
Technologies:
Themes & Sectors
composition
Investment
conditions
activities
Trends
nomic
tics
3.3. Supply of new inventions: new research paradigms
3.3.1. Advanced medical sciences
3.3.2. Advanced process technology
3.3.3. Cognitive sciences
3.3.4. Intelligent mechatronics
3.3.5. Molecular biotechnology
3.3.6. Nano-engineering
3.3.7. New energy technologies
3.3.8. Novel materials
3.3.9. Ubiquitous computing
3.4. Supply of new economic multipliers: innovation waves
3.4.1. Economic and environmental industrial processes
3.4.2. Effect based security operations
3.4.3. Efficient and effective health care
3.4.4. High tech product manufacturing
3.4.5. Information economy
3.4.6. Refocusing government, new governance concepts
3.4.9. Safe and healthy food
3.4.10. Sustainability
Institutional side
4.1. Increasing globalization in a context of innovation and rationalization
4.2 Intellectual property rights
4.3. International outsourcing and the labour markets
4.4. The role of organizational change
Emerging economies

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The cross tabulation enables us to identify overall approximate patterns in which different trends
have different relevance in themes and the sectors analysed. The first pattern to highlight is that
in many cases, there are some factors that are important in some themes, but which are fairly
irrelevant in others. The exceptions here are globalization and emerging economies, which are
very relevant in all the themes and sectors analysed. It should be noted that these two drivers are
intrinsic contributors to global economic integration. The second important pattern is the cluster of
drivers on the institutional side (IPRs, outsourcing and effects on labour markets, organizational
change, and innovation and rationalization), which are also important for all themes and sectors
analysed. These factors have been mentioned in the recent literature. Other known drivers of
competitiveness were identified by the analysis, but were shown to be less important. These in-
clude ubiquitous computing, the availability and cost of energy, and mobility trends. Some entirely
new patterns related to European competitiveness emerged including the ageing of the European
population; the emergence of markets for technologies in conjunction with high technology manu-
facturing; sustainability and the environment; increasing reliance on human resources for science
ant technology; the increasing interdependence between services and manufacturing; and the
rise of innovation science.
A vertical reading focusing on individual themes against developments for each theme, identifies
several relevant trends. Three examples are given below:
Somewhat surprisingly, the demand side cluster of drivers and challenges for structural, organ-
izational and sector composition were not found to be sufficiently relevant to have a significant
impact on the industrial organization of European industry. This is likely due to the level of aggre-
gation and abstraction in the analysis, a hypothesis that is supported by the fact that some trends
were found to be relevant for the competitiveness of the three sectors analysed. This is discussed
below. On the supply side, the cluster of trends including innovation as source of competitive ad-
vantage, globalization, new research paradigms and innovation waves were found to be highly
relevant. All these trends had relevance for the institutional side and for the emerging economies.
In the case of research and science and technological development requirements, demand side
global trends were identified as important challenges in the next 15 years. These include the age-
ing population, climate change, epidemics and pandemics and globalization, energy, raw materi-
als usage and waste, water and mobility. On the supply side the response of science and tech-
nology will be moderated by the level of government support for it, the increasing reliance of firms
on the open innovation model to create synergies and reduce risks, and the increasing reliance
on human resources and lack of skills. In addition, the requirements of science and technology
development will be mediated by the increased level of innovation waves such as effect based
security; new concepts for governance, health and food safety, the information society and sus-
tainability.
Third, in terms of human resources, skills and labour market conditions there are a few demand
side global trends that are relevant. These include the aging population and its impact on the cost
of labour and pensions, global shifts in economic power, pervasive globalisation and social equal-
ity. Supply side drivers, such as the growing role of the service sector in the economy, the emer-
gence of markets for technology and the increasing reliance of society on science and technol-
ogy. All institutional side aspects (innovation and rationalisation, IPRs, international outsourcing
and organisational change) and the emerging economies were considered highly relevant.
With regard to the patterns of trends and drivers at sector level and their likely effects at Euro-
pean level, we can say that overall our hypotheses are valid. From Table 25 it is clear that global
trends and consumption trends will have an impact on the structural, organisational and sectoral
composition of the European economy. In the European level analysis in Task two these effects
were not discernible, but were definitely identified by the sectoral analyses in task three (see Ap-
pendix 1).

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3. Policy implications - The role of R&D and Innovation policy
In this section we summarize the main policy implications of the insights and discussion in the
previous chapters of this report. First, the aging population, must be taken account of in industrial
policy and competitiveness. The large numbers of elderly people are expected to promote the
creation of new markets for products and services (including leisure), put pressure on govern-
ment expenditure on care and health services, produce a new breed of entrepreneurs and affect
the capacity of regions to retain and attract economic activities given their cost structures. Innova-
tion is required in the institutional arrangements that facilitate the retention of talent including the
introduction of flexible retirement arrangements and financial mechanisms that enable experi-
enced people to start up businesses. The ageing population demands the coordination of several
streams of policy linked to industrial and innovation policy (e.g., health, immigration, pensions
and labour, etc.).
In the 1980s and 1990s the upsurge in inter and intra country trade in intermediate goods led to
structural changes across the economy, Currently, changes in R&D and Innovation are occurring
and having similar effects. The new model of open innovation has been increasingly adopted by
leading firms to organise innovative activities and increase innovative performance. This model
favours the creation and success of entrepreneurial firms, which can benefit from collaboration
over innovative activities with established firms. This is confirmed by the sectoral analyses in this
study. The three sectors surveyed (telemedicine, aeronautics and traditional and cleaner envi-
ronmental technologies) are characterized by the fact that they integrate and source not only in-
termediate goods from other sectors but also R&D and innovations. The role of and challenge for
government policy is to increase awareness, commitment and skills in relation to the systems
integration of businesses and institutions to enable them to operate successfully in an environ-
ment of open innovation, collaboration and knowledge transfer. This will be especially important
for small firms. If SMEs are to survive in the context of open innovation, government and industry
must encourage an effective IPR regime to provide a market for technology that provides both
new and established firms with alternative means to commercialize their knowledge and innova-
tions in order to reap economic returns from them. The new mode of commercialization of innova-
tion requires new managerial practices and organizational arrangements. The challenge for in-
dustrial firms is to develop new practices that enhance internal capabilities (by mobilizing avail-
able skills and human capital) and external capabilities (by drawing on external collaborations
and social capital).
For Research and technological development and their related requirements we highlight some of
the general fields of R&D for which policy implications have been identified. First, all the trends
and drivers identified have some implications for the variety of research disciplines, technologies,
and industry sectors. Similarly, the innovation waves and research paradigms identified draw on
knowledge from a variety of research fields. Thus, from a policy perspective, it would not be sen-
sible to bound research, technology and innovation policies within single disciplines or user
communities. Policy analysis, design and implementation must be based on interdisciplinary, and
systemic approaches (exemplified by this current report). Second, many of the issues covered
in this report have connotations that go beyond mere industrial policy (e.g., the ageing population
and environment). The solutions to many of these challenges require a combination of novel
products and different ways of organizing their production, delivery, and maintenance. Here, the
service sector will assume great importance. Third, most of the research paradigms mentioned
have already been the subjects of public R&D programmes and focused policy initiatives, and
have produced incremental innovations. Some of the challenges will require new knowledge and
capabilities to build on existing scientific and industrial resources (environmental sustainability).
Fourth, and most importantly, innovation should be related to human social behavioural change:
all three types of innovation - technical, organizational and institutional change are needed to en-
sure a better quality of life for citizens. Thus, a direct policy implication is that regulatory environ-
ments and other socio-economic conditions are crucial to the deployment of many of the tech-
nologies discussed in this report and should be the main focus of change (for instance, technol-

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ogy used to address security concerns). A consequence for research policy is that research on
socio-economic issues will be necessary to support the establishment of socio-economic condi-
tions and an institutional environment enabling the application of technological solutions to social
problems.
In terms of human resources, there are three policy issues related to skills and labour market
conditions. First, globalization and technological change and the labour-saving effects of interna-
tional outsourcing present a critical challenge for European competitiveness. The impact on em-
ployment of globalization and the diffusion of new technologies depends on the effectiveness of
different compensation mechanisms via decreasing prices and new investments that facilitate fast
reinsertion of displaced labour. Thus European economic policy should support both the provid-
ers and the users of the new technologies. Second, the emerging economies combined with new
technologies, are likely to induce a change in the relative ratio between skilled and unskilled
workers in favour of the former. This will affect the labour market in two ways. On one hand, this
change is already resulting in lower wages for both unskilled and skilled workers, and higher un-
employment among low skilled workers. On the other hand, the reduction in wages has been ac-
companied by increases in productivity and profits. This has two particular policy implications. In
terms of competitiveness, there is a need to promote public education and training and re-training
systems to satisfy private demands for skills, in order to maximize economic performance. Also,
blue collar workers will be exposed to a higher risk of redundancy in the context of globalization
and labour-saving organizational and technological changes. Human resources management and
education policies may be able to mitigate the impact of globalization and technological change
upon the most vulnerable employees.
In relation to the location of economic activities and investment attractiveness four issues should
be highlighted. First, the net effects of off-shoring in the last 20 years have been positive concern-
ing profits and productivity and negative on wages.58 Thus, there is a need for industrial policy
related to smart outsourcing to benefit local jobs and wages while boosting productivity and prof-
its. The design of such a policy should consider the trends in the average age of European coun-
try populations bearing in mind that a large proportion of the labour force will become relatively
more expensive and less flexible from 2010, reaching a peak in 2050. Second, high energy prices
are likely to continue as a result of increased demand. This will likely have a negative effect on
economic activities and affect the relocation of manufacturing activities dependent on cheap la-
bour. The policy challenge here is to ensure reliable sources of energy for the EU, while putting in
place the framework conditions required for investment in alternative sources of energy and new
transport systems. Third, in terms of regulation related to environmental protection, and health
and safety, experience has shown that energy and resource intensive businesses are more likely
to relocate to countries with cheaper energy sources. Fourth, if Europe is to remain competitive
and attractive to investors in a context of unrestricted global FDI flows it must maintain and im-
prove investment policy, investment promotion and facilitation, trade, tax and competition policy,
corporate governance, and general public governance, and human resource development. The
introduction of business-friendly policies and practices and their enforcement through good regu-
lation will be necessary to attract investment. Potential investors need to be assured that they can
operate in a minimum-risk, stable and predictable environment where the rule of law applies. In
this regard European policy and regulation should ensure that intellectual and physical (intangible
and tangible) property will be safe from misappropriation or destruction to persuade investors of
the benefits to be gained. The challenge of this package of policies will be to strike the right bal-
ance between the benefits to be derived from investment and the effort involved in attracting it.
Lastly, the focus of industrial policy will be important. The guiding themes in this report are com-
petitiveness and the role of R&D and innovation. Competitiveness is the capability and perform-
ance of a firm, an industry, an industry cluster, a nation or a region to sell and supply and supply
goods and/or services to a market - local, regional, or global. A region or a nation s competitive-
ness is generally assessed in terms of its capability to maintain a position of surplus in the inter-
58
See for example The Economist (Sep 16, 2006, p.14).

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national trade balance through control of part of the global market. Such a competitive position
can be maintained, improved, or lost over time. Thus, national performance is dependent on the
ability of governments and industry to co-design and implement appropriate policies and frame-
work conditions. The role of government is to implement the necessary and sufficient conditions
for firms to participate in the international competitive process. We have seen from the above that
the challenges are many, that there are interrelationships and causalities among trends, and in
turn these are related to optimal inputs for competitiveness and competitive performance.
This study has shown that there are new research paradigms that can potentially enable struc-
tural change in the economy. Such events are at the low end of the cycle of innovation (i.e.,
R&D). Structural change occurs only when application and mass diffusion becomes an innovation
wave (for example, the application of steam, or microelectronics). These waves are always un-
derpinned by institutional reform, new knowledge structures and new services. The sectoral
analyses in this report have shown that in some sectors currently it is less important to support
R&D while in contrast it is crucial to deploy and apply technologies that already exist but have not
been sufficiently diffused due to institutional and market failures. Examples here are telemedicine
and environmental technologies. In some cases both aspects are equally important, for instance
in the aeronautics sector while in others, for example sustainable innovation, major R&D efforts
and discovery are required to make a difference. The lesson for policy design is that there is a
need to look at the whole innovation cycle to design policy packages that are multi-dimensional
and systemic by nature. Thus, they encompass not only R&D initiatives but also support and pro-
mote new products, processes, practices and services for global diffusion. The problems involved
are that such policies will be complex and their implementation and evaluation of performance not
straightforward.

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Annexes
Annex 1. Task three - Strategic Industrial Sectors for the
EU
This Annex deals with strategic sectors for the competitiveness of European industry. The need
to define which sectors are of most interest arises from the need not only to obtain the best eco-
nomic returns, but also to respond to the challenges of evolving markets, technologies and socie-
tal needs. Building on the findings from Tasks one and two, the objective of Task three was to
identify those industrial sectors that are of strategic interest to the EU and are related to the re-
sults from the first two tasks in this study. In task one we explored global trends on the supply,
demand and institutional sides of the market. We explored the potential role of new emerging
economies, looking particularly at the cases of China and India. Using the inputs and insights
from task one (a large number global trends) we undertook an exploration of the potential effects
of those trends on European competitiveness. In exploring European competitiveness we
adopted an input approach to the competitive process. Several categories were assumed to de-
termine the overall competitiveness of Europe. These were macro economic implications; struc-
tural and organisational factors; changes in industrial activities; scale and sector composition;
research, technological development and related requirements; human resources, skills, and la-
bour market conditions; localization of economic activities, infrastructure; and framing conditions
for investment attractiveness. Each of these categories was defined to achieve a better under-
standing of the effect of global trends on each category.
In this sectoral analysis of potential lead markets in order to cross reference the findings from
tasks one and two, we organise our findings as follow. For each sector selected, the sector is first
briefly defined based on its major traits in terms of growth trends, technologies and services un-
derpinning its development. Second, and again for each sector, using the results from task one
the main drivers affecting sector development are discussed. Third, market trends in terms of
sector composition, service economy, and institutional matters and organisational change are
analysed. Finally, based on the discussion in these three sections, an exploration of the role of
R&D and innovation is conducted. The role of innovation at the theoretical level is designed to
satisfy societal demands and find solutions to emerging challenges posed by societal develop-
ments and the evolution of nature itself. Innovation is supposed to spur economic activity multipli-
ers as well as wealth. Although this would seem straightforward, once our theories are tested
against different contextual situations and sector specificities (we explore three sectors), forces
and challenges, they begin to appear rather messy.
The sectors were selected based on four criteria. First whether the sector was identified several
times in terms of the global trends identified in task one. Second, if the sector was ranked high in
terms of growth rate, employment, exports and R&D investment. Third, if the sector was of inter-
est to the research agenda of the European JRC-IPTS. Fourth, if the research team had exper-
tise in the sector. Several sectors met these criteria including: Energy (renewable energy and
increasing thermodynamic efficiency in current electronic, electric, electro-mechanic and me-
chanic systems including buildings); health (including pharmaceuticals, telemedicine, special-
ized biomedical equipment), transport (including automotive and aeronautics); environmental
technologies (including traditional sectors such as water, air, recycling, and new approaches to
cleaner production); chemical products; machinery and equipment; construction; and food. We
selected: Telemedicine, aeronautics; and environmental technologies as cases to apply the
methodology proposed here.

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A1.1. Health Sector Telemedicine
A1.1.1 Introduction
Since the late 1990s, telemedicine has been touted as a new and dynamic area of healthcare to
complement traditional medical services, which would continue to evolve as new technologies
broadened its scope of application (Tang, Curry and Gann 2000). Then, and now, telemedicine
was envisaged as providing speedier response, faster diagnosis, continual monitoring, and en-
hanced visual-based communication and consultation between recipient and the medical profes-
sional, as well as medical and public health information. However, most health care providers in
Europe have adopted only rudimentary forms of telemedicine, such as sensors, and medical and
public health education (more below) or are even only starting to introduce it, in the form of tele-
consultations, or adoption of a telemedicine service. The telemedicine sector is under-developed
and its use is fragmented across Europe. Nevertheless, since the late 1990s trial runs and pilot
projects have been run across Europe to test the workability of telemedicine services, by various
national university medical faculties in Austria, Croatia, Poland, Hungary and the UK.
For the purposes of this study, and given the broad range of technologies used for the delivery of
telemedicine, we treat telemedicine as a sub-sector of the healthcare service sector, and a sector
of the computer (including software), communication and medical equipment industries. A caveat
is needed, which is that telemedicine requires the integrated equipment of a reliable and robust
communications infrastructure. In the absence of such an infrastructure, the delivery of telemedi-
cine is not possible. Telemedicine constitutes a real market activity, despite its nascent stage.
Telemedicine technologies
For the purposes of this project, we define telemedicine as the exchange of medical information
among sites via ICT-based (including satellite) communications, for the purpose of treating pa-
tients, improving patient care health, and for the education of both patient and healthcare pro-
vider. The technologies that underpin the delivery of telemedicine include:
o Broadband, (including 3G) for transmission of images, data, etc. and videoconferenc-
ing.
o Wireless (WiFi) for locational transmission of images, data, etc, such as from scenes
of accidents.
o Store and forward this is used when a face to face encounter between physicians is not
necessary. Store and forward telemedicine uses a software program that sends a photo,
movie and/or audio file with text to consulting physicians using the Internet in much the
same way a file attachment is sent along with an email. The receiving physician can act
on the information at their convenience, and return an evaluation in the same manner.
One of the most common applications of telemedicine in the US, teleradiology, makes
almost exclusive use of store and forward. Store and forward technology is highly suit-
able to diagnostic modalities, for instance, high-risk foetal ultrasound examinations per-
formed at Fairview Lakes Medical Center in Wyoming, are transmitted to perinatologists
at Fairview-University of Minnesota Medical Center for interpretation (Hoff 2004).
o Imaging and video telepresence of experts in remote locations; transmission and re-
mote viewing of images to hospitals, medical centres, etc; remote access to databases;
delivery of healthcare/medical treatment to prisons, disaster areas, war zones, etc. This
technology is used in conjunction with store and forward.
o Optical diagnostics associated with imaging technology for surgery, treatment of vari-
ous afflictions and conditions, such as allergies, tissue degeneration and grafting, etc.
o Geographical positioning systems (GPS) integration into a camera-mobile phone with
Internet access to allow photographs to be sent from where they were taken; e.g. a dis-
abled or elderly person has hurt himself and requires medical attention.
o Smart card storage of personal health details; possibility of incorporating it into a mobile
phone with Internet access

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o Sensors -- continual monitoring can be conducted through medical and environmental
sensors that track the movements and vital signs of the homebound healthcare recipient.
The information is sent to an intelligent information-processing network, analyzed, de-
tected for anomalies in behaviour, and depending on the analysis, alerts the carer, or
prescribes treatment. Sensors can be used to take and transmit data such as tempera-
ture, blood pressure and sugar level to a medical centre for examination and checking
against existing health records.
Thus, the technologies that drive telemedicine affect both the way it is delivered, the type of care
that is delivered, and the tools used during the delivery of a telemedicine application. In other
words, any combination of the above technologies can deliver telemedicine. The integration of
these technologies depends on the range of telemedicine services chosen.
Telemedicine services
The catalogue of services below is impressive; yet it must be noted that, perhaps with the excep-
tion of e-booking, electronic patient records, medical education, and an increasing use of tele-
consultation, the other services are still very much in their infancy for a number of reasons which
are discussed below. However, with maturation, and greater innovation in telemedicine technolo-
gies, and most importantly, institutional and organizational reforms in the healthcare service in-
dustry, the extent and breadth of medical specialties where telemedicine technologies would
prove clinically feasible could expand, for instance to orthopaedics, psychiatry, neurology, paedi-
atrics, internal medicine and ophthalmology (Chandra 2003).
Current telemedicine services include:
o Tele-consultation performed in some medical centres and hospitals across the EU, in-
cluding in remote regions. For instance, the European Commission-funded HEALTH OP-
TIMUM has helped to deliver this service to remote locations in Spain, Italy and Den-
mark. Coupled with a tele-laboratory service that allows patient test samples to be ana-
lyzed remotely, the Internet-based HEALTH OPTIMUM solutions has helped to improve
healthcare in these remote regions where they were tested, and are continuing to be
used. This form of tele-medicine has been in wide use for many years in the US. For in-
stance, tele-consultation was initiated in prisons, where the costs of and risks involved in
transporting prisoners to health facilities need to be minimized.
o Tele-radiology transmission of x-rays.
o Tele-surgery for instance, in the US surgeons use videoconferencing in the operating
room to exchange live, real time information with other hospitals and institutions. Small
video cameras built into endoscopes provide a high quality video signal that can then be
transmitted to colleagues at a distant site. The military and some university research cen-
tres in the US are involved in developing robotics equipment for tele-surgery applications.
A surgeon in one location can remotely control a robotics arm for surgery in another loca-
tion. The military has developed this technology particularly for battlefield use, and some
US academic medical centres and research organizations are testing and using the tech-
nology (Brown 1996).
o Telepharmacy (e-prescription) in the UK, the NHS has piloted an Electronic Prescrip-
tion Service to which prescribers and dispensers will be connected. By 2007, every gen-
eral practitioner s (GP) surgery and community pharmacy and other dispensers will have
access to the service. It involves a bar-coded script (prescription), which can be taken to
any pharmacy, and allows patients to nominate the pharmacy most convenient for them
to collect their medication from. The prescription notification is transmitted to the dispen-
sary so that the medication can be prepared. In the US, especially in more remote towns,
the pharmacy technician will fill the prescription that has been transmitted to her via a lo-
cal network. The pharmacist will also have the ability to talk to the patient using videocon-
ferencing technology in order to instruct the patient regarding the medication, its side ef-
fects, and any special considerations. Other e-prescription services available in the US
include a vending machine with pre-packaged quantities of the most commonly pre-
scribed drugs. The pharmacist activates this remotely when the patient holds the pre-
scription up to a video camera. The pharmacist then remotely releases the package from

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the machine and the patient holds this in front of the camera for a final check by the
pharmacist (Hoff 2004). According to the Audit Commission, 1,000 people in Britain die
from prescription errors and adverse reaction to medicines. This costs taxpayers about
£500 million annually (Douglas 2003). The UK Government argues that e-prescription
would mitigate this risk.
o Telecardiology -- remote analysis equipment allows healthcare professionals to take a
patient s cardiac details and send the results to a specialist located elsewhere. Some
mobile phones available in Japan incorporate electrodes allowing them to be used as
electrocardiograms.
o Teledermatology use of images for teleconsultation on skin conditions.
o E-booking remote booking of appointments, e.g., from home.
o Electronic patient records (EPR) in the UK, EPR give doctors and health professionals
access to a more detailed patient record, which includes specialists reports, the GP s
prescribing record, and hospital discharge summaries. The UK aims to roll out EPR na-
tionally by the end of 2007 (a delay of two years).
o Medical education and public health information involve huge databases of clinical,
medical and health-related information for use in training, by trained healthcare and
medical personnel, and the public use; also sometimes involves remotely performed sur-
geries and treatment for classroom demonstrations. Associated with this service is the
UK NHS Direct telephone-based service to respond to health-related queries. The UK
Government introduced this in 1999, and by 2004, it had developed from a small pilot
scheme to a unique national service, which now handles over half a million telephone
calls a month. Its accompanying service, NHS Direct Online, also conducts half a million
on-line transactions every month via the Internet, making it probably the largest single e-
health service in the world. The NHS Direct telephone number now provides a single
point of access for out-of-hours care, enabling fast and easy access to multi-disciplinary
emergency care networks (Molas et al. 2003).
There are a number of drivers that will promote the development and take-up of telemedicine.
These were identified in the late 1990s and are still as compelling and relevant.
A1.1.2. Main drivers affecting the sector
Ageing
The issue of population ageing and its effect on healthcare has been highlighted as an important
area of research since the late 1990s. For instance, in 1998 the OECD argued that such research
was needed because people were living longer and this would impose a heavy toll on countries
healthcare systems. The report noted that over the next 25 years the number of people aged 65
and over would rise by 70 million in the industrialized countries, while the number of those of
working age would rise by 5 million over the same period (OECD 1998). By 2050, it is estimated
that the number of people over 65 will be about two billion. Such estimates imply that the inci-
dence of chronic disease will grow and the number of disabled persons will also rise. Evidence of
age-related health interventions, such as for the infirm and those needing rehabilitation, has been
documented in some countries in Europe (European e-Business Market Watch 2003; Curry et. al.
2003).
Other international organizations, such as the World Health Organization and the International
Telecommunication Union, have also been investigating the implications of an ageing population
for the quality of care and life (ITU 1997; OTA 1995; GAO 1997). The solution proposed by these
international institutions and agencies for managing healthcare is through electronic delivery of
services.
Increasing demand
Increasing affluence and a better educated public is accompanying this changing environment in
which people are living longer and healthier lives, at least in the advanced economies. As the
baby boomers are reaching retirement age, they are forming part of a growing clientele that

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knows and wants more which is leading to new demands for better medical and healthcare ser-
vices.
Healthcare recipients are insisting on more information to allow them to be more involved in their
own healthcare means and delivery mechanisms. Long waiting lists for treatment and attention
from physicians are not being tolerated. The greater availability of information through the Inter-
net and other sources is signalling the end of medical paternalism and a move toward treatments
being negotiated rather than handed down (Ham 2003). People generally become more anxious
when they are not told things that they should know. Teleconsultation could be means of acceler-
ating the delivery of this kind of information.
Cost savings
Cost savings are a much-rehearsed reason for the deployment of telemedicine. To date there is
little available data on what exactly these cost savings might be. However, anecdotal evidence
provides some insights. For instance, in trials in Veneto, as part of the European Commission
funded project HEALTH OPTIMUM, teleconsultation was used to link primary healthcare facilities
to hospital neurology departments, allowing patients with head injuries to be accurately diag-
nosed by a specialist without having to be physically transferred to a hospital. This allegedly has
resulted in a 79% reduction in the number of people being referred to a specialist facility; the fig-
ure was 53% before deployment of teleconsultation. Neurologists are able to diagnose the patient
remotely and determine whether or not they need specialized care
(http://www.healthoptimum.info/index.jsp?pagID=113). If surgery is required, teleconsultation pro-
vides physicians with access to information about the patient. Thus, savings come from not ad-
mitting patients who do not need hospitalization and/or surgery. In Aragon (Spain) and Funen
(Denmark), both part of HEALTH OPTIMUM project, similar levels of savings were achieved.
Healthware, a project headed by Alcatel Alenia Space, to test the use of satellite technology,
identified e-learning, patient monitoring and rural telemedicine as the areas most likely to provide
immediate returns on investment. However, according to a report prepared for the European
Space Agency on Healthware, such investments need to be made on a large scale to achieve the
economies of scale that provide the greatest savings and benefit (Beaudion 2006).
Thus, it is plausible to expect that savings can accrue from the widespread deployment of tele-
medicine but that an efficient and reliable communication infrastructure needs to be in place. Up-
front costs are involved in terms of diagnostic and computer equipment. Thus, the savings may
only be achievable over a relatively long period and after national deployment of these services.
Obstacles
Cultural change and user acceptance. User acceptance of the new technologies is a major ob-
stacle, which is fundamental to the take-up of telemedicine services, or any new technology.
While the younger generation of healthcare recipients may be more IT savvy, and therefore
more receptive to videoconferencing, teleconsultation and telediagnosis, etc. the older generation
may be more reluctant to be teleconsulted or be telediagnosed, or be more dubious of telemedi-
cine services. Although telemedicine services are not intended to replace traditional forms of
healthcare, but rather to supplement them and to provide faster consultation and treatment, vari-
ous studies (Tang et al. 2000; Molas et al. 2003, Curry et al. 2002) have shown that there contin-
ues to be a preference for face-to-face consultation among the older generation.
For instance, in 1998 the US Federal Office of Rural Health Policy, a main funder of telemedicine
projects, stated that "in the final analysis, it will be human component at each end of the system --
not the technology -- that will determine whether it [telemedicine] is successful or not"
(http://www.uswest.com/interprise/articles/telemedicine1.html.) This same source also noted that
consumers of health care will ultimately make the decision as to whether or not telemedicine
catches on based on their reaction to computerization and dehumanization of the physician-
patient interaction."
From the medical/healthcare professional perspective, there is a need for changes in culture and
traditional practice. For instance, in the case of e-booking, specialist consultants will be required

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to open their appointment books to GPs. This means that GPs will have control over the former s
schedule. Given the seniority of consultants over GPs, this may not be easily negotiated. Physi-
cians are sceptical about diagnosing and treating patients at a distance and do not seem keen to
adopt use of the new equipment. These concerns are mainly related to the quality and control of
patient care from telemedicine technologies (Tang et al. 2000).
Furthermore, training of physicians and nursing staff in what could be initially complex procedures
involving complex software packages, may not be welcomed because of existing heavy work-
loads. Older physicians, GPs and nurses may not be as familiar with computers as the younger
generation of healthcare professionals. Routines are hard to dismantle and the mantra if it ain t
broke, why fix it seems to prevail in current medical culture and practice.
Privacy and confidentiality of personal data. The use of technology in facilitating healthcare must
not compromise patient privacy or individually identifiable health information. Telemedicine tech-
nologies will have to comply with confidentiality regulations. The issue of privacy and confidential-
ity of personal health data is thus a concern for potential recipients of telemedicine services. A
main worry is the perceived intrusion that surveillance sensors, in particular, create for the
user/recipient. For instance, the care recipient may not especially wish to have her personal hab-
its and activities monitored continually, although this monitoring facility is a central feature of
telemedicine. Sensors do not discriminate and unless care recipients can be assured that their
information will be kept confidential and secure, the widespread uptake of this simple form of
telemedicine may be thwarted. National and EU legislation on data privacy should help to allay
such concerns. However, a similar concern over confidentiality and security of personal data was
found with the use of smart cards. Taken the ingenuity of hackers who appear to be able to pene-
trate digital systems or decipher complex algorithms, a smart card that carries personal health
data could be a relatively easy target for identity and data theft. Store and forward technology can
also be vulnerable to hacking, leading to misappropriation of images of personal health details,
for instance.
Technology choice. Acceptance will be influenced by the kind of technology involved. From the
healthcare perspective, the less healthcare recipients have to tinker with the technology, for in-
stance, sensors, the easier it will be for them to accept it. An Internet-based telemedicine system,
however, could present some difficulties. Internet technology presumes that care recipients know
how to operate a computer, and more significantly, that penetration of computers per 100 house-
holds is high, probably more than 40%. Despite the impressive growth in Internet users in
Europe, it must be remembered that much telemedicine delivery is aimed at the elderly and those
in remote locations, who are less likely to be familiar with or have access to the technology.
Therefore, for effective national implementation of telemedicine, the demographic and income
breakdown of the Internet population should be analyzed.
From the perspective of the healthcare/medical personnel, the need for minimal tinkering with the
technology also applies. As noted above, the delivery of telemedicine requires training in complex
procedures and software packages. Finally, a proper choice of technologies to ensure compatibil-
ity between requirements and user (physician and healthcare personnel) will not be straightfor-
ward, although consultation with telemedicine solutions suppliers would resolve many of the prob-
lems.
Cost. Upgrading and replacing legacy systems incurs large upfront costs, for example, the £12.2
billion installation of the UK health IT infrastructure. With the spiralling cost of healthcare that
most countries face today, the allocation of such a resource is fraught with difficulties. While Ja-
pan, the US, Australia, Sweden, the Netherlands, some regions in Spain and the UK, for in-
stance, have invested in upgrading their health IT infrastructures to support the delivery of tele-
medicine, other countries will need to spend vast amounts if their IT infrastructure is to be of the
right standard to deliver telemedicine. If telemedicine can be shown to deliver long term cost sav-
ings, then governments will be more likely to allocate resources to reform their health IT infra-
structures. At the moment, budgetary constraints are a major barrier for many countries.
In Europe the public sector controls nearly 75% of all major hospitals. Thus, it has the power to
boost the development of the fledgling telemedicine market. The next section reviews market

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trends and addresses how government can help this market through institutional and organiza-
tional innovation and changes.
A1.1.3. Market trends

In order to obtain a better understanding of the development and future of the telemedicine mar-
ket, we need to look at three aspects. They are (1) sectoral composition, (2) role in the service
economy; and (3) the institutional and organizational changes that need to be considered.
Sector composition
As noted above, the market has been slow to exploit telemedicine technologies, despite demo-
graphic studies that show that, within the next 30 years, the over-60s will form the largest group
in society (OECD 1998, Frost and Sullivan 2006). One reason for this despite the initial hype is
the fragmented state of the European healthcare IT sector. According to Frost and Sullivan, the
European healthcare IT sector remains essentially fragmented, with different vendors controlling
different niche segments (E-Health Insider 2005). Continuation of this fragmentation could hinder
the growth of this sector, which would have a potentially dampening effect on the growth of the
telemedicine market.
Nonetheless, the trend in European healthcare IT spending is an improving one. In 2004 it was:
(1) hardware US$30 billion; (2) software US$28 billion; and (3) consultancy services US$1
billion. In 2005, the total healthcare IT spend increased to hardware about US$38 billion; soft-
ware US$30 billion; and consultancy services US$1.2 billion (Datamonitor 2005). By 2010,
Datamonitor estimates that healthcare ICT spending for the three categories of investment will
rise to: hardware US$52 billion; software US$4 billion; and consultancy services US$18
billion. Market analysts Frost and Sullivan estimate that just the upgrading of current European
IT-based information systems will yield a market worth US$6.3 billion (E-Health Insider, 2005).
These high forecast growth rates can be attributed, in part, to implementation programmes for
clinical information systems in major European markets including the UK, Germany, France and
Scandinavia. Initiatives such as Germany s Health Smartcard, the UK NHS National Programme
for Information Technology and the European Commission s e-Health initiative may all have a
positive effect on the growth rate of the European IT healthcare market and the potential for new
telemedicine business opportunities in Europe. Specifically, the estimated £12.2 billion construc-
tion of the UK healthcare infrastructure delivery system to facilitate better care through the wider
introduction of telemedicine-related services, including teleconsultation and EPRs, would seem to
offer great opportunities for healthcare service suppliers, equipment and IT-related providers.
In a separate study by the European Commission, the European Healthcare Information Society
Technology (HIST) market was estimated to be approximately 11 billion Euros in 2001, account-
ing for less than 2% of the total western European ICT market of about 643 billion Euros per year
(Novotny 2004). The total European healthcare market in 2001 was 700 billion Euros, implying
that the HIST market for the same year represents a meagre 1.6% (Novotny 2004).59 Considering
that the EU currently spends an average of 8.3% of GDP on health, and the costs are likely to
spiral with an ageing population that is living longer, this too suggests a potential for growth of
telemedicine.
Service economy
Telemedicine sits squarely in the centre of the service economy. The healthcare sector is a lead-
ing sector in Europe and all other industrialized countries (Novotny 2004). According to the
OECD, the service sector has become quantitatively the most important sector in the OECD
economies (OECD 2005). For several reasons, the OECD points out that innovation in service
industries, such as telecommunication and computer related (particularly in software) business
services, exceeds the R&D intensities in the manufacturing sector (OECD 2005, p. 40). Innova-
tion in telemedicine, as shown above, is highly dependent on software development for the range
59
More recent data are not available.

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of services it can deliver. Wide implementation of telemedicine either nationally or on a pan-
European basis could help foster robust market activity in this sector.
Arguably companies with proven integrated IT solutions for the healthcare market will continue to
take the lead in the European markets. For instance, the strong trend towards integrated health-
care delivery in major markets, such as the UK, Germany, the Netherlands and Scandinavia, will
help fuel the activities of these suppliers. Technology suppliers that have implemented legacy
systems will also likely retain a strong hold on healthcare providers. But as they start replacing
legacy systems and begin to upgrade these systems, it is likely that opportunities for new suppli-
ers will be created. A quick search on Google for small companies providing telemedicine-
technology solutions and equipment shows that there is a plethora of these suppliers, each with
its own suite of products and solutions. There does not appear, therefore, to be a scarcity of such
suppliers, but in order to gain a competitive edge, these suppliers need to be relatively quickly
used by the healthcare system ; in other words, to be embedded in the system, be it national or
pan-European.
As noted above, observers have indicated that growth in telemedicine is promising. However, the
key question is what have been or what are the barriers to the wider take-up of telemedicine? For
Europe, the wide variety of national health systems and mix of public and private healthcare pro-
vision, present a fundamental obstacle to a pan-European market for telemedicine. And even if a
pan-European market were developed, there is a strong possibility that each country would sup-
port its own domestic suppliers. This raises another issue of whether a telemedicine market
should first be created at national level? Arguably, this might stimulate market development. As is
discussed below, there are four main national obstacles to a wider rollout of the whole range of
telemedicine services.
Institutional and organizational change matters

Co-ordination. Government departments tend to work in silos. However, healthcare and social
care are invariably linked. It is widely acknowledged that those requiring social care are in the
lower income group, are older and generally require more medical care. Therefore co-ordination
between the main national public providers of healthcare and social care, and the local authorities
and housing authorities, will be needed. The overlapping structure of healthcare and support ser-
vices argues for greater co-ordination between these multiple actors to avoid duplication of effort
and enable more resources to be devoted to the smooth implementation of telemedicine.
Co-ordination would improve the coherence of telemedicine delivery, and the development of an
integrated delivery system. Fragmented planning, and piecemeal implementation of telemedicine
will jeopardize the efficient introduction and deployment of these services. As noted earlier in the
European Space Agency study, a wide scale integrated delivery system will exploit economies of
scale for both healthcare provider and supplier.
Continual co-operation with the private sector. By actively fostering active co-operation and col-
laboration with private sector providers, public health professionals and officials can keep abreast
of technical developments, which may then help to assuage their concerns over telemedicine,
such as the safety, reliability and cost of these applications. Furthermore, most hospitals in
Europe lack the resources and skills to build and maintain IT infrastructures, and train staff to
handle complex software packages. One option would be to consider outsourcing to an applica-
tion service provider (Frost and Sullivan 2006), a practice already adopted in the UK, so that the
huge capital and implementation costs of acquiring new technology can be reduced. (Ironically,
despite this rationale, the UK Government is experiencing huge cost overruns and delays in-
curred by its consortium of outsourcers. Huge IT infrastructure projects, however, are known to
suffer from such problems and the UK seems to have a long history of such failures.) Nonethe-
less, with the increasing focus on network infrastructure and the scarce resources available to
public healthcare departments, and lack of skills, IT healthcare-related applications, such as
telemedicine, can arguably be more efficiently operated by an outsourcer or application service
provider. This then requires a change in institutional and organizational practices.
Reimbursement/fee payment. Reimbursement under the national health scheme will likely need
reform. For instance, under what conditions would the national health authorities pay for tele-

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medicine diagnosis? How would a practitioner charge for five minutes of consultation with a pa-
tient through teleconsultation, even if there were no "actual" treatment involved? And what kind of
private insurance cover would be provided in relation to telemedicine? What kind of costs would
be reimbursable? New regulations and institutional processes will need to be worked out with
insurance companies and national health services. A reform of the scheme for reimbursements
responding to the aspects would require innovative thinking on the part of the public health poli-
cymakers.
Safety and quality standards. This involves technical and professional telemedicine standards.
Here, public sector and private sector cooperation is particularly important for the formation of
standards. Governments will want to consider providing a platform to co-ordinate the different
telemedicine market players, including the insurance sector, to discuss the establishment of stan-
dards. Furthermore, technical standards authorities may want to consider whether telemedicine
systems should be regarded as medical devices which would have implications for testing and
certification. Compatibility, interconnectivity and interoperability of multiple systems also need to
be ensured. For instance, the Telemedicine Alliance consortium comprising the European Space
Agency, the World Health Organization and the International Telecommunication Union, sup-
ported by DG Information Society to study the creation of a pan-European e-health area has
been trying to establish interoperablity standards since 2002
((http://www.esa.int/SPECIALS/Telemedicine_Alliance/SEM26E5Y3EE_0.html).
With respect to professional standards, audit guidelines for safe practice will need to be instituted.
Associated with this may be consideration of harmonization of clinical terms across the European
Union. This could be a basis for standards for consistent and uniform telemedicine practices, es-
pecially in light of possible cross-jurisdictional treatment. A pan-European telemedicine system
would have greater potential of boosting development of the European telemedicine sector. The
current move of the US and the NHS to develop a world standard in clinical terminology may be a
signal of the feasibility of this. It would allow standardization of EPRs. British patients travelling to
France, for example, for medical treatment (for reasons of cost and speedier treatment) might be
able to remain in the UK and receive telemedicine services confident that the details in their
EPRs would have the same meaning in France as in the UK.
In sum, the undeveloped state of the telemedicine market and its inherent uncertainties, suggest
a positive role for governments in furthering its development. This could be through public pro-
curement, or as also noted above, by provision of a platform for the formulation of standards and
certification requirements.
Ethical standards. These must be devised to ensure that each telemedicine application involving
clinical care should provide care to the same standard as in a face-to-face situation. Clear proto-
cols and guidelines must be developed to identify appropriate parties with the rights to confiden-
tial information.
Liability of medical staff, telemedicine equipment and infrastructure provider. There must be clari-
fication on these points. For instance, can the infrastructure provider, for instance, the telecom-
munication operator, be held liable in the event of a fault in the infrastructure, which affects the
quality of the transmitted image? Malpractice liability will need to be determined in the event of
two physicians being involved in a telemedicine treatment. It is clear here that more than two par-
ties would be involved in any contractual service agreement, thus involving the insurance sector.
The development of working methods and treatment guidelines. Telemedicine is a new form of
healthcare/medical delivery with no established treatment guidelines. In order to establish guide-
lines for best practice, evaluations of working practices will need to be undertaken at regular in-
tervals, which in turn will require that performance evaluation criteria be developed. Associated
with this issue would be systematic co-ordination of staff training and staff planning. A common
core curriculum for all care professionals should be created to help alleviate any mistrust and
doubts among care professionals. This curriculum would clarify the requirements for the admini-
stration and management of telemedicine services. Resistance among doctors, nurses and other
health professionals to new equipment, practices, and methods will have to be overcome
through a series of confidence building measures.

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Information dissemination and public education. It will be important to reassure and inform con-
sumers about the changing face of healthcare delivery. To ensure that information campaigns are
effective providers of telemedicine (public and private sectors, or a mix of both) should be en-
couraged to co-ordinate information for accuracy and consistency. Information on the develop-
ment of policy and plans for implementation of telemedicine should be made available to public
and private care, and health professionals. This information could be delivered electronically or
on paper and made available in care and health agencies/offices, clinics, consumer advisory bu-
reaus, post offices, etc.
Evaluation of telemedicine pilots. In countries where pilots or trial runs are being conducted, pol-
icy makers will want to consider developing a robust evaluation methodology that could be ap-
plied to these trials to identify the quality of treatment, as well as the social, economic and medi-
cal benefits to all stakeholders. The evaluation costs could be carried jointly by the public, private
and voluntary sectors. The results of these evaluations could establish reliable evidence that
could be disseminated to the public and health professionals, and providers and suppliers.
Evaluation could help to identify good practice, which could be published.
This section has highlighted the key institutional and organizational challenges that require inno-
vative thinking to develop the telemedicine market. This market is in its infancy, although there
are pockets of developments across the European Union. The fragmentation of the market in
terms of sector makeup, may not be a major problem for the development of the telemedicine
market; the implementation and scattered small-scale clusters of activities will be more problem-
atic. Small-scale activities will not bring economies of scale for either the healthcare providers or
telemedicine solutions/equipment vendors. This is a key issue for the European telemedicine sec-
tor.
A1.1.4. The role of R&D and innovation
Telemedicine is a segment of the health sector that cuts across a number of industries, mainly
healthcare services, medical equipment, communications and computer (including software) in-
dustries. Therefore the telemedicine sector is an integrative sector, which not only involves a
number of sectors and industries, but also a variety of technologies. Underpinning the perform-
ance of telemedicine applications is the vital role of a reliable and fast communications network. It
has been noted that with the exception of wider use of sensors, store and forward applications,
and medical and public health education, and the introduction of electronic patient records and
tele-consultation, other telemedicine services are in an embryonic stage.
Telemedicine is clearly part of the service economy and if, as the OECD has argued, the service
economy is the main driver of today s economy, then telemedicine as part of the healthcare sec-
tor, itself a leading sector in the European economy, deserves more attention. The challenge for
the European telemedicine sector lies not in research but in deployment. There is ongoing R&D
and innovation in this area, for instance through European Commission and national funded pro-
jects and pilot programmes. There is also some innovative activity in the private sector exempli-
fied by the range of telemedicine solutions currently available. R&D and innovation may not be
the key challenge here, although this is not to suggest that continuing innovation in telemedicine
is not important. Indeed innovation will help to expand the range of telemedicine applications
through innovative integration of the technologies. However, even the available selection of tele-
medicine services is currently under-deployed.
Governments will necessarily drive the introduction and implementation of telemedicine. In the
case of the European Union, medical and healthcare are generally provided by the public sector.
It is clear that unless European Union Member States have the resources and the political will to
lead, drive, and help develop the market, telemedicine in Europe will continue to lag behind that
60
in Japan, Australia and the US. India appears to have recognized the potential of telemedicine
60
Since 2002, national funding in the US for telemedicine services has been reduced significantly. After 9/11, however,
additional funding was allocated for telemedicine, but to date, the funds have not been disbursed.

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and could in time prove a cheap competitor to Europe
(http://www.hospitalmanagement.net/ihfdocs/Indian_telemedi-
cine.pdf#search=%22telemedicine%20technologies%22; Chandra 2003). Recently, India has
been offering medical treatment to patients in the UK. As we noted in the Task 1 Report, a range
of IT-based services is being outsourced to India by western economies. Thus, there is a possibil-
ity that with wider implementation of telemedicine services in Europe, offshoring or outsourcing of
these services will become more attractive, which would produce some cost savings for the
Europe s health bills.
The list of institutional and organizational innovative measures or reforms that governments will
need to consider is long; in addition, resources will need to be invested in upgrades to the health-
care IT infrastructure. Unless these measures are undertaken the telemedicine sector will con-
tinue to perform sub-optimally. Telemedicine is a multidisciplinary domain, which requires con-
vergence of ethics, science, computers, communications, culture, and institutional/organizational
processes. Unless these issues are acknowledged and dealt with, the potential of telemedicine,
telehealth and e-health is still left to our imaginations (Brown 2005).
A1.2 Transport sector: Aeronautics

A1.2.1 Introduction
The aircraft industry is the main industrial sector supporting air transport services. This section
examines the aircraft industry other industrial sectors and associated service activities that are
central to the future of aeronautics and its contribution to European wealth creation.
Setting the boundaries to this area of activity is difficult . Apart from the confluence between
manufacturing and services activities, firms involved in the development and production of com-
mercial aircraft are usually also active in the space and military aircraft markets. Although military
production often has very different market characteristics and product specifications, the way that
firms combine these activities varies from company to company. For some firms it is difficult to
separate activities oriented towards the military from those targeted to the civilian market. Often
research programmes are focused on technologies that are applicable to both markets, and suc-
cess in one market may depend on the capabilities developed in the other.
The industry is a leading employer in the European Union. According to estimates from the Aero-
space and Defence Industries Association of Europe, aeronautics (both civilian and military) ac-
counted for 420,000 employees in 20 European countries61 (ASD 2005), with France and the UK
alone accounting for well over half of this total. Naturally, the level of employment related to the
air transport industry is much larger: EU employment in the aircraft industry and all jobs directly
related to the operation of aircraft including airlines, airports, air traffic control, and regulatory
bodies - amounts to some 3 million jobs (Advisory Council for Aeronautics Research in Europe
2004).
The market has grown substantially in recent years, and continuing growth is forecast resulting
from the combination of increasing volumes of air traffic (some sources estimate a rate of annual
growth close to 5% up to 2015) and the replacement of old aircraft. However, industrial capacity
is also growing and new competitors are emerging in some market segments, e.g. regional air-
craft, and various aircraft components and sub-systems. Overcapacity cannot be ruled out, and
new competitors are likely to joint the industrial giants in Europe and the US.
Although entry barriers are high, the commercial aircraft market is highly competitive and will be-
come even more so over the next decades. Customers are placing increasing demands on
manufacturers to reduce purchase and operating costs. Producers are responding with a combi-
61
The old EU15 plus the Czech Republic, Poland, Norway, Switzerland and Turkey.

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nation of technological developments allowing for savings in the operation of aircraft, and innova-
tive ways of offering long-term services to operators. Direct running costs per passenger/mile are
falling as a result of lower fuel consumption and cheaper and faster maintenance operations
(personnel and maintenance costs account for the highest percentage of direct running
costs).Also, technologies that reduce the time an aircraft needs to be grounded to perform main-
tenance and repair operations, allow the operator to use it more intensively and therefore extract
higher revenues from its capital investment. Innovation is a crucial factor for competitiveness in
the sector and aeronautic firms are research intensive organizations, typically investing between
10% and 20% of their turnover in R&D.
A1.2.2 Main drivers affecting the sector

Several of the drivers identified in Task 1 have a significant influence on the development of air
transport and the commercial aircraft industry. Some drivers identified in Task 1 point to in-
creased demand for transport; both for goods and people. These are globalization, environment
and security, which are discussed below.
Globalization
Globalization, however defined, is built on growing international travel. Air transport is the crucial
factor in this pattern, and growing international air travel is expected to increase demand for air-
planes and the associated products and services needed to operate large fleets of commercial
aircraft. Yet, air transport is often singled out as a major source of greenhouse gases and as a
generator of air and noise pollution, all of which have negative environmental impacts on locali-
ties close to airports and congested air lanes. There has long been a debate on the extent and
nature of the environmental effects of air travel. The industry points out that aircraft emissions
account for only 4% of total greenhouse gas emissions. Yet, this 4% could be potentially signifi-
cant because (1) gases deposited in the upper atmosphere can have a greater global warming
effect than those deposited closer to the surface; and (2) the exhaust gases from jet engines in
addition to carbon dioxide can have a much greater impact on the atmosphere than carbon diox-
62
ide alone. These effects are not completely understood and there is ongoing scientific and po-
litical debate on the impact of aircraft emissions in the upper atmosphere and the potential for
technological change to reduce it.
The environment
The environmental drivers identified in this report are both spurring technological development in
the aircraft industry and posing a major threat to its future development. There is strong pressure
on aircraft and jet engine manufacturers to develop new, more energy-efficient and lower emis-
sion means of air transport. The industry is optimistic about what can be achieved through tech-
nological improvements: fuel consumption per mile flown is forecast to fall by 40%-50% over the
next 50 years (Foresight Defence Aerospace and Systems Panel 2000), continuing the trend that
has seen aircraft fuel consumption half since the 1960s (AECMA 2001). These trends are pro-
jected on the basis of continuing technological advances in several interrelated fields including
new materials (smart structural materials, ceramics, coatings), lower-fuel burn engines, and
aerodynamic improvements.
Yet, the projected growth of air travel could cancel out any environmental gains that might accrue
from increased fuel efficiency. Proposals from environmentalist groups to curtail air travel through
63
increased taxation are gaining political currency. From their perspective, success would be a
reduction in air travel. However, this would have a knock-on impact on the aircraft industry, and
62
See for instance, GAO (2000).
63
The Swedish government has announced that it plans to impose a flat environmental tax of up to 45 on all passen-
gers arriving and departing from Swedish airports. Other governments such as France s, are proposing levying taxes on
air travel for other reasons than environmental objectives.

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on all travel-related services. The potential economic consequences of a reduction in air travel
have not been analysed in detail,64 but we know that the regional effect would be severe: aero-
space industries tend to be concentrated in regional clusters, and any downturn in the industry is
likely to have profound local effects in, for instance, the South-West of England, and Southern
France, where large industrial aerospace clusters have developed over recent years.
Security
Security concerns and the threat of terrorism are other factors that may affect the growth in air
travel. The effects of terrorist attacks on air travel are profound: a temporary fall in passenger
numbers followed the attacks of 9/11 and new and costly security measures had to be introduced
worldwide. Even a foiled attack can have profound consequences. The recent events in the UK,
following the discovery in July 2006 of a threatened attack possibly using liquid explosives cam-
ouflaged as beverages, brought about the immediate introduction of new security measures in all
UK airports and resulting chaos, as airports struggled to implement the new regulations. In-
creased efficiency in the management of customer flow in airports is crucial to the success of the
sector and is one of the long-term objectives set by the Advisory Council for Aeronautics Re-
search in Europe (ACARE). ACARE established a target to reduce the time spent by passengers
in airports to under 15 minutes for short-haul flights, and 30 minutes for long-haul flights (Advisory
Council for Aeronautics Research in Europe 2004,18). Yet, as a direct consequence of the new
security checks, in August 2006 UK airports were recommending extended check-in times of up
to 3 hours for European flights, and the possibility of Internet check-ins has been, for the time
being, practically abolished. These events illustrate the vulnerability of airport management to
changing security conditions. All research programmes on aeronautics and air travel now include
extensive research on security measures, from passive measures, related for instance to air-
frame structural strength, to active measures such as new monitoring equipment for airport secu-
rity and baggage screening.
A1.2.3 Market trends

Sector composition
The aircraft industry can be described as a multi-technology sector . Aircraft are highly complex
systems incorporating tens of thousands of different components and building on the knowledge
from many different scientific disciplines and technological fields (aerodynamics, electronic sys-
tems, new materials, structures). The need for technology integration poses significant innovation
challenges. No single firm can develop and control all the technologies needed for aircraft devel-
opment and firms have to rely on the technologies developed by suppliers. Multi-firm collabora-
tion arrangements and intensive technology transfer processes that characterize the open inno-
vation models analyzed elsewhere in this report are an essential trait of aircraft development and
manufacture. The more efficient a collaborative network, bringing together supplier firms and air-
65
craft system assemblers, the more competitive that network will become.
Large aircraft manufacturers such as Airbus, depend on how collaboration across dispersed sites
within and outside the corporation is organised. Advanced ICT systems exist to facilitate real-time
collaboration in product design, and complex configuration management tasks over the life-
cycle of an aircraft. However, the uptake of all the capabilities that these tools potentially offer has
been slow (Tang and Molas-Gallart 2005). There are concerns related to cost, and their potential
negative implications for Intellectual Property protection.
64
The Association of European Airlines claims that the proposal to reduce air travel in Europe by 25% would represent a
loss of 83,000 jobs in direct employment alone, i.e. in airlines and airport services (Association of European Airlines
2006,15). This does not include the indirect effects on the aircraft industry, and the local effects in regions that have come
to depend on tourism and air travel for their development.
65
The importance of the complex of web producers, distributors, users, and product maintenance organizations to the
success of a product, and the implications for industrial strategy have been analyzed using concepts such as industrial
ecology and ecosystems (Iansiti and Levien 2004).

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There has been progress made in the development and implementation of ICT networks to sup-
port commercial transactions within the supply chain. The aerospace industry was one of the
early developers and adopters of Electronic Data Interchange (EDI) systems and the importance
of these and other e-commerce systems for the management of supply chains and, conse-
quently, industrial competitiveness, has long been recognized in industrial analyses and foresight
exercises (Foresight Defence Aerospace and Systems Panel 2000). Yet, the development of B2B
systems and portals has been problematic. A swarm of commercial exchanges, many unsuccess-
66
ful, were set up at the turn of the century. The most successful of these initiatives is Exostar, a
joint venture launched by BAE Systems, Boeing, Lockheed Martin, Raytheon and Rolls Royce.
Exostar has been responsible for the establishment of hundreds of procurement systems linking
over 16,000 firms and development of other systems for commercial and technical data ex-
change. It has mainly been involved in US and UK procurement programmes. The diversity of
portals and procurement systems imposed by systems assemblers and final customers, poses a
problem for small and medium-sized suppliers working with several customers, and may lead to
market fragmentation. The development and impact of B2B initiatives in the aerospace market
has received relatively little attention during the last few years, particularly when compared with
the huge interest they engendered between 1999 and 2001.
Eventually, the development of more efficient and comprehensive ICT networks to support prod-
uct development and production will facilitate the dispersion of R&D and manufacturing activities
in distant locations, and will, therefore, make outsourcing an even more viable possibility for sys-
tems assemblers. This development can be considered a threat to niche subcontractors, who
derive competitive advantage from their geographical proximity to the system assembler sites.
Yet this does not translate into a threat for the totality of the European aircraft industry. An effi-
cient, global supply network will improve the competitiveness of the prime contractor and provide
a robust ecosystem guaranteeing long term survival of its products. Further, smaller third and
fourth tier suppliers could also outsource part of their manufacturing activities to cheaper coun-
tries (Bravura Consulting 2004). The organizational and technological capabilities needed to set
up an international supply network are valuable, scarce and very difficult to imitate and repro-
duce; in other words, they can provide a basis for long-term competitiveness of aircraft systems
assemblers located in Europe.
Service economy
The importance of service provision in the future development of the aircraft industry cannot be
underestimated. This section addresses two areas where service provision will determine the fu-
ture industrial development of the sector. The first is directly related to the aircraft industry and
the second refers to the environment in which aircraft operate and may affect future demand for
aircraft.
The provision of Repair, Maintenance and Overhaul services
The suppliers of aircraft (both commercial and military) are assuming the tasks of support and
maintenance previously the responsibility of aircraft owners. In the past large aircraft operators
had their own in-house maintenance facilities, and the manufacturer s responsibility was limited to
the supply of aircraft and spare parts. Customers have increasingly focused on the core activity
of running aircraft fleets, and are transferring maintenance and support activities to system sup-
pliers. Operators are interested in controlling, and being able to plan, the costs of owning aircraft.
The purchase price is a small part of the cost of owning and operating aircraft throughout their
66
A group of commercial airlines and operators (Air France, American Airlines, British Airways, Continental Airlines, Delta
Air Lines, Iberia Airlines, SAirGroup, United Air Lines and United Parcel Service) set up AirNewCo. Many firms set up their
own web-based trading portals. MyAircraft is a joint venture among United Technologies Corp., Honeywell International
Inc., BFGoodrich Co. and solutions provider i2 Technologies. Raytheon set up EverythingAircraft.com, TRW Aeronautical
Systems established aerospares.com, Airbus Sup@irWorld, Boeing Exostar Market Place, Thales Exindus supplier portal,
Dassault Aviation F7X Virtual Plateau, the French Ministry of Defence «Armement Portal», etc.

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life-cycle, and maintenance expenses are much higher than the acquisition price.67 Operators are
therefore seeking long-term maintenance contracts that will reduce the uncertainty and risks as-
sociated with aircraft ownership.
Suppliers are seeing this trend as a substantial commercial opportunity: a new market is opening
up requiring new skills and organizational capabilities. Systems assemblers have moved from a
traditional prime-contracting role to the provision of customized services (Davies and Tang 2000).
In some case, operators are buying hours of flying time from the manufacturers: for several years
Rolls Royce has been operating the well-known (and trade-marked) power-by-the-hour concept,
whereby users pay for the hours they fly an engine and Rolls Royce commits to providing a
specified level of service. Many other companies have set up service divisions to improve their
capabilities in these emerging markets68 and have developed new product offerings encompass-
ing maintenance, repair and overhaul tasks.69 These approaches are likely to become increas-
ingly common as life-cycle support and maintenance contracts spread to commercial aviation.
This shift to services and solutions (Davies et al. 2001) calls for corporate strategies oriented to
building new core skills and realigning industrial activities within the corporation and the supply
networks. The mix of activities that characterize these approaches does away with the traditional
differentiations between manufacture and service sectors, and makes it inappropriate to define
policy actions along the sectoral boundaries that typified industrial activities and accompanying
policies in the twentieth century.
Air traffic control services
Air traffic (ATC) control is a key factor in the ability of commercial aircraft operators to work effi-
ciently and to reduce the environmental impact of air travel. Increased numbers of flights have
been accompanied by congestion problems and economic, safety, and environmental implica-
tions. The number of flights in European skies that have experienced delays has grown steadily
over the last ten years. Every day, hundreds of aircraft are obliged to circle airports waiting for a
landing slot, which has an environmental impact and incurs economic losses. Congestion results
in averaging routes by assigning to airlines sub-optimal flight profiles equivalent to driving long
distances in third gear (Association of European Airlines 2006,19) with consequent waste of fuel
and associated environmental impact.
ATC systems will have to improve if they are to deal with further traffic increases. For example,
modern systems can reduce the space between aircraft while maintaining safety, and allow a
faster rate of take-off and landing at airports. This can reduce aircraft congestion on airport ap-
proaches, a serious problem for large international hubs. Part of the challenge is organizational
and institutional: to develop an integrated European ATC system means breaking with the com-
plex architecture that patched together an arrangement composed of national systems, using dif-
70
ferent standards and procedures. It has been estimated that the fragmentation of European air-
space costs between 880 million and 1,400 million (Helios Economics and Policy Services
2006). Currently, initiatives are under way to create an integrated, single control system in
Europe. The European Commission has launched the Single European Sky initiative to improve
the management of European air space by achieving an integrated air traffic management archi-
tecture.71 Yet, this raises questions of national control and other problems, as the move away
from national airspaces will affect the status of current national ATC service providers.
A significant part of the challenge is technological. The development of modern ATC centres can
be an extremely complex and costly endeavour, involving system integration problems that can-
not be easily solved with current processes and tools. This is being recognized by the European
67
It is estimated that defence and aerospace companies extract 75% of their revenue from maintenance and other after-
market sales.
68
For instance, BAeSystems set up a Customer Solutions and Support division (targeted to the defence sector) and
another Customer Solutions division for the US market (both military and civilian).
69
For instance, since 2002 Honeywell has offered an Integrated Services Solutions (ISS) programme providing mainte-
nance, logistics and spare parts management for airlines.
70
In 2000 the EU had 68 ATC centres using 22 different operating systems.
71
In its current definition, the Plan envisages a Development Phase of 2008 to 2013 and a deployment phase 2014 to
2020.

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Commission. Almost two-thirds of the first tranche of projects funded up to 2000 under the FP 5
new perspectives on aeronautics key action addressed aspects of air traffic management, in-
cluding, for instance, the modelling of traffic flows, new tools for aircraft positioning, and new in-
strumentation (Europe Under a Single Sky 2000).
A1.2.4 Institutional matters, organisational change and research priorities

The aircraft industries, and all associated industrial and service activities needed to support air
transport are a large employer. If the demand for air travel continues to grow, and therefore the
market for civilian aircraft can be sustained in the long-term, the industry will be able to maintain
its important role as a developer and first-user of new advanced technologies. European firms are
well-positioned within these markets and should play a central role in the global aerospace indus-
tries. The technological fields in need of research investment have been the subject of many
studies and foresight initiatives. For instance, in the European Union, the Advisory Council for
Aeronautics Research in Europe was founded following the recommendation of the Vision 2020
report on the future of air transport published in 2001. The Council was tasked with identification
of long-term research priorities and needs, and has published two major reports defining priority
research areas, which are comprehensive and forward looking reports and propose various sce-
narios and long-term projections (2020, 2050). The analyses consider the development of 10
technological areas: flight physics, aerostructures, propulsion, aircraft avionics systems and
equipment, flight mechanics, integrated design and validation, air traffic management, airports,
human factors, and alternative concepts and scenarios (Advisory Council for Aeronautics Re-
search in Europe 2004). Within this field this, and other studies, have identified several areas in
need of further research, including:
Systems to track aircraft without the need for transponders
Advanced navigation systems
High-performance air-ground communication links
Advanced simulation systems, synthetic environments
Human factors analysis for pilot workload
Air traffic models. Models for optimising take-off and approach patterns
Dynamic systems for traffic allocation
Real time detection equipment for airport security, including systems for the detection of
biological and chemical materials
Crisis management systems
Vehicle movement controls, and vehicle inspection technology
Airport surroundings surveillance systems
Passenger identification and control systems
Biometric recognition systems, smart card travel documentation
Airport infrastructure design
Advanced systems for the detection and avoidance of air turbulence
Optimised air frame design
Low noise drag generation
Adaptive winglets
New materials for weight reduction and reduced fuel consumption
Flexible machining equipment
Noise shielding designs
Bomb-proof cargo containers
High temperature materials and coating for jet engine components
Lean combustion technologies
Low-powered de-icing devices
Engine controls for noise reduction
Smart maintenance systems.

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However, the most important factors supporting future industrial development and competitive-
ness in this area, identified in this section, are often of an organizational and institutional nature.
Organizational innovations will be required to improve the efficiency and competitiveness of air-
craft systems assemblers and their supplier networks. Institutional changes will be required if a
European integrated ATC system is to be established. In this highly competitive, high-technology
industry, R&D investments are absolutely necessary if European firms are to maintain their com-
petitiveness against established rivals in the US, emerging niche prime contractors in countries
like Brazil, and increasingly numerous and efficient subcontractors worldwide. The high rates of
R&D investment, covering a broad range of technologies, will need to be maintained. If organiza-
tional, institutional and managerial issues are not addressed, there is a risk that the results of
technological research investments will not find commercial success. The capacity to manage
systems integration and open innovation systems in an international context is crucial to the suc-
cess of the industry, as it increases the efficiency with which air traffic and airports are managed.
Areas where research is needed include:
The institutional background to the fragmentation of air traffic management systems.
along national lines in the EU, and the political processes needed to facilitate the single
skies agenda.
The development, implementation, and harmonization of airport security procedures
The analysis of the difficulties in the implementation and operation of B2B and electronic
commerce portals. Identification of success and failure factors. Their impact on SME
suppliers.
The capacities that aerospace SMEs would require to be able to develop outsourcing op-
erations.
The identification of regulatory and managerial barriers to the implementation of IT-based
tools to support inter-organizational collaboration. Development of policies to support the
international diffusion of technical data interchange and collaboration tools.
Analysis of current and future demand for integrated services: How is the structure of air
transport operators changing and how will this affect the tasks being requested by prime
contractors? What are the strategies that aerospace firms need to develop if they want to
move from a focus on systems assembly to a focus on service delivery.

The aircraft industry is main industrial sector supporting air transport services. The market has
grown substantially in recent years, and industrial estimates forecast continuing growth as a re-
sult of the combination of increasing volume of air traffic and the replacement of old aircraft. The
aircraft industry can be described as a multi-technology sector . Aircrafts are highly complex sys-
tems that build on knowledge from many scientific disciplines and technological fields. The need
for technology integration poses significant innovation challenges. The multi-firm collaboration
arrangements and intensive technology transfer processes that characterize the industry in a
fashion that fits the open innovation model. The barriers to entry are high but the commercial
aircraft market is very competitive and will become more so over coming decades. Customers
demands for manufacturers to reduce purchase and operating costs are increasing. Differentia-
tion and increased productivity innovation are crucial for competitiveness in the aeronautic sector.
Firms in the sector typically invest between 10% and 20% of their turnover in R&D.
As mentioned above the main drivers of the sector growth are globalization, environmental and
security issues. Globalization is built upon increased international travel. Air transport is the cru-
cial factor in this pattern, and growing international air travel is expected to increase demand for
airplanes and associated products and services. Environmental drivers are both spurring techno-
logical development in the aircraft industry and posing a threat to its future development. There is
strong pressure on aircraft and jet engine manufacturers to develop more energy-efficient and
lower emission means of air transport. Security concerns and the threat of terrorism are addi-
tional factors that may affect the growth of air travel.

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[The importance to which service provision will be a key factor in the future development of the
aircraft industry cannot be underestimated.] Service provision will become extremely important to
the future development of the aircraft industry. Suppliers of aircraft (both commercial and military)
are taking over support and maintenance tasks that previously were the responsibility of aircraft
owners. Systems assemblers have moved from a prime-contracting role to customised service
provision. These features will become increasingly common as life-cycle support and mainte-
nance contracts spread to commercial aviation. Similarly (ATC) is a key factor for efficient com-
mercial aircraft operation and reduction of the environmental impacts of air travel. Congestion has
become a major problem and ATC systems will have to be substantially improved to cope. First,
there is an organizational and institutional challenge to develop an integrated European ATC sys-
tem, which means breaking with the complex architecture that patched together an arrangement
of national systems, using different standards and procedures. Second and equally important will
be the technology. The development of modern ATC centres will be complex and costly, involving
system integration problems that cannot be easily solved with current processes and tools.
There are ten technological areas that will need research on new processes and tools: flight
physics, aero-structures, propulsion, aircraft avionics systems and equipment, flight mechanics,
integrated design and validation, air traffic management, airports, human factors, and alternative
concepts and scenarios. Yet, the most important factors supporting future industrial development
and competitiveness in this area that we have identified in this section are often of an organisa-
tional and institutional nature. Organizational innovations will be required to improve the efficiency
and competitiveness of aircraft systems assemblers and their supplier networks. The high rates
of R&D investment, covering a broad range of technologies, will need to be maintained. Yet,
without addressing organisational, institutional and managerial issues, there is a risk that the re-
sults of technological research investments may not find commercial success. The capacity to
manage systems integration and open innovation systems in an international context is crucial to
the success of the industry, as it is the capacity to increase the efficiency with which air traffic and
airports are managed. The organisational and technological capabilities needed to organise an
international supply network are valuable, scarce and very difficult to imitate and reproduce; in
other words, they can provide the basis for long-term competitiveness of aircraft systems assem-
blers located in Europe.
A1.3 Environmental sector

A1.3.1. Introduction
The accelerated growth of the environmental technology sector can be traced back to the early
seventies after the Stockholm conference (see www.unep.org). The economic effects of the de-
ployment of environmental technologies stimulated via regulation have been the subject of de-
bate for more than a decade. The overall results concerning the net effects of environmental
regulation are still inconclusive from the perspective of the sectors forced to adopt environmental
technologies .72 The environmental sector has been seen by industry as an added burden and, in
some instances, as negatively affecting competitiveness. For example, sectors that have been
heavily regulated are iron and steel, pulp and paper, energy, transport, construction, etc. When
looking at the effects of the environmental sector development at national level in terms of jobs
creation and market size the picture changes. In contrast to other sectors that to a large extent
came about as a result of regulation - for instance, insurance services, health and safety - envi-
ronmental technologies have traditionally faced strong resistance from industry. It is only recently
that the sector has been seen in a more positive light, and especially in countries that are net ex-
porters of environmental technologies. As in case of the two sectors reviewed above, the envi-
ronmental technology sector is an economic activity that is firmly integrated in the inter- and intra-
72
For a review of the literature see Montalvo (2002).

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trade of intermediate goods. Its sophistication and innovative advances depend on new enabling
technologies from other sectors. For example the use of a combination of geographic information
systems (GIS) and remote sensing via satellite has become the norm in the management and
monitoring of forests, minerals, fishing banks, traffic, emissions, surface water, etc.
A1.3.2. Environmental technologies

Definition of the sector is still being debated in terms of its legal, financial and competition impli-
cations. The sector has been defined by the technologies and services it provides to the econ-
omy. The most commonly used definition is that quoted in COM (2004) in the European Environ-
mental Technologies Action Plan. According to COM:
Environmentally sound technologies protect the environment, are less polluting, use all
resources in a more sustainable manner, recycle more of their wastes and products, and
handle residual wastes in a more acceptable manner than the technologies for which
they were substitutes. Environmentally sound technologies in the context of pollution are
process and product technologies that generate low or no waste, for the prevention of
pollution. They also cover end of the pipe technologies for treatment of pollution after it
has been generated. Environmentally sound technologies are not just individual tech-
nologies, but total systems which include know-how, procedures, goods and services,
and equipment as well as organisational and managerial procedures. (COM, 2004)
Similarly the OECD s (2003) report on the global environmental goods and services industry the
environmental sector includes the production of goods and services that span pollution control
and clean-up technologies, to recycling and professional services. So far, the sector has been
described as being constituted by those goods and services that provide environmental protec-
tion in domains such as: water, solid waste, air, soil, noise, natural resources, etc. According to
the OECD (2003) the sector is integrated by: 73
Environmental equipment
waste-water treatment equipment;
waste management and recycling equipment;
air pollution control equipment;
noise reduction equipment;
monitoring instruments, scientific, research and laboratory equipment;
natural resource conservation/protection and urban amenities.
Environmental services
waste-water operations;
waste handling and facility operations;
air pollution control operations;
noise reduction operations;
analytical, monitoring and related conservation and protection services;
technical and engineering services;
environmental research and development;
environmental training and education;
accounting and legal services;
consulting services;
other environmental business services;
other: eco-tourism.
73
For a further description of each of these areas of activity see OECD (1999).

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Cleaner production technologies and pollution prevention practices occur frequently across all
sectors. Despite the broad scope of application of cleaner technologies and the impact on the
technological structure of some sectors, cleaner technologies are not captured explicitly in the
industrial classification system or in any national account systems (input-output tables). Many
products like more efficient power trains, biodegradable packing and detergents, lighting, isolation
materials, heat pumps, and new forms of production are not accounted for in the environmental
sector. Currently there are several research projects being financed by the EU Commission (DG
Research) to explore what are eco-innovations, and establish a typology that could lead to a reli-
able accounting of the sector s participation in the economy.74
A1.3.3. Market trends

Sector composition
The global environmental technologies market reached approximately $US556 billion in 2003
75
(Globe Net, 2005). Recent estimates project a total value of $US850 billion by 2010. With vary-
ing numbers, some estimations indicate that environmental technologies (or eco-industries) in
Europe employ over 2 million people. European firms participating in the global market account
for about one-third and are growing at 5% per year (COM 2006). Figure 7 shows the size of the
main global markets in 2003 and market segmentation per application type in 2005. The US
(40%), the European Union (31%) and Japan (17%) are the leading exporters and have the larg-
est internal markets of environmental technologies. The market in Europe reached $ US165 bil-
lion in 2003. The environmental technologies sector is expected to generate large business op-
portunities in the near and long-term. If we look at traditional segmentations of the market, the
largest business areas are wastewater treatment, and environmental instrumentation.
Resource
E. Europe; Canada; Remediation
13,6; 3% management
10,9; 2% 5% Cleaner
10%
Solid waste technologies
L America; Asia; 27,1; 5%
9,3; 2% 13% 1%
Monitoring
15%
Japan; 92,4;
17%
US; 214,5;
40%
W Europe; Noise
Wastewater 12%
165; 31% 34%
Air
10%
Figure 7. Environmental technologies: World markets and market segmentation (US Dollars)
Sources: POPA-CTDA Project synthesis report (2006).
Water and wastewater treatment presents the greatest opportunities in the global market. The
global water market has been growing rapidly over the last decade and accounts for 34% of the
world s total environmental market. This is followed by solid waste management (13%), noise
control (12%), and emissions control (10%). Globally, the environmental monitoring and instru-
74
See, for example, ongoing research projects: Eco-Drive (leader Leiden, G.Huppes) and Exipol (Leaders TNO-
A.Tukker; U.Bath A.Markandya)
75
Excluding cleaner technologies.

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mentation (and closely related information systems) market has an estimated value of $US7.1
billion. It is in this area that innovation occurs most frequently in automation of equipment and
information technology applications. Given the trends in energy, water, and raw materials con-
sumption and generated waste, and expected growth demand from emerging economies shown
in task one, it is very likely that the demand for pollution control, sanitation, and environmental
services and equipment in general, will increase sharply in the next decade. The area ( i.e.,
cleaner technologies) that promises best results in terms of long term competitiveness and envi-
ronmental protection is currently surprisingly low (1%). As mentioned above, the inclusion of
cleaner technologies in national accounting systems has still not been defined to include all types
of eco-innovations. Thus the numbers are likely to misrepresent trends in the sector.
A1.3.4. Main drivers affecting the sector

In Task one several of the global drivers identified have influenced the development of environ-
mental technologies, and the sector as a whole. On the demand side, over exploitation of natural
resources, population growth, energy consumption, materials usage and waste, water consump-
tion and management, mobility and urban concentration and more recently, climate change,
globalization and trade are highlighting the need for control of the secondary and tertiary effects
of human activities on the environment. On the supply side, the appearance of new technologies
has enabled advances in sophisticated environmental technologies. Examples include advanced
process technologies, new energy technologies, nano-engineering, novel materials, sensor and
computed retrofit systems, etc. Despite the obvious undesired consequences of economic activi-
ties on the environment, the diffusion of environmental technologies has been traditionally driven
by government intervention regulation based on the enforcement of standards applied to polluting
firms or users of polluting products. In addition, government intervention has resulted in invest-
ments in large infrastructural projects such as drinking and waste water treatment facilities in de-
veloped and developing countries.
While the drivers of traditional environmental (end-of-the-pipe) technologies are fairly evident in
the environmental policy and regulation since the mid 1970s, the drivers of newer environmental
76
technologies related to new products and processes is far more complex. While compliance
behaviour has clear targets and costs, the development and adoption of new products and proc-
77
esses fall in the category of innovation. In this case the process of environmental protection via
innovation has characteristics of an open ended process that carries risks in relation to invest-
ments and potential outcomes. Public policy will likely be less successful in promoting innovation
in cleaner technologies via taxes, subsidies or standards, when targets concern radical modifica-
tion to products and/or processes.
The current share of cleaner technologies in the total market of is minute but can be expected to
change radically in the next 10 to 20 years. Montalvo et al. (2006) conducted a survey in seven
technological clusters at the firm level in Europe, on the factors affecting the development and
adoption of clean technologies,. The outlook for the drivers of innovation is projected to improve
78
dramatically in the next 10 years. Figure 8 depicts expected trends in a number of drivers and
the propensity of firms to engage in innovation. On average, all drivers identified (and the associ-
ated propensity to innovate) are expected to shift upwards, thus generating better conditions and
more pressure for innovation.
76
See Montalvo (2006) for a review of the literature on the drivers of eco-innovations at firm level.
77
As defined by Abernathy and Utterback (1975).
78
Figure 8 shows the rational expectations of a group of respondents that include regulators, developers and adopters of
new cleaner technologies in Europe. A large variety of rational expectations were classified and clustered in 10 domains
depicted on the RHS of Figure 8. The survey included cleaner vehicles, renewable energies, energy efficiency in build-
ings, white biotechnology, biorefineries, stationaire fuel cells and biofuels.

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Very
high 7 Willingness to innovate
Developers
All
(Cleaner Vehicles) Environmental Risk
6
Economic Risk
5
Regulatory Pressure
4 Community Pressure
Market Pressure
3
Technological Capabilities
2 Organisational Learning
Strategic Alliances
Very
low 1
2005 2010 2015 2020 2025 2005 2010 2015 2020 2025 Networks of Collaboration
N=356/2440 N=18/22
Figure 8. Rational expectations concerning drivers of innovation to the year 2025 (firm level).
Source: POPA-CTDA Project synthesis report (2006).
The graphs show scores achieved for the whole sample and give an example of scores achieved for cleaner vehicles.
Factors such as perception of environmental problems, regulatory pressures, and market pres-
sures (from competitors and customers); and the technological capabilities in-house, availability Comment [CL1]: this is not a
of enabling technologies and outsourcing of new knowledge through alliances and collaboration sentence .
are all expected to rise in the next 20 years. In the case of economic risk it is expected that the
factors influencing it, such as new business opportunities, willingness to pay for cleaner more
expensive products, technological risk, availability of venture capital, will present optimal condi-
tions, reducing the currently perceived economic risk in the development of new cleaner tech-
nologies. Similar patterns were found in the seven technological cluster investigated. For exam-
ple, in the case cleaner power trains, the trends in the different drivers clearly indicated that both
producers and users of new power trains expect the competitive, regulatory and consumer con-
text to demand cleaner vehicles. These demands will be coupled with more complex and urgent
environmental transport related problems and will be opening new opportunities for business,
and lower the economic risks of investment in new production and distribution platforms.
This increased pressure is confirmed by the warnings from EU Commissioners to the automotive
industry in Europe that stringent regulation will be implemented in Europe s automotive markets if
the manufacturers of automobiles do not meet the agreements made concerning CO2 emissions.
This warning was echoed in the US by the government of the State of California which sued the
major manufacturers (General Motors Corp., Ford Motor Co., Toyota Motor Corp., the U.S. arm of
Germany's DaimlerChrysler AG and the North American units of Japan's Honda Motor Co. and
Nissan Motor Co. Ltd.) for damages related to emissions from automobiles (Scientific American,
2006). Thus innovation in mass production of cleaner technological options will become impera-
tive in the medium an long term in the automotive industry.
A1.3.5. Institutional matters, organizational change and research priorities

As Task one of this study showed, given the global and market trends in traditional environmental
technologies the business opportunities are huge. Does European industrial policy effort should
focus mainly on supporting competition in current markets or are we looking at the role of innova-
tion to create new markets? In contrast with the other two sectors examined, finding a specific
activity in the environmental technology sector to demonstrate the role of R&D and innovation is
not straightforward. in terms of whether the European environmental industry can remain com-
petitive in the long term? Here three issues worth to comment on. First, the industrial classifica-
tion of the sector urgently needs refinement. Second, there is a question over where policy efforts
should be focused - in current or lead markets? Third, traditional environmental technologies (to a

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large degree cleaner technologies also) do not address the global challenges posed by environ-
mental degradation in the long term. Out of these analysis of these three issues we can start to
define the role of R&D and innovation to renew and maintain in the long term the competitiveness
of European industries with an stake in the business generated by environmental sustainability
(this industry will not necessarily be the traditional environmental industry that account for 99% of
the market segmentation)..
Industrial classification of the environmental sector
Currently, there are two classifications of environmental technologies and services, which are
incompatible and misrepresent the sector complexity (e.g., Eurostat COMEXT and OECD Envi-
ronmental good and services Manual 1999). The lack of an accurate definition of environmental
technologies and an accurate industrial classification has legal consequences. For example, Hun-
tala (2003) in a series of articles reported that lack of an accurate definition of eco-innovation (or
cleaner production) has hampered access to loans and capital to upgrade facilities and equip-
ment in diverse parts of the globe. Similarly, availability of special tax regimes that discount in-
vestment in environmental protection over short time periods may be subsidising industry upgrad-
ing of production processes, in order to become more competitive. This may have implications
for international trade and competition law.
Competition in the markets or for the markets
Currently competition in the sector to a large extent occurs in the markets , but also to some de-
gree occurs for the markets . In current markets long term financial services and turn key pro-
jects characterize the typical medium and large size pollution control, sanitation and renewable
energy systems. Thus provision of economic resources to purchase facilities and equipment is a
strong component of firms competitiveness , where, despite existing regulation, the best avail-
able technology plays a small role in the decisions about what is finally installed in a factory or
municipality. For example, water treatment technologies are mature, and competition is mainly
based on price of equipment and the cost of capital needed. Many city governments across the
world are contracting for water treatment services (both drink and waste waters) with foreign in-
vestors, with the promise that this will be kept in place for up to 30 years The main global players
are well established (US 40%, Japan 20%, EU 30%, OECD 2005).
Following the analysis in the same segment, because water technologies are mature, mastery of
the technology requires only basic skills in few engineering fields. Thus, any country can in the
course of 5 10 years acquire sufficient skill (knowledge via reverse engineering) to compete
nationally and internationally provided that their companies have access to cheap venture capital.
Currently, firms working on traditional environmental technologies operate across diverse sectors.
In contrast, cleaner technologies are frequently sector specific, and particularly in relation to
modification of products and processes where in-depth knowledge of the technology relevant to
the sector is necessary. In depth knowledge in cleaner production systems is closer to what was
defined in Task two as the five dimensions that ensure competitiveness in the long term.79 Where
should the European eco-industry be in 15 years? What are the lead markets in the sector?
How clean is clean enough?
Despite the great business opportunities and potential for growth, the type of technologies (hard-
ware) mentioned above do not represent a solution for the long term protection and sustainability
of the environment. The reason is that once pollution has been generated, its control fails in the
long term; substances eventually escape containment and mingle, travelling from one physical
medium to another (see Figure 9 below). If, for example, pollutants are released into water and
are subsequently controlled through settlement, filtration and/or flotation, these treatments pro-
79
Valuable, scarce, non imitable or imperfectly imitable, substitution free or quasi-free, and non-separable forms of the
system where embedded.

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duce not just clean water, but also sludge. This must then be treated either by incineration
thereby being transformed into gases that pollute the air or confined, either in landfills or more
specialized facilities from which there is percolation through the soil and eventual return to ground
water. If the pollutants are released directly into the air for subsequent control through filtration,
adsorption or gas washing, a side-product is still produced, i.e., the captured pollutants, which in
turn need to be treated via incineration or confinement, thus repeating the cycle described in the
case of wastewater treatment. In other words, by whichever route, pollutants are always mixing
with, or have the potential to return to, the environment (Montalvo, 2002).
Furthermore, the industry that produces and promotes

Air these end-of-pipe technologies is just another interde-
pendent link in the supply chain system. As a conse-
Sludge
quence, it poses the same problems of pollution creation
Particles
incineration filtration even as it produces technical fixes aimed at pollution
Gas washing Pollutants Emissions abatement. The largest segment of the environmental
technology market (wastewater treatment) is a good ex-
ample of such interdependence, since it is at the centre
Water Soil of virtually all integrated pollution control systems for air
Sludge
disposition
or soil. Typically a wastewater treatment facility is inte-
Compounds grated by tanks (concrete, metal or plastic), an electro-
percolation
mechanical system to pump water in and out and to ad-
Figure 9. Cross mediums pollution cycle minister and mix chemical reagents, and a control system
Source: Montalvo (2002) for water flows, doses of chemicals, pH levels, and the
quality of treated water at the system s outflow. The
manufacture of the tanks is linked to the cement, steel, plastics and coating industries; the elec-
tro-mechanical system is linked to the metal-mechanic and electrical industry; and the control of
the purification of water is linked to the electronics industry.
As any possibility for innovation in wastewater treatment hardware is dependent upon these sup-
plier industries, end-of-pipe technologies cannot provide a solution to the problem they are in-
tended to solve. Rather, they simply extend the chain of problems. Similar problems to innovate
are faced in segments of this sector, such as air pollution control and cleaning up equipment and
facilities. It is not surprising that the core segments of the sector (pollution control in water, air
and soil) are characterized by stagnation in technological paradigms that are 20-30 years old.
The biggest technical advances have occurred in the application of information technologies to
monitoring and instrumentation.80

We have seen that the environmental sector has become important in terms of GDP and that
Europe is one of the big global players, accounting for 30% of the global market. The market in
traditional environmental technologies and services is projected to grow to 54% by 2010. This
increase is a response to environmental degradation and mismanagement of natural resources
and raw materials across the globe. There seems to be a real concern about the future and sus-
tainability of human life. The outlook for new cleaner technologies is very positive at least in the
eyes of the participants in the survey (Montalvo, et al., 2006) in terms of investment in the de-
velopment and adoption of cleaner technologies at firm level in the next 15 years. However, in
contrast to this positive outlook, we have also noted that the technologies in the sector are ma-
ture and catch up by emerging economies will be relatively rapid. We have also shown that the
technologies that underpin the environmental sector will fail to meet the future challenges of envi-
81
ronmental sustainability. What is the role of R&D and innovation here?
80
The expression technical advances is used here because the production and decommissioning of IT hardware has
also its environmental dark side (see Gassert 1985; Miljøproject, 2005).
81
Contrary to reports indicating that the problem of sustainable manufacturing is primarily located in the political and mar-
ket arenas (e.g., Futman 2004; Miljøproject, 2005) here we argue that there are severe technological limitations related to
the scale and scope of global production and consumption.

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The generation of residuals (pollutants or other) is a problem common to all industries, and espe-
cially advanced technology industries, such as microelectronics, micro-systems biology, nano-
technologies. The reason is that these advanced technologies require large amounts of pure ma-
terials, and large production and supporting systems per unit produced. The common thread
82
connecting all industrial activities is neglect of the first and second law of thermodynamics. For
more than 150 years of industrialization economic activities underpinned by our current techno-
logical stock have been and are producing pollution and causing environmental degradation (both
localized and global depending on the scale and scope of industrial operations and consumptions
patterns). The challenge lies in replacing a large proportion of our current technological stock
with new technologies underpinned by new science that does not violate, but accommodates the
first and second laws of thermodynamics. It is surprising that the implications of these laws have
been largely neglected and are still not readily accepted in the in the technology and industry pol-
icy arenas. The implications are huge, but the problem is becoming greater over time as global
economic growth increases with the development of Eastern European and the emergent
economies enter the mass consumption mode of development
On the positive side there is huge role for R&D and innovation to underpin the structural trans-
formation of the environmental sector and bring about structural change across the economy. If
this challenge is taken seriously as it should, given the severe anomaly of our current techno-
logical stock there is the possibility of rolling out one of he biggest economic multipliers of mod-
ern times. The sector requires industrial and innovation policy throughout the innovation cycle,
from basic research to diffusion and global exploitation. We could expect that given the appropri-
ate market and government policy stimuli at the macro level market segmentation would be as
depicted in Figure 10.
Remediation
Resource 5% Resource
Remediation management
Cleaner Solid waste management
5% 10% 2%
Solid waste technologies 10%
Wastewater
13% 1%
10%
Monitoring Air 2%
15%
Noise 2%
future
Cleaner
Wastewater Monitoring technologies
34% Noise 25% 44%
12%
Air
10%
Figure 10 Desirable market segmentation of environmental technologies in 2025
Our aim was to show that traditional segments. such as wastewater, noise, air, etc., for EU indus-
try to remain competitive in the long term and to contribute to environmental sustainability, R&D
and innovation is needed to underpin a new generation of products, production processes and
services. From their inception these processes and services must acknowledge and account for
the first and second laws of thermodynamics. This brings us to the question of what constitutes
the long term lead markets if current cleaner technologies, such as bio-fuels, clean cars, fuel
cells, photovoltaic cells, LED lighting , windmills, etc. all have environmental draw backs?
82
According to the first law, matter can neither be created nor destroyed, but only transformed. The second law refers to
the fact that every anthropogenic work produces a degradation of energy and matter. These laws have many implications
for product and process development in particular and for whole economic system in general. For a discussion see Geor-
gescu-Roegen (1971).

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Annex 2 Method to explore and screen challenges and
drivers
Task one encompassed two parallel research activities; the first consisted of a comprehensive
review of the literature relevant to industrial organization and global trends. The second targeted
foresight studies looking at emerging and future trends. The review targeted theoretical and em-
pirical developments over the last five years. The desk research consisted of an extensive elec-
tronic literature search and an informed review of recent and ongoing research through:
Screening of 30 relevant foresight studies related to the future of industrial activities.

These foresight studies were taken from a pool of 1,100 studies that where available at
the time of the survey;
While conducting the literature review to identify the main drivers at global level, the re-
viewers used key words (or themes of interest) designed to identify specific information to
provide insights on likely effects at the EU level and identify challenges and opportunities
to competitiveness in EU industry. This was necessary because the literature related to
the subject of this study encompasses a wide range of issues: global drivers are men-
tioned in reports and papers that address issues at the European and sector levels, and
conversely. This process is illustrated in Figure 9.
Themes
Task 1 Task 2 Task 3 Task 4
Themes
Figure 9. Backcasting task one
Conceptual method to screen foresight studies

As already mentioned, foresight studies were used as an initial source of trends and drivers. The
screening of the main driving factors was based on the model in Figure 10. We distinguished be-
tween demand oriented trends and drivers in the market/society (issues) and new supply oriented
emerging science and technology trends and drivers (S&T developments). We used a stylized
model to describe the interactions between the institutional framework and supply and demand in
three arenas: R&D, Industry and Markets.

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Trends and drivers in the
Institutional framework
research arena focused on
demand emerging S&T develop-
Research
Needs ments, e.g. What kinds of
questions
enabling sciences and
technologies will have a
S&T strong impact on industry?
Innovations Issues
developments
Trends and drivers in soci-

ety or the market focused
Inventions Functions on socio-economic chal-
lenges and changes in
supply
market demand. The ques-
tion guiding the search
could was: what are
R&D Arena Industry Arena Markets Arena
changing societal needs
and structures that require
Figure 10: Method to screen foresight studies new industrial structure
and activities? The screen-
ing of these three major
arenas was complemented by identification of the expected changes in the institutional frame-
work: new regulation, and new economic structures e.g. due to globalization, demographic, eco-
nomic and environmental developments, etc.
Organization of information gathered
There were many issues and drivers identified and their potential interaction is quite complex
when the system as a whole is considered. In order to reduce this intrinsic complexity to a level
that enabled analysis of the information collected in the literature review and brainstorming ses-
sions, the information was organized according to the structure presented in Table A2 below. The
approach adopted to classify the main socio-economic and institutional drivers was designed to
be incremental and to provide elements and tools to conduct the analysis required in Task 2 (Ef-
fects of the identified drivers in European industry).
Table A2. Main socio-economic and institutional factors shaping global markets
Factors Why? Sources
Justification
Industry (Supply side) Driver 1
Driver 2
Driver x
Intermediate and final consumers (Demand side) Driver 1
Driver 2
Driver y
Institutions Driver 1
Driver 2
Driver z
Emerging economies
The matrix contains a list of the main drivers in the areas of interest in this study (i.e., supply,
demand and institutions). For each main driver identified, a first attempt was made to:

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Define the most salient effects upon industrial activities at global level;
Justify why they were likely to be or likely become important;
Provide the source(s) supporting hypothesis that they were relevant drivers.
The matrix was intended to be the basis from which to conduct a morphological analysis of de-
mand-supply-institutions-emerging economies, insights from which could be used and applied to
the exploration of potential effects on European competitiveness (see Task two of this report).
The selection of the drivers (or important issues) included in the report was based on the exper-
tise of the research team in the topic and the new insights gained during the review. The final se-
lection (and inclusion) done was based in the cross reference of different sources and the confir-
mation of convergence of sources on issues that appear to have relevance at the global level.
The selection was based on a morphological method for policy analysis as proposed by Ritchey
(2005) and guided by the notion of what role could play R&D and innovation to face the challenge
identified. The definitional system created in the conduction of a morphological analysis can be
considered the first step to identify a set of relationships that underpin a set of hypothesis and a
theoretical model to test and concurrent falsification. Thus, this report constitutes the first step in
the production of a general model that integrates aspects from the demand, supply, institutions
and emerging economies towards testing relationships of correspondence with competitiveness
and economic growth. So far, the number of challenges identified resulted quite large and re-
sulted impossible to account for all potential effects at this stage. Although an indication is given
as to what drivers are apparently more relevant and deserve policy intervention no attempt was
made to make an exhaustive prioritisation across all themes and drivers. We understand and
disclaim for the cognitive limitations of the research team to account for all implications to the fu-
ture of the EU industry that the drivers described here may imply. The reader is invited to conduct
its own analysis. The summary of all drivers using the matrix described above are presented in
Annex II below.

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Annex 3 Summary of global drivers
This Annex present an overview and works as a summary of the drivers identified in the review of
literature concerning emerging issues affecting industry behaviour in the future as well as global
trends in markets in the supply side. It includes also a description of main issues arising in the
institutional side. Each factor or issue identified is accompanied by a short description of the
driver, and the source used (the justification of its importance is provided in the main text of this
report).
Table A3.1. Demand side - Overview of global challenges

Global challenge Description Sources
Ageing population[2, 3, The average age and the number of elderly is increasing in the world. This [1] Cahill et al., (1999)
8) is happening more rapidly in some regions (e.g., Western, China) than [2] NIC (2004)
others putting pressure on amongst others health care, retirement funds, [3] IPTS (2000)
mobility, accommodation, safety, coping with technology and social inclu-
[4] NIC (2000)
sion.
[5] Chatrie et al., (2005)
Climate change [2, 3, 4] Whether created, stimulated or unaffected by human industrialization, the
world is facing regional changes in temperature and weather inducing a [6] Verbeek (2003)
wide range of problems for the human population and its infrastructure. [7] Giorgi (2004)
Environmental degrada- The productive and regenerative capacity of the eco-system is declining, [8] UNDESA (2002)
tion [1, 4] threatening the extinct several species and putting pressure on amongst
[9] oNiel & Hortmans,
others flora and fauna, agriculture, biodiversity and quality of life.
Epidemics and pandem- Widespread infectious diseases among humans and animals like birds 2004; OECD, 2004;
ics disease, AIDS, SARS, BSE and swine fever are posing a serious threat to Colin et al., [2004]
the human population besides animal welfare, food safety and regional [10] UNDESA [2003]
economies. [11] SPVI,2001;EU-
Global shifts in eco- Major emerging market economies like the Asian Tigers and currently COM DGESA, [2006]
nomic power [9] China, India, Brasil and Mexico have generally had growth rates substan- [12] World Bank, 2006
tially higher than those of the G-7/8 members, shifting employment, produc-
tion and economic powers over the world.
Increasing pressure on Maintaining, and improving of health and health management will be inte-
health care grated in a much wider range of activities. This will be the result of an aging
population, the rise of active and engaged consumers and the emergence
of new technologies, which will change the perception of what individuals
can do to live healthier lives.
Over-exploitation of Material resources supplied by the earth and its lengthy processes like
natural resources1 minerals, petroleum, nutrients, metals, water and air but also living matters
like forests and fisheries are over-exploited threatening a scarcity or extinc-
tion. Necessarily human society must manage them or find alternative re-
sources.
Population growth [10] The number of people in certain countries, regions or cities is too large to be
sustained by available resources, such as land, water, food and fresh air,
inducing starvation, conflicts and environment degradation.
Pervasive globaliza- The worldwide integration of economic, cultural, political, and social sys-
tion2, 4 tems across geographical boundaries are transforming these systems radi-
cally, resulting in a 24/7 economy, specialization across the world, regional
unemployment and global interdependencies.
Social equality[11] Humans all over the world can differ in gender, race, religion, age, region or
class, but ethically, this may not affect the society in a range of possibilities
like employment, education and infrastructure.
Sustained economic As stated in the Lisbon agreements, the main economic challenge is to
growth [12] increase R&D and innovativeness of Europe towards more sustained eco-
nomic growth in the future, thereby strengthening the competitiveness of the
Union, dynamising its economy, and creating employment.
Terrorism and pervasive Violent acts often employed by non-state organizations targeting on destabi-
insecurity2, 4 lizing or destroying the fundamental political, constitutional, economic or
social structures of a country is perceived as a serious threat in Western
countries inducing a sense of insecurity to its populations and putting pres-
sure on national and international security.

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Table A3.2. Demand side - Summary of global consumption trends
Category Trend Why? Justification Source
Energy Energy consumption two- Economic growth and consump- UNDESA 2005
folded in the last 30 years. tion patterns towards the in-
Price of fossil fuel has creased use of energy in house-
soared in the last three year. holds and industry
It does not affect yet eco-
nomic growth.
Materials usage and waste
Water Water consumption has Population growth, industrial us- UNEP 2006
soared in after 1950 and the age,
trend continues since. Ex-
pected serious water short-
ages in many regions of the
world.
Mobility The movement of people and whereas transport is one of the OECD (2002); UNEP
goods is increasing in num- main contaminators of the envi- (2005), WBCSD, 2005;
ber and distance putting ronment., 23% overall CO2 emis- ERTRAC, 2004]
pressure on the availability of sions.
its infrastructure and the
speed of travel,
Land Soil degradation by sealing, increase of land use, for example EEA (2005a)
erosion and contamination for agriculture, settlements and
infrastructure
Urban concentration In 1950 one 0.33 of all earth Cities have always been centers UN-Habitat, 2005)
inhabitants live in cities. By for trade, production and con-
2004 this proportion in- sumption. The current size of cities
creased to half. By 2050 this acts now as magnet that continues
proportion is expected to attracting more people, business,
reach 2/3 of total inhabitants and associated problems to urban
concentration.
Food Two disparate trends, scar- Distribution of income, environ- WHO, 2003
city of food (famines) and mental disasters, lack of rainfall,
obesity and overweight in etc.
more affluent regions

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Annex A3.3 Demand side - Summary of consumption trends in European Union
Category Trend Why? Justification Source
Higher environmental stress Growing demand for natural Growing population in developing EEA (2005a)
resources such as food, countries; migration into EU mem- Danish EPA (2004)
fresh water, timber and fibre ber states; EEA (2004b)
due to growth and changing higher life expectancy; increasing
composition of population number of households
Ambient intelligence Multifunctional use of house Modernization of housing by inte- Danish EPA (2004)
Or Intelligent housing as living space, office space, grating smart electronic devices; EEA (2004b)
shopping space and comfort E-commerce/ tele-shopping;
zone Increase of tele-working;
Flexible working hours
Travel demand Increase in tourism and Increasing available time; Bentley&De Leeuw
investment in second homes Ageing; ( )
for recreational uses Cheaper and faster air transport; EEA (2004b)
Better road and air transport infra-
structures
Personalised diet Increase of food consump- Large array of products; High Danish EPA (2004)
tion with tendency towards availability through prepared and EEA (2004b)
fast, individual meals and convenience food;
personalized diets Time pressure;
Increasing number of women in
labour force;
Shrinking family size;
Individualism
Soil degradation by sealing, increase of land use, for example EEA (2005a)
erosion and contamination for agriculture, settlements and
infrastructure
Increasing levels of natural Increasing expenditure on R&D EEA (2005a)
resources efficiency for most
products and services
Growing demand for natural GDP increased with 40% in devel- EEA (2005a)
resources such as food, oped countries; global trade in
fresh water, timber and fibre raw materials grew by a factor 6 to
due to growth of GPD and 8
world trade
Increasing attention for de- Economic costs of urban traffic Bentley&De Leeuw
velopment of new modes of congestion and pollution ( )
transport such as fuel cells EEA (2004b)
and hybrid car, and high tech
communication platforms,
such as tele-working and
tele-shopping.
Healthier food Growing demand for qualita- Increasing demand for clean agri- Danish EPA (2004)
tive, safe and healthy food cultural practices; EEA (2004b)
Food safety problems such as
BDE, pig pest and avian flu
Energy demand Increase in household en- Increase of housing area per per- Danish EPA (2004)
ergy consumption and effi- son;
ciency related to heating, Increase in use of energy-using
household appliances and applications;
electronic goods Increase in number of households;
Insulation;
Energy-efficient heating appli-
ances
Traditional Energy sources Increasing consumption of Growth in transport sector; growth EEA (2005a)
scarcity fossil fuels such as crude oil in household sector; growth in
and natural gas service sector

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Annex A3.4 Supply Side: Changes in industrial organisation
Drivers Why important Source

The knowledge economy Innovation and new knowledge creation are key sources of competi- OECD (2004)
tive advantage and economic growth
S&T policies Governments have played an increasing role to support science, OECD (2004)
technology and innovation
Industrial R&D investment Although still the focus of public policy and corporate strategy, R&D OECD (2004)
investments are stable or declining in OECD countries (as other
forms of organisation of innovation are emerging)
Collaborations and open Firms search for innovation outside their R&D laboratories and OECD (2004), Ches-
innovation increasingly rely on collaborations brough, (2003.)
Entrepreneurial economy New firms are often those that bring new products and processes Audretsch and Thurik
into the market (especially in the case of radically new products) (2000)
and are responsible for a large share of economic growth and job
creation
Interdependence between Transformation in the offering along the value chain are importance OECD (2004), Pilat
services and manufacturing source of innovation and economic value for firms and Wölfl (2005), Da-
vies (2004)
Human resources for sci- In the knowledge based economy high skilled labour is a key re- OECD (2004)
ence and technology source of the firm. Access and retain of skilled personnel becomes
key for the firm.
Globalisation The global scale of production of products, services and knowledge Audretsch and Thurik
increase competition from low-cost and high-skilled countries, but (2000), OECD (2004)
also create opportunities for new market expansion, more efficient
organisation of the supply chain and outsourcing
Local proximity and regional Geographic proximity enable firms to benefit of knowledge spill over Geyer et al., (2003)
clusters and to adapt to the needs of local markets and Thurik, 2000)
Markets for technology The emergence of new market places to trade technology allows a Arora, Fosfuri, Gam-
division of innovative labour and the specialisation of firms in differ- bardella, (2001), Gans
ent activities of the overall process of innovation and Stern (2003),
Hargadon and Sutton
(2000).
Customers as sources of The process of democratization of innovation enables customers to Von Hippel (2005)
innovation express their needs and companies to leverage innovations from
their customers (without developing themselves)
Innovation technology (IvT) Application of new technologies that enhance the efficiency in re- Dodgson, Gann, and
search, design and development of new products and services Salter (2005)
New modes of knowledge Universities have transformed the way they produce and diffuse Gibbons et al (1995)
production knowledge, by developing links with users and sharing business like Etzkowitz (1999)
activities (licencing, spin-offs)
The experience economy Economic offering of high value for companies has moved towards Pine and Gilmore
a new step, away from the provision of services, and the making of (1999) Florida (2002).
goods, towards to the staging of experience for a new creative
class.

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Annex A3.5 Supply side: Overview of paradigm shifts
Research paradigm Description Sources
Advanced medical sci- New insights in the mechanisms of human organisms create new [1] Cahill et al., (1999)
ences1 opportunities for medical application. [2] NIC (2004)
Advanced process technol- Goal of advanced process technology is to develop a process path- [3] IPTS (2005)
ogy8 way or a series of reactions that converts relatively abundant, but [4] IPTS (2002)
poorly differentiated raw materials and feedstocks into desirable [5] IPTS (2000)
products for society at the lowest possible cost. [6] NIC (2000)
Cognitive science3, 7 The field of cognitive science consists of an interdisciplinary study of [7] Jackson (2003)
the structures of the human mind, including our sensory/ perceptual [8] Saritas (2004)
apparatus
High tech machining High tech machining focuses on fundamental research on the (me-
chanical) machining, like high power lasers, micro machining, etc.
Intelligent mechatronics1 Intelligent mechatronics is centered on mechanics, electronics and
computing which, combined, make possible the generation of sim-
pler, more economical, reliable and versatile systems.
Molecular biotechnology1, Molecular biotechnology is a collection of technologies to manipu-
2, 3, 5 late the structure and function of biological systems on the molecu-
lar scale into forms not found in nature.
Nanoengineering3, 6 Nanoengineering deals with the manipulation of atoms or molecules
to produce materials, devices and new technologies.
New energy technologies1, Current oil and coal-based energy production have serious envi-
4 ronmental disadvantages, are non-renewable and running out of
stock. New energy technologies are in focus to produce more sus-
tainable from renewable sources and to store energy more effi-
ciently.
Novel materials1, 4, 5 Due to advantages in chemistry and nanoengineering, scientists
can design and create fundamentally new materials to deliver de-
sired properties for a specific application and environment.
Ubiquitous computing1 Ubiquitous computing describes a state in which computer-based
devices become so cheap, seamlessly interoperable and easy to
use that they will find application across a broad swathe of everyday
activities.

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Annex A3.6 Supply side: Overview of innovation waves
Innovation wave Description Sources
Economic and environmental Industrial processes, like chemical and food processing are redes- [1] Cahill, Eamon and
industrial processes7 igned to be economic more viable and more environmental friendly. Fabiana Scapolo
Effects-based security op- Security operations including warfare, national security and per- (1999)
erations sonal security are effect based oriented, consciously avoiding unde- [2] IPTS (2005)
sired effects.83 [3] IPTS (2002)
Efficient and effective Health care is under pressure to be more efficient and effective, [4] IPTS (2000)
healthcare1, 4 mainly due to ageing population and the increase of possible medi- [5] Institute for the
cal treatments. future (2003)
High tech product manufac- The further use of ICT in the manufacturing industry increases the [6] Chatrie et al(2005)
turing high-tech character of manufacturing. [7] Weber(2005)
Information economy1, 2 To maximize the effort in this field economically and socially, the [8] Borsch,(2004)
future generation of ICT will be more integrated into the environ-
ment and more accessible, offering a multitude of services and
applications more easily.
Refocusing government and Increasing pressure and expectation combined with trends towards
citizenship (new governance globalisation, privatisation and liberalization give way to a new sys-
concepts) tem of governance. Participative managed methods of governance
to gain more legitimacy are applied.
Safe and healthy food1 Recent animal diseases as BSE and birds disease have put food
safety into focus. Diets and obesitas also has put health in place, as
well as the possibility to manipulate food for health issues.
Sustainability 8, 6, 1, 3, Agriculture is developing towards a more sustainable character for
farmer, the environment and the society with less toxic and use of
more ecological production processes. Driven by demand for sus-
tainability and customer individuality, as well as developments in
materials, ICT and energy technologies, innovations are initiated in
the construction process and buildings. The current energy system
must be made more sustainable as fossil fuels are slowly depleting,
while demand is growing and fossil fuels stimulate environmental
problems such as climate change. Sustainability and spatial pres-
sure are influencing the way regions, cities and rural areas are
organized. Increasing mobility demand and issues on sustainability
and accessibility give way to this trend.
83
The focus on desired effects and the actions required to achieve them, implies a thoroughly considered planned, exe-
cuted, and assessed security operation.

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Annex 3.7 Summary Institutional Side: Key Future Drivers
Drivers Why important Source
GLOBALIZATION Since the 80s, the world economy has become increasingly con- Cimoli & Katz (2003);
nected and integrated ; on the one hand the decreasing transpor- ILO World Commission
tation costs and the diffusion of Information and Communication on the Social Dimen-
Technologies have implied a fast downgrading of the concept of sion of Globalisation
distance , while on the other hand gross trade, Foreign Direct (2004);
Investment (FDI), capital flows and technology transfer have risen Stiglitz, J.E. (2002),
significantly. This trend should further accelerate in the next dec-
ades, provided wars or other catastrophic events will not occur.
REGIONALIZATION Geographic concentration of population, external and network ex- Breschi and Lissoni
ternalities and agglomeration economies make regions rather than (2001); Lundvall, et al.,
nations the main actors in global competition and the main drivers 2002;
of economic growth. This trend is still underway and should con- - OECD (2005),
tinue in the next two decades, although might be partially counter-
balanced by filtering down of activities away from the more con-
gested areas in the cities of the developed world.
INTERNATIONAL OUT- According to Heckscher-Ohlin theorem, developed richer countries Feenstra, R. (1998);
SOURCING should outsource through both trade specialization and FDI Ghose, A. K. (2003);
labour intensive and unskilled activities to developing countries ILO (2001);
where unskilled labour is cheaper. Although this tendency is still Wood, A. (2001)
underway, more recently emerging economies are increasingly
catching-up in terms of education, skills and technological absorp-
tive capacity . Hence, nowadays international outsourcing also
involves higher value added activities and international competition
is not anymore North-South/knowledge intensive-labour intensive
goods, but much more comprehensive and intra-industry (rather
than inter-industry).
THE ROLE OF ORGAN- The lean production is spreading around the world. Decentralisa- Brynjolfsson and Hitt,
IZATIONAL CHANGE tion and delayering; collective work as work teams and quality cir- L.M. (2000), Caroli, E.
cles; multi-tasking workers and job rotation are increasingly com- (2001); Petit and Soete
mon features of national and transnational firms corporate govern- (2001); Hitt & Bryn-
ance. In the next two decades we can forecast a deepening of new jolfsson (2002); Solow
organizational practices in the developed countries and an exten- (1987); Torrisi (1998)
sive diffusion of the same practices in the developing ones.
INTELLECTUAL PROP- Alikhan, S. (2000),

ERTY RIGHTS On the one hand, patents and IPR are institutional devices to make Dasgupta and David
appropriable an invention and/or an innovation, so avoiding free (1994), Hertel et al.,
riding and under-provision of innovation activity at the level of the (2003); Murray and
firm, sector, national and international system. On the other hand, Stern. (2005),
open science and open innovation (think for instance to the open
source software - OSS) are increasingly diffusing worldwide.
LABOUR MARKETS Increasing globalisation, international outsourcing and technologi- Feenstr (2000); Free-
cal/organizational changes are challenging European labour mar- man and Soete .
kets in terms of employment levels, skill-bias, sectoral mobility and (1994); Freeman
regulatory frameworks. In the last two decades the occupations (1995), ILO (2005),
which have been negatively affected by these drivers have been the Piva et al., (2005);
unskilled workers in traditional manufacturing sectors because of Vivarelli, M. (2006),
outsourcing of unskilled-intensive activities in the developing world.
In the next decades, given the likely trends described above, the
challenge will become more generalized affecting most categories
of workers with the exception of the very up-skilled and the ones
employed in sheltered sectors such as non tradeable public and
private sectors. In this context, the risk of a rush to the bottom is
increasing and spreading around the different economic sectors and
occupations.

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Annex A3.8 Summary of China s Drivers for Growth
Category
Driver Why? Justification Source
Social Reforming the Improving human capital; upgrading skills Herd 2005
Education system quotient; development of technology-intensive NSF 2006
comparative advantage Shenkar 2005
Tao 2003
Economic (1) Liberalization Lowering of tariffs; BusinessWeek 2004
Phenomenal growth of exports; Lardy 2003[
Phenomenal growth of imports Shenkar 2005
Trade as share of GDP soared; Tao 2003
Restructuring of economy shift from agricul-
ture to other sectors
(2) Foreign Direct Creation of jobs and higher wages; UN World Investment
Investment Growth of international trade; Report 2004
Growth of productivity; IMF 2002;
Increased technology transfer (through foreign Burton 2003; 2004
firms); OECD 2000;
Upgrading of skills; BusinessWeek 2004
Growth ofGDP; Lardy 2003
Transformed industrial structure; Tao 2003
Opportunities for new entrants and diversifica-
tion of ownership pattern
(3) Privatisation Growth of private sector (now more than 60% Lardy 2003;
and Deregulation of GDP); OECD 2005;
More flexible employment conditions; Hu and Khan 1997;
Improved return on assets; Shenkar 2005
Abolition of price controls leading to increased
productivity
(4) R&D Expendi- Increased research capability; Feng and von
ture Attraction of foreign high tech firms; Tunzelmann 2005;
Shenkar 2005;
BusinessWeek 2004
Institutional General Gradual shift to market economy; Economist 1996;
Reform of broad economic institutions; Johnson, Ostry and
Privatisation of state-owned enterprises Subramaniam 2006;
Better governance Child and Tse 2001
Law Provide improved investor-friendly and sta- Feng and von
ble environment; Tunzelmann 2005;
Better governance and decrease of invest- PatNews 2006;
ment risk; Luo 2003
Stimulation of growth of SMEs;
Increase of employment
Financial Slow transformation of a state-dominated Luo 2003;
banking system; Knowl-
Improvement of a near-chaotic and inefficient edge@Wharton;
financial system; Financial Times 2006
New policies, and prudential and supervi-
sory/regulatory institutions;
Vibrant stock exchanges (Shanghai and
Shenzen)

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Annex A3.9 Summary of India s Drivers for Growth
Category Driver Why? Justification Sources
Social Concepcion 2000;
(1) Demography A large population of working age demo- Kelkar 2004.
graphic dividend -- which will help sustain
growth.
(2) Improved life This, together with (1) above, suggests a Fischer, 2002 ; Kelkar
expectancy sustainable working-age population 2004
(3) Improved A literate and a skilled labour force are fun- Fischer 2002; Kochhar
literacy and in- damentals for economic progress. et. al, 2006; Kelkar
vestment in 2004.
higher education
and training
Economic
(1) Liberalization, Increased international trade in merchandise Knowledge@Wharton,
privatization and and services. Important measures, such as March 3, 2006;
deregulation significant cuts in tariffs; removal of quantita- Kochhar et. al, IMF
tive restrictions, increasing foreign direct in- 2006; Rodrik and
vestment opportunities through permitting Subramanian 2004;
increased foreign equity in a broad swathe of Desai, 1999; Kelkar
industries. Deregulation of telecoms and the 2004; Dahlman and
financial/securities markets, leading to pres- Utz 2003; Panagariya
ence of foreign and private banks and vibrant 2004
trading activity. Privatization of infrastructure-
related sectors and electricity
(2) Long standing This has resulted in a growing high-value Wolf 2006; Kochhar et.
bias toward skill added service intensive sector has general 2006.; IMF 2005.
intensive pattern ated high employment, although this has
of economic militated against the development of labour-
development intensive mass employment
(3) Growth of Particularly in pharmaceuticals, software and Rodrik and Subrama-
R&D facilities by IT-related services nian, 2004(a); 2004b;
foreign and do- Kelkar
mestic companies
(4) Global IT Strengthened Indias IT capabilities; IMF 2006; Kochhar
boom Developed a core of skills for skill-intensive 2005; Kelkar 2004;
and high value added activities Dahlman and Utz
2003; Gordon and
Gupta 2004
(5) Increased Skilled labour for IT and other professional Rodrik and Subrama-
demand of out- services; nian, 2004a; Kelkar
sourcing by for- Cheap labour for labour intensive production 2004
eign companies
Institutional Provides credible governance -- Rules of the
(1) Democracy game are well established and implemented; Wolf, Financial Times,
Provides more stability February 15, 2006;
An entrenched legal system helps to provide Kochhar 2006; Kelkar
credibility as a destination for foreign and 2004; Burton 2004.
domestic investment.
The legal system also has managed to control
corruption promotes confidence for business
operations and foreign investment.
(2) Democratic Devolved economic decision-making to states; Narayana 2005; Kelkar
decentralization Development of new state institutions cata- 2005; Kocchar 2006;
lyzed marked economic development in sev- Panagarya 2004
eral states
(3) Prudential and Ensures stronger governance in private finan- Fischer, 2002; Kelkar
supervisory sys- cial institutions to withstand political interfer- 2004; IMF 2005
tems are continu- ence;

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ally strengthened Improves reliability and predictability;
for the financial Reduces risk investment.
sector
(4) Vibrant stock Key building blocks for modernizing the finan- Kelkar 2004; Sarkar
exchanges cial sector; 2003; IMF 2005;
Stimulates competition Kochhar 2006

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Annex 4. Sectors ranking on production, employment
and exports
The STAN database for Industrial Analysis provides a tool for analysing industrial performance at
a detailed level of activity. The last available version is based on the International Standard In-
dustrial Classification Rev.3 ISIC 3 (compatible with NACE Rev.1).
STAN database allows to create the following three aggregates for the 15 countries belonging to
the EU15:
1) Production (goods and services, whether sold or stocked).

2) Employment (number of persons)84
3) Exports (only goods)
Time spans have been selected in order to include more countries as possible; series have been
extended to the most recent year, provided data for the major European countries were included.
85
Values have been expressed at current prices . For Denmark, Sweden and United Kingdom
time-related exchange rates have been applied in order to have all the monetary variables in
Euro.
Table A4.1 presents a detailed description of the industrial aggregations reporting also the avail-
able and/or missing data in the original STAN database for each sector in each country.
The ANBERD (Analytical Business Enterprise Research and Development) database provides a
consistent dataset that overcomes the problems of international comparability of industrial R&D
expenditures. The OECD Secretariat has created a database for 19 of the largest R&D perform-
ing countries. Unfortunately, with respect to EU15, data for Austria, Greece, Luxembourg and
Portugal are not included. The last release presents industrial R&D expenditures in ISIC Revision
3.
Table A4.1 Definition of information gaps in the data set
INDUSTRY ISIC
Rev.3 Information gaps
AGRICULTURE, HUNT-
ING, FORESTRY AND
FISHING 01-05
Production data is missing for Austria, Belgium, Greece, Ireland, Luxembourg and Spain; Employ-
AGRICULTURE, HUNTING AND ment data is missing for Austria, Belgium, Greece, Ireland, Luxembourg, Spain and United King-
FORESTRY 01-02 dom; Export data is missing for Austria and Luxembourg.
Production data is missing for Austria, Belgium, Greece, Ireland, Luxembourg and Spain; Employ-
ment data is missing for Austria, Belgium, Greece, Ireland, Luxembourg, Spain, Sweden and
FISHING 05 United Kingdom; Export data is missing for Austria and Luxembourg.
MINING AND QUARRY-
ING 10-14
MINING AND QUARRYING OF Production data is missing for Belgium, Greece, Ireland, Luxembourg, Netherlands, Portugal and
ENERGY PRODUCING MATERI- Spain; Employment data is missing for Belgium, France, Greece, Ireland, Luxembourg, Portugal
ALS 10-12 and United Kingdom; Export data is missing for France, Luxembourg and Sweden.
MINING AND QUARRYING EX- Production data is missing for Belgium, Greece, Ireland, Portugal and Spain; Employment data is
CEPT ENERGY PRODUCING missing for Belgium, France, Greece, Ireland, Portugal and Spain; Export data is missing for
MATERIALS 13-14 France and Luxembourg.
84
Unfortunately, data in full-time equivalents are not available for most European countries.
85
This does not have any influence on the sectoral rankings obtained .

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TOTAL MANUFACTUR-
ING 15-37
Production data is available for Austria, Denmark, Finland, France, Germany, Spain, Sweden and
United Kingdom; Employment data is missing for Belgium, Greece, Ireland, Luxembourg, Portugal
FOOD PRODUCTS AND BEVER- and Sweden; Export data is missing for Luxembourg; R&D data is only available for Belgium,
AGES 15 France, Germany, Italy, Netherlands and Spain.
Production data is available for Austria, Denmark, Finland, France, Germany, Spain and United
Kingdom; Employment data is missing for Belgium, Greece, Ireland, Luxembourg, Portugal and
TOBACCO PRODUCTS 16 Sweden. Export data is missing for Luxembourg.
Production data is missing for Belgium, Greece, Luxembourg and Portugal; employment data is
missing for Belgium, Greece, Luxembourg, Portugal and Sweden; Export data is missing for Lux-
TEXTILES 17 embourg; R&D data is only available for Belgium, France, Germany, Netherlands and Spain.
Production data is missing for Belgium, Greece, Luxembourg and Portugal; Employment data is
WEARING APPAREL, DRESSING missing for Belgium, Greece, Luxembourg and Portugal; Export data is missing for Luxembourg;
AND DYING OF FUR 18 R&D data is only available for Belgium, Finland, France, Germany, Italy and Spain.
Production data is missing for Greece and Luxembourg; Employment data is missing for Greece
LEATHER, LEATHER PRODUCTS and Luxemburg; Export data is missing for Luxembourg; R&D data is only available for Belgium,
AND FOOTWEAR 19 Finland, France, Germany, Italy and Spain.
Production data is missing for Greece; Employment data is missing for Greece and Luxembourg;
WOOD AND PRODUCTS OF Export data is missing for Luxembourg; R&D data is only available for Belgium, Denmark, Finland,
WOOD AND CORK 20 France, Germany, Italy, Netherlands, Spain and Sweden.
Production data is missing for Belgium, Greece, Luxembourg and Portugal; Employment data is
missing for Belgium, Greece, Luxembourg and Portugal; Export data is missing for Luxembourg;
PULP, PAPER AND PAPER R&D data is only available for Belgium, Finland, France, Germany, Italy, Netherlands, Spain and
PRODUCTS 21 Sweden.
Production data is missing for Greece, Ireland and Luxembourg; Employment data is missing for
Greece, Luxembourg, Netherlands and Portugal; Export data is missing for Luxembourg; R&D data
PRINTING AND PUBLISHING 22 is only available for Belgium, Finland, France, Germany, Italy, Netherlands, Spain and Sweden.
Production data is missing for Greece, Ireland and Luxembourg; Employment data is missing for
Greece, Luxembourg, Netherlands and Portugal; Export data is missing for Luxembourg; R&D data
COKE, REFINED PETROLEUM is only available for Belgium, Finland, France, Germany, Italy, Netherlands, Spain, Sweden and
PRODUCTS AND NUCLEAR FUEL 23 United Kingdom.
Production data is missing for Greece; Employment data is missing for Greece and Spain; Export
CHEMICALS AND CHEMICAL data is missing for Luxembourg; R&D data is missing for Austria, Greece, Ireland, Luxembourg and
PRODUCTS 24 Portugal.
Production data is missing for Greece; Employment data is missing for Greece; Export data is
RUBBER AND PLASTICS PROD- missing for Luxembourg; R&D data is missing for Austria, Greece, Ireland, Luxembourg and Portu-
UCTS 25 gal.
Production data is missing for Greece; Employment data is missing for Greece; Export data is
OTHER NON-METALLIC MINERAL missing for Luxembourg; R&D data is missing for Austria, Greece, Ireland, Luxembourg and Portu-
PRODUCTS 26 gal.
Production data is missing for Belgium, Greece and Portugal; Employment data is missing for
Belgium, Greece and Portugal; Export data is missing for Luxembourg; R&D data is missing for
BASIC METALS 27 Austria, Greece, Ireland, Luxembourg and Portugal.
FABRICATED METAL PROD- Production data is missing for Belgium, Greece and Portugal; Employment data is missing for
UCTS, except machinery and Belgium, Greece and Portugal; Export data is missing for Luxembourg; R&D data is missing for
equipment 28 Austria, Greece, Ireland, Italy, Luxembourg and Portugal.
Production data is missing for Belgium and Greece; Employment data is missing for Belgium and
MACHINERY AND EQUIPMENT, Greece; Export data is missing for Luxembourg; R&D data is missing for Austria, Greece, Ireland,
N.E.C. 29 Luxembourg and Portugal.
Production data is missing for Belgium, Greece, Luxembourg, Netherlands and Portugal; Employ-
ment data is missing for Belgium, Greece, Luxembourg, Netherlands and Portugal; Export data is
OFFICE, ACCOUNTING AND missing for Luxembourg; R&D data is missing for Austria, Greece, Ireland, Luxembourg and Portu-
COMPUTING MACHINERY 30 gal.
Production data is missing for Belgium, Greece, Luxemburg, Netherlands and Portugal; Employ-
ment data is missing for Belgium, Greece, Luxemburg, Netherlands and Portugal; Export data is
ELECTRICAL MACHINERY AND missing for Luxemburg; R&D data is missing for Austria, Greece, Ireland, Luxembourg and Portu-
APPARATUS, NEC 31 gal.
Production data is missing for Belgium, Greece, Luxembourg, Netherlands and Portugal; Employ-
ment data is missing for Belgium, Greece, Luxembourg, Netherlands and Portugal; Export data is
RADIO, TELEVISION AND COM- missing for Luxembourg; R&D data is missing for Austria, Greece, Ireland, Luxembourg and Portu-
MUNICATION EQUIPMENT 32 gal.
Production data is missing for Belgium, Greece, Luxembourg and Netherlands; Employment data is
MEDICAL, PRECISION AND OP- missing for Belgium, Greece, Luxembourg, Netherlands and Portugal; Export data is missing for
TICAL INSTRUMENTS 33 Luxembourg; R&D data is missing for Austria, Greece, Ireland, Luxembourg and Portugal.
Production data is missing for Belgium, Greece and Luxembourg; Employment data is missing for
MOTOR VEHICLES, TRAILERS Belgium, Greece and Luxembourg; Export data is missing for Luxembourg; R&D data is missing for
AND SEMI-TRAILERS 34 Austria, Denmark, Greece, Ireland, Luxembourg and Portugal.
Production data is missing for Belgium, Greece and Luxembourg; Employment data is missing for
OTHER TRANSPORT EQUIP- Belgium, Greece and Luxembourg; Export data is missing for Luxembourg and United Kingdom;
MENT 35 R&D data is missing for Austria, Greece, Ireland, Luxembourg and Portugal.
Production data is missing for Belgium, Greece, Ireland, Netherlands, Portugal and Sweden; Em-
ployment data is missing for Belgium, Greece, Ireland, Netherlands, Portugal and Sweden; No data
MANUFACTURING NEC 36 on export; R&D data is missing for Austria, Greece, Ireland, Luxembourg and Portugal.

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Production data is missing for Belgium, Greece, Ireland, Netherlands, Portugal, Sweden and
United Kingdom; Employment data is missing for Greece, Ireland, Netherlands, Portugal, Spain
and United Kingdom; No data on export; R&D data is missing for Austria, Denmark, Greece, Ire-
RECYCLING 37 land, Luxembourg, Netherlands, Portugal and Sweden.
ELECTRICITY, GAS
AND WATER SUPPLY 40-41
Production data is available for Austria, Denmark, Finland, France, Luxembourg and United King-
dom; Employment data is available for Austria, Belgium, Denmark, Finland, France, Germany,
ELECTRICITY, GAS, STEAM AND Luxembourg and Spain; Export data is available for Denmark, Finland, France, Germany, Spain
HOT WATER SUPPLY 40 and United Kingdom; R&D data is missing for Austria, Greece, Ireland, Luxembourg and Portugal.
Production data is available for Austria, Denmark, Finland, France, Luxembourg and United King-
dom; Employment data is available for Austria, Denmark, Finland, France, Germany, Luxembourg
COLLECTION, PURIFICATION and Spain; No data on export; R&D data is missing for Austria, Greece, Ireland, Luxembourg and
AND DISTRIBUTION OF WATER 41 Portugal.
Production data is missing for Belgium, Greece, Ireland and Spain; Employment data is missing for
Greece; No data on export; R&D data is missing for Austria, Greece, Ireland, Luxembourg and
CONSTRUCTION 45 Portugal.
WHOLESALE AND RE-
TAIL TRADE; RESTAU-
RANTS AND HOTELS 50-55
Production data is missing for Belgium, Greece, Ireland, Portugal, Spain and Sweden; Employment
SALE, MAINTENANCE AND RE- data is missing for Belgium, Greece, Ireland, Portugal, Spain and Sweden; No data on export;R&D
PAIR OF MOTOR VEHICLES; RE- data is missing for Austria, France, Germany, Greece, Ireland, Luxembourg, Portugal and United
TAIL SALE OF FUEL 50 Kingdom.
WHOLESALE, TRADE & COM- data is missing for Belgium, Greece, Ireland, Portugal, Spain and Sweden; No data on export; R&D
MISSION EXCL. MOTOR VEHI- data is missing for Austria, France, Germany, Greece, Ireland, Luxembourg, Portugal and United
CLES 51 Kingdom.
RETAIL TRADE EXCL. MOTOR data is missing for Greece, Ireland, Portugal, Spain and Sweden; No data on export; R&D data is
VEHICLES; REPAIR OF HOUSE- missing for Austria, France, Germany, Greece, Ireland, Luxembourg, Portugal and United King-
HOLD GOODS 52 dom.
HOTELS AND RESTAURANTS 55 Greece, Ireland and Spain; no data on export; R&D data is available only for Belgium.
TRANSPORT AND
STORAGE AND COM-
MUNICATION 60-64
Production data is missing for Belgium, Greece, Ireland, Italy, Luxemburg, Portugal and Spain;
Employment data is missing for Belgium, Greece, Ireland, Italy, Luxembourg, Portugal and Spain;
LAND TRANSPORT; no data on export; R&D data is missing for Austria, Denmark, France, Greece, Ireland, Luxem-
TRANSPORT VIA PIPELINES 60 bourg, Netherlands, Portugal, Sweden and United Kingdom.
no data on export; R&D data is missing for Austria, Denmark, France, Greece, Ireland, Luxem-
WATER TRANSPORT 61 bourg, Netherlands, Portugal, Sweden and United Kingdom.
no data on export; R&D data is missing for Austria, Denmark, France, Greece, Ireland, Luxem-
AIR TRANSPORT 62 bourg, Netherlands, Portugal, Sweden and United Kingdom.
Employment data is missing for Belgium, Greece, Ireland, Italy, Luxemburg, Portugal and Spain; no
SUPPORTING AND AUXILIARY data on export; R&D data is missing for Austria, Denmark, France, Greece, Ireland, Luxembourg,
TRANSPORT ACTIVITIES 63 Netherlands, Portugal, Sweden and United Kingdom.
Production data is missing for Belgium, Greece, Ireland, Luxemburg and Spain; Employment data
POST AND TELECOMMUNICA- is missing for Belgium, Greece, Ireland, Luxembourg and Spain; no data on export; R&D data is
TIONS 64 missing for Austria, Germany, Greece, Ireland, Luxembourg and Portugal.
FINANCE, INSURANCE,
REAL ESTATE AND
BUSINESS SERVICES 65-74
FINANCIAL INTERMEDIATION Production data is missing for Belgium, Greece, Ireland, Portugal, Spain and Sweden; Employment
except insurance and pension fund- data is missing for Belgium, Greece, Ireland, Portugal, Spain and Sweden; no data on export; R&D
ing 65 data is only available for Belgium, Denmark and Netherlands.
INSURANCE AND PENSION Production data is missing for Belgium, Greece, Ireland, Portugal, Spain and Sweden; Employment
FUNDING, except compulsory so- data is missing for Belgium, Greece, Ireland, Portugal, Spain and Sweden; no data on export; R&D
cial security 66 data is only available for Belgium, Denmark and Netherlands.
ACTIVITIES RELATED TO FINAN- data is missing for Belgium, Greece, Ireland, Portugal, Spain and Sweden; no data on export; R&D
CIAL INTERMEDIATION 67 data is only available for Belgium, Denmark and Netherlands.

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Production data is missing for Belgium, Greece, Ireland, Portugal and Spain; Employment data is
REAL ESTATE ACTIVITIES 70 missing for Belgium, Greece, Ireland, Portugal and Spain; no data on export; no data on R&D
Production data is missing for Belgium, Greece, Ireland, Italy, Portugal and Spain; Employment
RENTING OF MACHINERY AND data is missing for Belgium, Greece, Ireland, Italy, Portugal and Spain; no data on export; no data
EQUIPMENT 71 on R&D.
COMPUTER AND RELATED AC- Belgium, Greece and Ireland; no data on export; R&D data is missing for Austria, Germany,
TIVITIES 72 Greece, Ireland, Luxembourg and Portugal.
Production data is missing for Belgium, Greece, Ireland, Italy, Luxemburg, Spain and Sweden;
Employment data is missing for Belgium, Greece, Ireland, Italy, Luxembourg and Sweden; no data
on export; R&D data is missing for Austria, Finland, France, Germany, Greece, Ireland, Luxem-
RESEARCH AND DEVELOPMENT 73 bourg and Portugal.
Belgium, Greece and Ireland; Export data available only for Denmark, Finland, France, Germany,
Italy, Netherlands, Sweden and United Kingdom; R&D data is missing for Austria, Finland, France,
OTHER BUSINESS ACTIVITIES 74 Germany, Greece, Ireland, Luxembourg and Portugal.
COMMUNITY SOCIAL
AND PERSONAL SER-
VICES 75-99
PUBLIC ADMIN. AND DEFENCE; Production data is missing for Belgium, Greece, Ireland and Spain; Employment data is missing for
COMPULSORY SOCIAL SECU- Belgium, Greece and Ireland; no data on export; R&D data is missing for Austria, Denmark,
RITY 75 France, Germany, Greece, Ireland, Luxembourg, Netherlands and Portugal.
Production data is missing for Greece and Spain; Employment data is missing for Greece; no data
on export; R&D data is missing for Austria, Denmark, France, Germany, Greece, Ireland, Luxem-
EDUCATION 80 bourg, Netherlands and Portugal.
Production data is missing for Belgium and Spain; Employment data is missing for Belgium; no
data on export; R&D data is missing for Austria, Denmark, France, Germany, Greece, Ireland,
HEALTH AND SOCIAL WORK 85 Luxembourg, Netherlands and Portugal.
OTHER COMMUNITY, SOCIAL Production data is missing for Ireland and Spain; no data on export; R&D data is missing for Aus-
AND PERSONAL SERVICES 90-93 tria, Denmark, France, Germany, Greece, Ireland, Luxembourg, Netherlands and Portugal.
Production data is missing for France, Portugal, Spain, Sweden and United Kingdom; Employment
data is missing for France, Portugal, Spain, Sweden and United Kingdom; no data on export; R&D
PRIVATE HOUSEHOLDS WITH data is missing for Austria, Denmark, France, Germany, Greece, Ireland, Luxembourg, Netherlands
EMPLOYED PERSONS 95 and Portugal.
EXTRA-TERRITORIAL ORGANI-
ZATIONS AND BODIES 99 No data

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Table A4.2 Production (value of goods and/or services produced, Growth Industry share
whether sold or stocked) in MN of Euro rate on the total
ISIC 1993- value of produc-
Rev.3 2002 (%) tion in 2002
COMPUTER AND RELATED ACTIVITIES 72 140,1 0,8
RECYCLING 37 136,5 0,1
MOTOR VEHICLES, TRAILERS AND SEMI-TRAILERS 34 113 3,7
ACTIVITIES RELATED TO FINANCIAL INTERMEDIATION 67 110,6 0,7
POST AND TELECOMMUNICATIONS 64 100,6 2,3
OTHER BUSINESS ACTIVITIES 74 100 7,4
RADIO, TELEVISION AND COMMUNICATION EQUIPMENT 32 86,7 1,0
SUPPORTING AND AUXILIARY TRANSPORT ACTIVITIES 63 84,4 1,6
INSURANCE AND PENSION FUNDING, except compulsory social security 66 78,1 1,5
WATER TRANSPORT 61 75,4 0,3
AIR TRANSPORT 62 74,9 0,5
OTHER TRANSPORT EQUIPMENT 35 72,9 1,0
COKE, REFINED PETROLEUM PRODUCTS AND NUCLEAR FUEL 23 67,7 1,2
HEALTH AND SOCIAL WORK 85 65,2 5,6
RENTING OF MACHINERY AND EQUIPMENT 71 63,8 1,7
SALE, MAINTENANCE AND REPAIR OF MOTOR VEHICLES; RETAIL SALE OF
FUEL 50 60,9 1,6
MEDICAL, PRECISION AND OPTICAL INSTRUMENTS 33 58,5 0,8
FINANCIAL INTERMEDIATION except insurance and pension funding 65 58,2 3,3
REAL ESTATE ACTIVITIES 70 57,7 7,0
PRIVATE HOUSEHOLDS WITH EMPLOYED PERSONS 95 57,7 0,1
RESEARCH AND DEVELOPMENT 73 57,6 0,6
RETAIL TRADE EXCL. MOTOR VEHICLES; REPAIR OF HOUSEHOLD GOODS 52 57,5 3,7
HOTELS AND RESTAURANTS 55 56,5 2,6
RUBBER AND PLASTICS PRODUCTS 25 54,2 1,3
MACHINERY AND EQUIPMENT, N.E.C. 29 53,2 3,1
EDUCATION 80 52,1 3,4
WOOD AND PRODUCTS OF WOOD AND CORK 20 51,7 0,7
WHOLESALE, TRADE & COMMISSION EXCL. MOTOR VEHICLES 51 51,5 4,2
FABRICATED METAL PRODUCTS, except machinery and equipment 28 49,8 2,3
PULP, PAPER AND PAPER PRODUCTS 21 47,5 1,0
COLLECTION, PURIFICATION AND DISTRIBUTION OF WATER 41 46,3 0,1
PRINTING AND PUBLISHING 22 45,5 1,6
LAND TRANSPORT; TRANSPORT VIA PIPELINES 60 43,3 1,7
BASIC METALS 27 43 1,4
OFFICE, ACCOUNTING AND COMPUTING MACHINERY 30 43 0,4
OTHER NON-METALLIC MINERAL PRODUCTS 26 39,9 1,3
PUBLIC ADMIN. AND DEFENCE; COMPULSORY SOCIAL SECURITY 75 38,7 5,0
CHEMICALS AND CHEMICAL PRODUCTS 24 36,1 3,6
CONSTRUCTION 45 35,8 6,4
ELECTRICAL MACHINERY AND APPARATUS, NEC 31 35,3 1,3
ELECTRICITY, GAS, STEAM AND HOT WATER SUPPLY 40 33,1 1,0
MINING AND QUARRYING OF ENERGY PRODUCING MATERIALS 10-12 32,9 0,4
MANUFACTURING NEC 36 31,5 0,9
MINING AND QUARRYING EXCEPT ENERGY PRODUCING MATERIALS 13-14 31,2 0,2
OTHER COMMUNITY, SOCIAL AND PERSONAL SERVICES 90-93 30,5 3,0
FOOD PRODUCTS AND BEVERAGES 15 24,5 3,3
TOBACCO PRODUCTS 16 23 0,1
FISHING 05 21,5 0,1
LEATHER, LEATHER PRODUCTS AND FOOTWEAR 19 15,2 0,3
TEXTILES 17 14,2 0,7
AGRICULTURE, HUNTING AND FORESTRY 01-02 13,6 1,7

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WEARING APPAREL, DRESSING AND DYING OF FUR 18 4 0,5
EXTRA-TERRITORIAL ORGANIZATIONS AND BODIES 99 no data
Industry share
Table A4.3 Employment (total employment) - Number of persons Growth rate on total em-
ISIC 1993-2002 ployment in
Rev.3 (%) 2002

OTHER BUSINESS ACTIVITIES 74 50,4 9,1
RENTING OF MACHINERY AND EQUIPMENT 71 37,4 0,3
SUPPORTING AND AUXILIARY TRANSPORT ACTIVITIES 63 26,9 1,0
AIR TRANSPORT 62 22,1 0,2
REAL ESTATE ACTIVITIES 70 21,6 1,0
HEALTH AND SOCIAL WORK 85 21,5 11,0
PRIVATE HOUSEHOLDS WITH EMPLOYED PERSONS 95 21,3 1,4
ACTIVITIES RELATED TO FINANCIAL INTERMEDIATION 67 20,6 0,7
RETAIL TRADE EXCL. MOTOR VEHICLES; REPAIR OF HOUSEHOLD GOODS 52 11,3 7,6
EDUCATION 80 11,1 7,7
MOTOR VEHICLES, TRAILERS AND SEMI-TRAILERS 34 9,6 1,2
WHOLESALE, TRADE & COMMISSION EXCL. MOTOR VEHICLES 51 9,6 3,9
OFFICE, ACCOUNTING AND COMPUTING MACHINERY 30 9,2 0,2
FUEL 50 8,7 1,9
FINANCIAL INTERMEDIATION except insurance and pension funding 65 1,6 1,7
INSURANCE AND PENSION FUNDING, except compulsory social security 66 0,4 0,5
LAND TRANSPORT; TRANSPORT VIA PIPELINES 60 -1,4 1,8
WOOD AND PRODUCTS OF WOOD AND CORK 20 -1,7 0,6
PUBLIC ADMIN. AND DEFENCE; COMPULSORY SOCIAL SECURITY 75 -1,8 7,0
POST AND TELECOMMUNICATIONS 64 -3,1 1,4
PRINTING AND PUBLISHING 22 -3,7 1,2
PULP, PAPER AND PAPER PRODUCTS 21 -4,2 0,4
COLLECTION, PURIFICATION AND DISTRIBUTION OF WATER 41 -4,5 0,1
CHEMICALS AND CHEMICAL PRODUCTS 24 -5,3 0,3
OTHER TRANSPORT EQUIPMENT 35 -5,4 0,5
MANUFACTURING NEC 36 -7 0,8
BASIC METALS 27 -12,5 0,6
FISHING 05 -12,9 0,1
MINING AND QUARRYING EXCEPT ENERGY PRODUCING MATERIALS 13-14 -13,6 0,1
AGRICULTURE, HUNTING AND FORESTRY 01-02 -14,5 2,8
WATER TRANSPORT 61 -15,3 0,1
ELECTRICITY, GAS, STEAM AND HOT WATER SUPPLY 40 -15,8 0,3
TEXTILES 17 -19,8 0,6
COKE, REFINED PETROLEUM PRODUCTS AND NUCLEAR FUEL 23 -23,4 0,1

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LEATHER, LEATHER PRODUCTS AND FOOTWEAR 19 -31,6 0,3
TOBACCO PRODUCTS 16 -33,7 0,0
WEARING APPAREL, DRESSING AND DYING OF FUR 18 -42,8 0,5
MINING AND QUARRYING OF ENERGY PRODUCING MATERIALS 10-12 -47 0,1
EXTRA-TERRITORIAL ORGANIZATIONS AND BODIES 99 no data
Growth Industry
rate share on the
Table A4.4 Export of goods in MN of Euro 1993- total value of
ISIC 2002 export in
Rev.3 (%) 2002
MOTOR VEHICLES, TRAILERS AND SEMI-TRAILERS 34 143,5 14,2
MINING AND QUARRYING OF ENERGY PRODUCING MATERIALS 10-12 101,6 1,0
TOBACCO PRODUCTS 16 100,9 0,4
PRINTING AND PUBLISHING 22 92 1,5
FISHING 05 79,7 0,1
MINING AND QUARRYING EXCEPT ENERGY PRODUCING MATERIALS 13-14 73,4 0,8
WEARING APPAREL, DRESSING AND DYING OF FUR 18 64,9 1,7
BASIC METALS 27 63,6 4,3
ELECTRICITY, GAS, STEAM AND HOT WATER SUPPLY 40 45,5 0,2
AGRICULTURE, HUNTING AND FORESTRY 01-02 44,2 2,2
TEXTILES 17 34,7 2,9
MANUFACTURING NEC 36 -
RECYCLING 37 -
COLLECTION, PURIFICATION AND DISTRIBUTION OF WATER 41 -
CONSTRUCTION 45 -
FUEL 50 -
WHOLESALE, TRADE & COMMISSION EXCL. MOTOR VEHICLES 51 -
RETAIL TRADE EXCL. MOTOR VEHICLES; REPAIR OF HOUSEHOLD GOODS 52 -
HOTELS AND RESTAURANTS 55 -
LAND TRANSPORT; TRANSPORT VIA PIPELINES 60 -
WATER TRANSPORT 61 -
AIR TRANSPORT 62 -
SUPPORTING AND AUXILIARY TRANSPORT ACTIVITIES 63 -
POST AND TELECOMMUNICATIONS 64 -
FINANCIAL INTERMEDIATION except insurance and pension funding 65 -
INSURANCE AND PENSION FUNDING, except compulsory social security 66 -
ACTIVITIES RELATED TO FINANCIAL INTERMEDIATION 67 -
REAL ESTATE ACTIVITIES 70 -
RENTING OF MACHINERY AND EQUIPMENT 71 -

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COMPUTER AND RELATED ACTIVITIES 72 -
RESEARCH AND DEVELOPMENT 73 -
PUBLIC ADMIN. AND DEFENCE; COMPULSORY SOCIAL SECURITY 75 -
EDUCATION 80 -
HEALTH AND SOCIAL WORK 85 -
EXTRA-TERRITORIAL ORGANIZATIONS AND BODIES 99 -
PRIVATE HOUSEHOLDS WITH EMPLOYED PERSONS 95 -

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Industry
Table A4.5 RESEARCH AND DEVELOPMENT in MN of Euro Growth share on the
ISIC rate 1995- total value of
Rev.3 2001 (%) R&D in 2001
583,7 (65 to
FINANCIAL INTERMEDIATION except insurance and pension funding 65 67) 0,3
INSURANCE AND PENSION FUNDING, except compulsory social security 66
ACTIVITIES RELATED TO FINANCIAL INTERMEDIATION 67
295,4 (60 to
LAND TRANSPORT; TRANSPORT VIA PIPELINES 60 63) 0,8
WATER TRANSPORT 61
AIR TRANSPORT 62
SUPPORTING AND AUXILIARY TRANSPORT ACTIVITIES 63
COMMUNITY SOCIAL AND PERSONAL SERVICES 75-99 256 0,1
POST AND TELECOMMUNICATIONS 64 130,2 3,0
SALE, MAINTENANCE & REPAIR OF MOTOR VEHICLES; RETAIL SALE OF
FUEL 50 104 (50 to 52) 1,3
WHOLESALE, TRADE & COMMISSION EXCL. MOTOR VEHICLES 51
RETAIL TRADE EXCL. MOTOR VEHICLES; REPAIR OF HOUSEHOLD GOODS 52
WEARING APPAREL, DRESSING AND DYING OF FUR 18 82,4 0,1
MOTOR VEHICLES, TRAILERS AND SEMI-TRAILERS 34 72 16,7
TEXTILES 17 64 0,4
FOOD PRODUCTS AND BEVERAGES 15 55 1,2
MANUFACTURING NEC 36 39,6 0,6
PRINTING AND PUBLISHING 22 14,9 0,1
BASIC METALS 27 11,8 1,0
TOBACCO PRODUCTS 16 -5,1 0,1
ELECTRICITY, GAS AND WATER SUPPLY 40-41 -11,6 0,8
ELECTRICITY, GAS, STEAM AND HOT WATER SUPPLY 40
COLLECTION, PURIFICATION AND DISTRIBUTION OF WATER 41
REAL ESTATE ACTIVITIES 70
RENTING OF MACHINERY AND EQUIPMENT 71
PUBLIC ADMIN. AND DEFENCE; COMPULSORY SOCIAL SECURITY 75
EDUCATION 80
HEALTH AND SOCIAL WORK 85
OTHER COMMUNITY, SOCIAL AND PERSONAL SERVICES 90-93
PRIVATE HOUSEHOLDS WITH EMPLOYED PERSONS 95

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EXTRA-TERRITORIAL ORGANIZATIONS AND BODIES 99

Final Report
Page 163 of 163

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FINAL REPORT

DRIVING FACTORS AND CHALLENGES FOR EU INDUSTRY AND THE

Framework Service Contract

Dr. Carlos Montalvo (team manager and report overall editor),

Prof. Marco Vivarelli Catholic University of Milan Italy

Prof. Jordi Molas-Gallart INGENIO, University of Valencia Spain

Dr. Puay Tang SPRU, University of Sussex United Kingdom

Dr. Anette Braun VDI Germany

Dr. Carlos Montalvo (team manager and report overall editor)

This report should be cited as:

Framework Service Contract 150083-2005-02-BE

Issue Version Comments Date Change

Framework Service Contract 150083-2005-02-BE

II. Demand side.............................................................................................. 12

5.1 India .......................................................................................................... 41

Framework Service Contract 150083-2005-02-BE

World markets trends: Implications for European Industry

Framework Service Contract 150083-2005-02-BE

Conclusions and policy implications ......................................................... 97

Annexes ....................................................................................................... 116

A1.1. Health Sector Telemedicine .......................................................... 117

Framework Service Contract 150083-2005-02-BE

Framework Service Contract 150083-2005-02-BE

Framework Service Contract 150083-2005-02-BE

Rationale of this study

Objectives and Methodology

Methodology and overall approach

Framework Service Contract 150083-2005-02-BE

In order to achieve these objectives, four tasks were conducted:

Framework Service Contract 150083-2005-02-BE

Main driving factors that will shape the market in the

Framework Service Contract 150083-2005-02-BE

2.1 Global challenges

Eradicate extreme poverty and hunger;

2.1.1 Ageing population

Framework Service Contract 150083-2005-02-BE

Figure 1 World trends in population ageing

2.1.2 Climate change

2.1.3 Epidemics and pandemics

Framework Service Contract 150083-2005-02-BE

2.1.4 Global shifts in economic power

Figure 2 Expected shift in GDPs between 2003-2050 (GDP in US bn$)

2.1.5 Increasing pressure on health care

Framework Service Contract 150083-2005-02-BE

2.1.6. Over-exploitation of natural resources

2.1.7 Population growth

Framework Service Contract 150083-2005-02-BE

Source: United Nations Population Division (2003)

2.1.8. Pervasive globalization

2.1.9. Social equality

Framework Service Contract 150083-2005-02-BE

Table 2 Projected economic growth in the world

Memorandum items 2003 2004e 2005f 2006f 2007f

Note: PPP = purchasing power parity; e = estimate; f= forecast.

Source: World Bank 2006.

Framework Service Contract 150083-2005-02-BE

2.1.11. Terrorism and pervasive insecurity

2.2 Consumption trends

Energy consumption levels are directly 350 Electricity production

tion, transportation intensity, and the Energy use

Framework Service Contract 150083-2005-02-BE

Dollars per 1000 cubic feet (gas)