Desperate for digital

By Désirée Rückert and Christoph Weiss

The pandemic has sped up the digital transformation across almost all economic sectors. Most firms in the European Union and the United States expect the COVID-19 outbreak to have a long-term impact on the use of digital technologies, according to Digitalisation in Europe 2020: Evidence from the EIB Investment Survey. More than one-third of firms expect the pandemic to have a permanent effect on the services or products they offer as well as on their supply chains.

 

But the pandemic also opened up a chasm between tech-savvy firms and those struggling to digitalise. Firms that already had a strong digital presence maintained contact with their clients, suppliers and employees when European economies were forced to close. Firms that didn’t, such as small local businesses, shut for weeks or months on end.

European companies are global leaders in many traditional industries, such as automotive, pharmaceuticals, luxury goods and services. They are less present in fast-growing digital sectors, like software and computer services. Unlike China, the European Union doesn’t appear to be investing enough in research and development to generate new digital leaders. Europe’s weakness in digitalisation could jeopardise its long-term competitiveness and put control of Europeans’ private data in the hands of foreign firms. ­

Trailing in digital adoption

Europe lags the United States not just in the creation of digital technologies, but also in the adoption of existing digital technologies. By 2020, 37% of European firms had still not adopted any advanced digital technology, compared with 27% in the United States.

The failure to adopt recent digital technologies ultimately weighs on European firms’ competitiveness. Firms that have implemented advanced digital technologies tend to perform better than non-digital firms. In addition to innovating more, they also invest more, have better management practices, grow faster and create higher paying jobs. The gap with the United States is particularly marked for the construction and service sectors, and in the adoption of “internet of things.”

Smaller firms tend to have lower rates of digital adoption than larger firms. But the level of adoption for firms with less than 50 employees is particularly low in Europe, where firms tend to be smaller than in the United States. That’s a shame, because microenterprises and small and medium-sized enterprises are the backbone of the European economy. They represent 99% of all businesses and more than two-thirds of employment in the European Union, compared with slightly more than 40% of employment in the United States.

 

Pandemic catches firms out

The coronavirus pandemic woke many European firms up to the importance of digitalisation. Many firms now recognise that they need to catch up.

Catching up, however, requires investment. The pandemic took a toll on firms’ ability and willingness to invest (see related article on investment). Many firms saw revenues dry up as lockdowns curtailed their activity. To cope, they focused on short-term survival strategies and pulled back on investment plans. Failing to invest will further impede the ability of firms to create, transfer and adopt new technologies and will ultimately hurt their competitiveness. Strengthening Europe’s digital infrastructure could encourage firms to invest. While the majority of European households now have access to broadband internet, the spread of fast connections could be improved.

The European Union has a lot to gain from encouraging digital investments. Digitalised firms tend to be significantly more productive than traditional firms – and the difference is particularly marked in countries that are very advanced. For example, median labour productivity is 37% higher for digital firms in Finland than for non-digital ones. At 76%, Finland’s digital adoption rate is particularly high, according to the digitalisation report.

The digital peril

EU firms’ laggard position in digital innovation and in digital adoption could jeopardise Europe’s long-term competitiveness. A substantial share of EU firms are not implementing any digital technology and have no plans to invest in their digital transformation.

The difficulty European small digital firms have in obtaining financing also puts innovation at risk. Small digital firms are more likely to face credit constraints than traditional firms, forcing them to rely on internal funds like cash flow or profits to grow. Less developed venture capital markets in Europe also hinder their development.

The barriers to digital investment carry a huge opportunity cost. Digital firms have been a motor of innovation and job creation in Europe in recent years. The jobs they add pay better and offer better chances at advancement, in part because digital firms tend to train their employees more. Digital firms have also weathered the pandemic better than non-digital ones. Many European firms say the pandemic is likely to result in a permanent reduction in employment, according to the Investment Survey. Digital firms, however, are less likely to cut jobs.

Increasing digitalisation should be a cornerstone of the European economic recovery. To accelerate the pace of digital innovation and adoption, Europe should focus above all on three elements:

• an enabling ecosystem
• the right kind of financial support for investment
• a European vision to counter the digital imbalances that exist across the European Union.

Digitalisation is key for sustainable growth. Europe needs to make it a priority.