Innovation in the Service Sector –Selected Facts and Some Policy Conclusions

by

Georg Licht, Günther Ebling, Norbert Janz and Hildrun Niggemann

Zentrum für Europäische Wirtschaftsforschung (ZEW)

Center for European Economic Research

Mannheim

December 1999

Prepared as part of the project “Innovation Policy in a Knowledge-Based Economy”commissioned by the European Commission

* This paper summarizes previous work based on the German Innovation Surveys in Servicescalled Mannheim Innovation Panel in Services which is conducted on behalf of the GermanMinistry of Education and Research by the Center for European Economic Research at Mann-heim, Germany. For more information please contact the first author.

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Preface

Data on innovation in services are quite rare. In 1998, EUROSTAT has initiated a large effort

to generate data on innovation in services by expanding the community innovation survey to a

wide range of market services. However, data resulting from this endeavor are not yet avail-

able for most European countries. They significantly increase the knowledge about innovative

activity in services and allow to draw some policy conclusions. As data of CIS II are not yet

available at the micro-level I decided to use the German Innovation Survey in Services to il-

lustrate some conclusions based on innovation survey data of service industries.

Although some of the conclusions concerning policy are based on the German situation, I

believe that most of them are also valid for other European countries. The main argument in

favor of this assumption is that the driving forces of innovation in services (diffusion of ICT

technology, deregulation, and increasing tradability of services) are the same in Germany and

other European countries.

The service sector as a whole is a rather heterogeneous conglomerate of industries. It is there-

fore often difficult to make generalizing statements or to come to clear conclusions. We will

concentrate on service industries which are particularly determined by market forces in most

European countries. We will not consider innovation e.g. in the health sector or in public

services, which are certainly very important arenas for innovation and also have a strong im-

pact on innovation in other sectors of the economy (e.g. medical equipment, pharmaceuticals).

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Table of Contents

1 BACKGROUND......................................................................................................................................4

2 DATA SOURCE AND MEASUREMENT ISSUES................................................................................6

3 INTERNATIONAL COMPETITION AND SERVICES .......................................................................9

4 ON THE NATURE OF INNOVATIVE ACTIVITY IN SERVICES ...................................................11

4.1 SHARE OF INNOVATIVE FIRMS AND THE STRUCTURE OF INNOVATION EXPENDITURE ...........................114.2 SOURCES OF KNOWLEDGE.................................................................................................................17

5 INNOVATION AND INFORMATION TECHNOLOGY IN SERVICES...........................................20

6 THE IMPACTS OF INNOVATION ON THE DEMAND FOR SKILLS IN SERVICES...................25

6.1 INNOVATION, IT AND GROWTH.........................................................................................................256.2 CHANGES IN THE SKILL STRUCTURE AND THE ROLE OF INNOVATION AND IT ......................................27

7 OBSTACLES TO INNOVATION IN THE SERVICE SECTOR........................................................34

8 SOME CONSEQUENCES FOR INNOVATION POLICY .................................................................36

REFERENCES..............................................................................................................................................42

APPENDIX 1: INDUSTRIES CONTAINED IN THE GERMAN INNOVATION SURVEY INSERVICES ACCORDING TO NACE, REV. 1, 1993 ..................................................................................44

APPENDIX 2: INNOVATION AND FIRM GROWTH IN NETHERLANDS 1994-96 DATA BASEDON THE DUTCH INNOVATION SURVEY ...............................................................................................45

APPENDIX 3: IMPACTS OF INNOVATION ON THE SKILL STRUCTURE EVIDENCE FORITALIAN SERVICE INDUSTRIES 1993-95 ...............................................................................................46

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1 Background

In the last decade most industrialized countries have experienced a sustained growth of value

added and employment in the service sector. Employment growth in the service sector was a

major engine for the creation of additional jobs. This generation of jobs in services has helped

to outweigh the decrease in the number of jobs in manufacturing. Given the high level of un-

employment in today’s Europe, it is of great concern to policy makers to stimulate the devel-

opment of the service sector. International comparison reveals that the employment share of

the service sector in some European countries (most notably in Germany) is significantly

lower than the proportion of jobs it currently provides in e.g. the USA or Canada.1 The ongo-

ing transformation into a service society becomes all the clearer when we additionally exam-

ine the changes in the activity structures of the manufacturing sector, where we have been

observing an accelerating shift away from traditional production operations and towards more

service-oriented activities for years now.

Moreover, there is also some concern on how these changes in the structure of our economies

will effect productivity and hence the ability to sustain high wages and a high living standard.

As shown by recent research, long-run productivity growth seems to be slower in most serv-

ices than in manufacturing (see e.g. van Ark, Monnikhof and Mulder 1999, O’Mahony 1999).

On one hand this can partly be attributed to measurement errors, but this is certainly not the

whole story.2 However, productivity growth in services has increased in recent years, which

1 However, the international comparison of employment shares is sometimes misleading when

hours of work are not taken into account or some employee groups are systematically not in-cluded in the comparison. This is relevant e.g. with regard to the so called 630-DM-jobs inGermany (see DIW 1998 for more details and some alternative calculations of a German UScomparisons).

2 See for details on the measurement problem a recent special issue of the Canadian Journal ofEconomics (1999, Vol. 32 April).

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can at least partly be attributed to the increasing importance of product and process innovation

in services. The diffusion of information and telecommunication technologies, and the de-

regulation in services have been the driving forces behind this development. Increasing inno-

vative activities in services, as well as the increasing importance of service innovation for the

economy as a whole, will certainly affect the employment prospects of this sector. Whether

the expansion of services will continue to function as the job engine it was in the past, is a

question which cannot be answered yet. Especially the service sector’s increased use of tech-

nology will probably change its skill structure in the same way as it did in manufacturing.

The expansion of services will thus probably not help to overcome the pressing structural

problem of unemployment which manifests itself in much larger unemployment rates for low

skilled workers relative to skilled workers in nearly all OECD economies (see e.g. Legler et al

1999).

This paper addresses selected aspects of innovation in services. First, we introduce the inno-

vation survey as a data source to assess innovation activity in services and discuss some as-

pects which limit our ability to measure technological change in services. Chapter 3 argues

that deregulation and globalisation is an important driving force for innovation in services.

Investment in ICT is a consequence, but also the source of, increased international competi-

tion in the service market. Chapter 4 looks at some characteristics of innovation activity in

services. We shortly discuss the role of R&D, human capital and social capital. Chapter 5 is

devoted to information and telecommunication technology. We show that ICT is the most

important new technology for service sector innovation. Again, we highlight the complemen-

tarity of investments in ICT and investments in human capital. The growing interest in serv-

ices is mainly due to the expectation that the expansion of services will be crucial to solve

Europe’s unemployment problem. However, as we will show in Chapter 6, the rise of the

knowledge-based service society will shift employment demand towards higher skill levels.

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Moreover, a lack of IT workers is expected to occur. Chapter 7 shortly mentions some obsta-

cles to innovation in services. Chapter 8 finally discusses some policy options to foster the

rise of the knowledge-based service society.

2 Data Source and Measurement Issues

The data we present is based on the German Innovation Survey in Service (first and the sec-

ond wave of the Mannheim Innovation Panel for the Service Sector (MIP-S)). The second

wave is based on the second edition of the OSLO manual, which explicitly considers service

sector innovations (OECD 1997). The first wave took place in 1995-1996. The second wave,

which also represents the German part of the community innovation surveys (CIS) coordi-

nated by EUROSTAT, was conducted in 1998. Innovation in services was more or less de-

fined similar to innovation in manufacturing; i.e. as the introduction of significantly new

products and services or the implementation of significantly improved processes. Some im-

portant measurement issues, however, remain yet to be solved. These issues comprise the

measurement of the output of innovations as well as the measurement of some innovation

inputs. Expenditure on research and (experimental) development as well as the number of

R&D employees are the traditional measures for innovative effort. A vast number of studies

on an economy-wide level or the level of single industries show that R&D expenditure corre-

lates with innovation output, e.g. productivity growth. Some problems in services arise from

the definition and interpretation of research and development (R&D). The traditional concept

of R&D relates to technological innovations in the manufacturing sector. In the service sector

the partly immaterial character of services or the interactive nature of innovation in business

services requires a modification of the traditional treatment of R&D in firm surveys. We

found that the interpretation of R&D by service sector firms is - at least in some cases - not

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compatible with the traditional definition of R&D in official R&D statistics. Nevertheless,

involvement of a firm in R&D activities (as stated by the firms) can be used as an indicator

that a firm devotes significant resources to product development and design purposes.

Measurement problems of the innovative output in services are also related to the interactive

nature of many service innovations. Furthermore, productivity measurement problems in

services arise due to the use of new technologies because, unlike in manufacturing, innovation

in services is often neither represented by new services nor by process improvements which

increase output or decrease input requirements. Innovation in service is often more closely

connected to the way products are delivered. Technological change is, for example, associated

with the number of hours during which a service can be delivered or with improvements in

the spatial dimension of the services (e.g. home banking). The quality of a service (e.g. user-

friendliness) is another component of innovation which is usually not correctly reflected in the

measurable output (see Licht and Moch 1999 or Baldwin et al.1998 for an approach to meas-

ure service outputs in qualitative terms). The multidimensionality of service sector innovation

output partly explains the existing problems in tracking the productivity growth of services.

One should be cautious about to judging the productivity growth figures in the service indus-

try which are relatively low compared to manufacturing, should be judged cautiously. Im-

provements in service production and qualitative improvements of service products have an

impact on the services and the whole economy. These improvements are one driving force for

structural change generating incomes and probably additional jobs, although the full effects

are probably not reflected in the measured product of services, but in the product of the cus-

tomers of service firms.

Another conclusion can be derived from relating innovation output and potential inputs to

innovation processes of service sector firms. To do this, we shortly highlight the results pre-

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sented in Licht and Moch (1999) who view IT-investment, R&D, human capital and physical

investment as main input-factors for innovation in services. To sum up, Licht and Moch found

that IT-investment has significant effects on the flexibility to adjust products to customer

needs, on the user-friendliness of the products, the temporal availability of services, and de-

livery periods, but only a weak impact on a firm’s per-employee productivity. Thus, we con-

clude that the effects of IT-investment on innovation in services are reflected mainly in prod-

uct quality improvement. Direct productivity impact or quality improvement of the production

process for services seem to be less affected by IT. Non-IT physical investment (total invest-

ment minus IT-investment) is especially important when the flexibility in adjusting products

to specific customer needs, fulfilling legal standards and regulation, and the productivity of

customers are viewed as innovation output of services. Finally, R&D efforts seem to be rele-

vant to enhance the productivity of the firms at hand as well as the productivity of their cus-

tomers. R&D is also associated with components like reliability of the service and the ability

to fulfill various regulatory requirements. Similarly, firm’s expenditures on human capital

enhance productivity and the quality of services. Human capital investment and client-related

continuous learning turned out to be even more important in services than in manufacturing.

Hence, an innovation survey in services should try to measure human capital input, which can

be thought of as playing as crucial a role for service innovations as R&D does for manufac-

turing innovations.

What we should keep in mind is that neither traditional output measures for innovative per-

formance like patents or the share of high-tech exports, nor traditional productivity measures

are useable indicators to evaluate innovation activities in service. We therefore base our ob-

servation on innovation in service mainly on innovation survey data.

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3 International Competition and Services

The increasing importance of service industries as providers of jobs in all national economies

has not yet resulted in a corresponding openness of the national markets.3 Although interna-

tional trade in services is increasing, the expansion of world trade in the nineties is primarily

due to manufacturing products. There is some evidence that the single market program and

the EURO have stimulated international exchange of services. However, only a minority of

service firms is active in international markets. Figure 1 shows the share of exporting firms

(with more than 5

employees) in some

selected service in-

dustries in Germany

and gives a bench-

mark figure for the

manufacturing sec-

tor. I expect similar

results for the rest of

Europe for Software

and EDP services as

well as technical

services.

Looking at the characteristics of exporting vs. non-exporting firms we find that past product

and process innovation are more common to exporting than to non-exporting firms. Further-

3 We have to admit that internationalization of the markets for services in some industries take the

form of FDI and not exports (e.g. FDI of insurance companies, the banking sector; even in the

Figure 1: Share of Exporting Firms in Selected ServiceIndustries in Germany in 1997

0 20 40 60 80

OtherBusiness S..

Technical

Services

Software

Insurance

Transpo

Retail trade

Wholesalestrade

Share in %

Average Manufacturing

Average Services

Source: ZEW (1998): Mannheim Innovation Panel − Service SectorComment: Banking Sector not considered

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more, the export probability increases with a firm’s human capital and decreases with its labor

costs. Thus, innovation is also a driving force for international competitiveness in services

(see Janz and Ebling 1999). Furthermore, one can expect that internationalization (tradability)

will increase in the future. This is especially true in those industries where ICT investment

dominates innovation activities. In addition, import competition is also expected to grow. And

– at least in Germany – there is a trade deficit in most of the service industries. An increasing

number of firms will be hit by international competition which will lead to a decrease in

prices and will be a major threat to existing suppliers in those markets. Even firms which ex-

pect to increase their export they fear that the additional competitive threats from import will

out-weight this.

German service companies

have fallen behind the in-

ternational activities of

their foreign competitors,

notably in those service

industries where deregula-

tion sets in later than in

other European countries.4

In any case, the share of

firms which face interna-

tional competition is larger

localized markets of certified accountant there is a considerable market share of US or UKbased international accounting groups (e.g. Ernest & Young; Arthur Anderson)

4 However, the larger size of the German markets makes exporting to German a more interestingoption for foreign firms than the other way round.

Figure 2: Export Activities 1996 and Medium-Term Ex-pectations

0 10 20 30 40 50 60 70

Other BusinessServices

Technical Services

Computer Services

Insurances

Transport

Retail trade

Wholesale trade

Overall average export

international competition

international competition

international competition

international competition

international competition

international competition

international competition

international competition

export

export

export

export

export

export

export

share of firms in %

Source: ZEW (1998): Mannheim Innovation Panel −Service Sector

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in every industry than the share of exporting firms (see Figure 2). And – based on the ex-

pected development of the market – this gap will not disappear in the near future.

Deregulation in services should therefore be stimulated instead of being slowed down. The

sooner European service providers are subject to international competition, the sooner re-

structuring, innovation and learning to use new technologies will start; which in turn will en-

able firms to defend their (home) market share and improve their ability to enter foreign mar-

kets.5 In addition, the various national systems to foster export activities of SMEs (most serv-

ice companies are SMEs) should be adjusted to the needs of service companies to enter the

SEM. The changes for sales and employment growth, created by the increasing liberalization

of the SEM and the liberalization with in WTO framework, are - in any case - not fully real-

ized yet.

4 On the Nature of Innovative Activity in Services

4.1 Share of Innovative Firms and the Structure of Innovation Expenditure

One can no longer blame the service sector for not being innovative. Deregulation in many

areas of the service sector and the rapid development and diffusion of IT technologies have

opened up the market for international competition. Manufacturing companies concentrate on

their core competencies and increasingly source out ancillary service activities. Taken to-

gether, these developments increase competition in services and open up additional opportu-

nities for companies to improve their market position by introducing new products and en-

hance their efficiency by introducing and reinventing their production processes. We should

5 Licht et al. (1997) demonstrate that expected future import competition spurs innovation.

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therefore expect to find the largest share of innovating companies6 in those sectors where the

changes of market condition undergo the most severe changes. As Figure 3 shows, this ex-

pectation is confirmed by CIS data for Germany.7

The largest share of innovating companies is found in the telecom sector which was deregu-

lated in Germany in the midst nineties. This opens up new market opportunities which can be

realized by the introduction of new products and puts pressure on the previous monopoly firm

to increase productivity. Following in the row are software and IT service firms. Given the

rapid technological development, e.g. the introduction of intranet and internet, this does not

6 Innovating companies are defined – according to the OSLO manual – as companies which in-

troduce new or significantly improved products and implement significantly new productionprocess within a three years period (1994-1996).

7 Similar results are present by Klomp and van Leeuven (1999) or Evangelista (1999b). CIS-IIdata for other European countries confirm these interpretation although some notable differ-ences between EU members are present.

Figure 3: Share of Innovating Companies in the Selected German Service Sectorsin 1996

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Share of Innovating Companies

Manufacturing

Modern Services

Traditional Services

Telecom

Software / IT-Serv.

Financial Services

Engineering S.

Other Business S.

Retail Trade

Wholesale Trade

Transport S.

Source: ZEW (1998): Mannheim Innovation Panel – Service Sector

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come as a surprise either. However, somewhat surprising is that engineering and technologi-

cal business services come next. Given the slacking demand in manufacturing and in the con-

struction sector in the time period covered by our survey, there is a large pressure to increase

the efficiency by process innovation in order to cope with falling prices in that period. As in-

dicated by Table 1, the introduction of IT technology plays a central role in this sector. To-

gether with the ‘other business services’ which consist of a rather heterogeneous set of firms

this sector can be comprised using label ‘modern service sector’. In average, the share of in-

novating firms in this group of industries is quite similar to the average share of innovating

companies in the German manufacturing and mining sector8. Even this simple comparison

shows that innovation is no longer the domain of manufacturing. New technologies change

services in ways increasingly similar to those in manufacturing in the past.

Despite the comparable percentage of innovative companies in both the manufacturing and

the service sector, there are considerable differences in the structures of the innovation corpo-

rate activities between these two sectors. In the service sector process innovations play a less

important role. More than half of the companies refer to themselves as product innovators and

only 35% as process innovators. Process innovations are usually accompanied by product

innovations or are a direct result of them. At the same time one can observe that the distinc-

tion between product and process innovations is often blurred especially in the service sector,

which makes it sometime difficult to differentiate.9 Case study work suggests that merely

looking at a firm’s self-assessment on product vs. process innovation underestimates the im-

portance of process innovation. Most of the change, e.g. in banking, is due to an increased use

of ICT which clear changes the process of banking services and not the banking products.

8 Data for these aggregates refer to the year 1997. For details see Janz et al. 1999a and 1999b.

9 Despite of this problems the distinction of product and process innovation in innovation surveysseems to be a useful concept (see for more details Evangelista and Sirilli 1995).

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Looking at the most important innovation we can conclude that product innovation in service

often can be characterized as incremental product innovations or can be classified in a variety

of cases as process innovations. Licht et al. 1997 show that when taking the most important

innovation to distinguish between product and process innovation more firm perform process

than product innovation.

In addition, in-house development of new products is more common in services than in manu-

facturing. This also is in line with the interpretation the product innovation in services are

mainly incremental in nature. This points towards differences in the nature of innovations and

their development process in services and manufacturing. This is confirmed by looking at the

importance of R&D for innovation in services or the structure of investment in innovation.

Innovation expenditure in the service sector differs considerably, both in structure and size

from that in the manufacturing industry. In the manufacturing industry, the share of innova-

tion expenditure as a fraction of turnover constitutes about 5%; in the service sector it is only

about 1%. In most service industries, research and development has a comparably small im-

portance. It must be noted, however, that the service sector is highly heterogeneous. In terms

of structure of innovation expenditure (as well as other dimensions of the innovation process)

Figure 4: Structure of Innovation Expenditure in German Services 1997

software, patents

16%

maschinery andequipment

26%

training

18%

market introduction

10%

conception12%

extramuralR&D 6%

intramural R&D11%

Source: ZEW (1998): Mannheim Innovation Panel − Service Sector

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one companies from technical and IT industries are similar to technology-intensive firms in

manufacturing. Following the German CIS II survey, about 65% of the innovative IT service

providers and about 45% of the innovative technical service providers carry out R&D, com-

pared to only 14% in the entire service sector and slightly less than two thirds in the manu-

facturing industry.

Participation in R&D activities and even more so R&D intensity is relatively low in the serv-

ice sector, where human capital usually replaces R&D as main input factor for the develop-

ment and implementation of product and process innovations. Therefore, staff qualifications

are of significantly higher importance in the service sector than they are in the manufacturing

industry. Often, it is employee experience and expertise that constitutes the know-how of

service providers and that can therefore not always be captured. Traditional mechanisms for

the protection of intellectual property play a less significant role. In addition, product innova-

tions are easy to copy because of their often marginal nature and a limited scope of intellec-

tual property rights (e.g. think of a new concept of a type of insurance).

Investment in capital goods closely related to innovation activities amount to around one

quarter of the total innovation expenditure, most of which is related to ICT. The service sector

is the largest customer of ICT industries and often plays the role of the lead user of new ICT

technologies which strongly influences the development of technology. Especially companies

in knowledge-intensive services and business-related services stimulate technological change

to an extent which vastly exceeds the pure usage of technological activities in some other,

more traditional manufacturing or service branches such as transport or trade.

So, in most service industries innovation is stimulated by the use of knowledge embodied in

capital goods, the use of a high-qualified staff and a low degree of formalized knowledge

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generation. Investments in information and communication technologies often goes hand in

hand with new product and especially with process improvements.

In traditional service sector this seems to be in line with the idee of an inverse-innovation cy-

cle developed by Barras more than a decade ago when analyzing the impacts of investment in

computers on innovation in services.10 He argues that in the initial phase of market penetra-

tion ICT is used in the service sector for purposes of efficiency enhancement; it is not until a

later stage of diffusion that new products (services) based on ICT begin to develop and create

new market opportunities to satisfy new needs. This cycle differs between service sectors and

is also different from manufacturing where, traditionally, the first phase of the diffusion of a

new technology is characterized by a dominance of product innovation. In the second stage

the rate of product innovation decrease whereas the rate of process innovation increase. Fi-

nally, more process innovation dominate product innovation in the third stage.

Product innovations based on network technologies like IT are increasingly attractive the

large the installed base. So, product innovation in IT-based service are retarded and process

innovation in more attractive in the first phase of the diffusion of IT technologies. Process

innovation, however, are accompanied by large investment expenditure whereas product in-

novation more often based on formalized internal knowledge. The observation made using the

innovation survey are – especially for the more traditional service sectors – give rise to the

suspicion that an inverse innovation cycle is present.

As a consequence, technologically induced structural change is probably less frictionless in

services than in manufacturing - since process innovation probably destroys jobs first before

product innovation in a different sector will create additional jobs. However, large productiv-

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ity increases which is a consequence of the process innovation are hardly observed in most

service industries although large IT investments are made in the last decades.

The simultaneous occurrence of large IT investments and low productivity increases is often

refer to as the productivity paradox. Landauer (1997) presents a large variety of facts and in-

sights on the low productivity impact of IT based process innovations. But more recent evi-

dence is more optimistic about the productivity enhancing impact of IT investments (see Licht

and Moch 1999 for references) which is stronger today than in the past because the installed

base is larger and sufficient complementary investment in human capital and organizational

innovations are now available. This complementary assets are necessary to profit from a gen-

eral purpose technology like IT.

Productivity impacts, therefore, are retarded but will become increasingly important now. The

huge expected change in traditional retail banking partly explained by retarded productivity

impact and by a substitution impact of product innovation in banking which induce a change

in the structure of employment in banking (see section 6). So, also it can be supposed that an

inverse innovation cycle is present its consequences are not clear-cut because process inno-

vation in network industries need considerable time before the potential is exhausted.

4.2 Sources of Knowledge

In developing new products and introducing new processes, service providers relay heavily on

their own knowledge base. In most cases, this knowledge exists as experience of the em-

ployee and firm owner. Innovation is, therefore, based largely on tacit knowledge which is

10 Remember at this time centralized computing using mainframes was the dominating form of IT

investment.

- 18 -

stored in the head of the employees, in business and management routines and which is

transmitted informally in face-to-face contacts. The knowledge of the staff is the most impor-

tant prerequisite for innovations in the service sector and also indispensable for the use of

external sources of information which are required for developing innovations.

The fact that know-

how in the service

sector is strongly

linked to individu-

als, and that the pro-

cess generating

product and process

innovations is less

systematic, e.g. in

the form of R&D

activities, both point

to a general problem

for innovation ac-

tivities in the service

sector: Innovation processes strongly depend on situations and are less systematic. Govern-

mental incentives for promoting systematic R&D activities in service development („Service

Engineering“) could be highly beneficial stimulants in such a case.

Customers and competitors are the most frequently used external sources of knowledge,

whereby customers from the service sector are mentioned more often than customers from the

Figure 5: Sources of Information for Innovation in Services

0 5 10 15 20 25 30 35

Patents

Other Public Research

Universities

Consultants

Customers Manufacturing

Computer networks

Suppliers

Conference; Prof. Journals

Customers Services

Fairs, Exhibitions

Competitors

Share o firms in %

Source: ZEW (1998): Mannheim Innovation Panel − Service Sector

- 19 -

manufacturing industry. This points to a closer linkage of knowledge within the service sector

than between the service and the manufacturing sector.

Just as for manufacturing companies, national and international trade fairs and exhibitions

create the possibility for German service providers to have central contact exchanges where

they meet their international customers. Promoting participation in trade fairs and exhibitions

therefore represents a further starting point for economic politics.

Another essential difference between the manufacturing and service sectors lies in the varying

importance of know-how of companies from the same industry compared to the know-how of

their suppliers. Analyses lead to the assumption that this can also be attributed to the insuffi-

cient protection mechanisms for the intellectual property of services. The negative impact on

the inclination to innovate and on the type of innovation performed is obvious. It is well-

known that service innovation are hardly protected by patents, design or trademarks. Imitation

of successful service innovation are easy which lower the profitability of investments in inno-

vations. As already discussed above tacit knowledge stored in the brains of employees are the

most important form of knowledge used for innovation in services. Therefore, keeping key

employees with the firm is, therefore, crucial for protecting the competitive edge. In addition,

this strategy also is dangerous for two reasons. First, large proportions of knowledge are lost

if key employees leave the firm. This sometimes will lead to an under-investment in the

knowledge of employees when employers expect a large mobility of employees. Alternative

means for storing a firm’s knowledge is call for. However, internal knowledge management is

often not well developed. Secondly, absorption of new knowledge from external source is

may be hindered by the well-known “not-invented-here” phenomenon. This seems to be espe-

cially dangerous in area where technology is changing rapidly like in the case of IT. The –

reason for this negative impact on the absorptive capacity of a firm is probably rooted

employees’ fear that new knowledge question the internal hierarchy and present positions of

- 20 -

fear that new knowledge question the internal hierarchy and present positions of those key

employees.

The knowledge potential of universities, technical colleges and extra-curricular research in-

stitutions play a minor role. These institutions only occasionally offer practice-relevant serv-

ice-related know-how. Universities and research institutions have not yet sufficiently adapted

to the structural change and a knowledge-based service society, though they could well con-

tribute to the creation of innovation-relevant knowledge for the service sector.

5 Innovation and Information Technology in Services

Innovation in manufacturing and in services are often interrelated. The service sector aids

innovation in manufacturing by providing know-how. Service companies on the other hand

are major customers, and therefore important sources, of knowledge for manufacturing based

innovations. This is obvious from Table 1 that provides data on the share of companies which

invested in new physical goods, the share of companies which invested in information tech-

nologies, and the share of companies which provided further vocational education and train-

ing to their employees.

First of all, the overwhelming majority of companies in the surveyed service industries invests

in information technology. Of course, investment is more extensive in the modern service

sectors than in the traditional sector. However, the mere size of the traditional service sector

makes them important customers of information technology and as such strongly influences

the development of this technology. As it is well-known, financial services are one of the

largest users of IT. In addition, we also note that in the modern services investment in new

physical goods is closely related to investment in IT. The share of firms with investment in

- 21 -

new capital goods is more or less identical with the share of firms investing in IT in these

sectors.

Table 1: Innovation, Investment and Expenditure on Education

Share of Firms(1996)

InnovativeFirms

Firms buyingcapital goods

Firms with in-vestment in IT

Firms expenditureon CET and CVT

Wholesale Trade 54% 84% 79% 62%

Retail Trade 60% 92% 82% 73%

Transport 50% 88% 74% 51%

Telecom 100% 100% 100% 100%

Banking/Insurance 74% 91% 89% 90%

Software, IT services 83% 97% 97% 88%

Engineering Services 67% 100% 98% 81%

Other Business Services 61% 94% 88% 76%

CET = continuing vocational education; CVT = continuing vocational training

Source: ZEW (1998): Mannheim Innovation Panel – Service Sector

However, IT is not only the most important investment good; it also plays a central role for

innovation in the service sector. Table 2 contains the share of innovating companies which

state that their innovations are based certain technologies.11 Having a look at this table, the

dominant role of information technologies for innovation in services becomes clear immedi-

ately. Even in the least IT-active sector – retail trade – 87% of the innovators believe that IT

was important for the innovations introduced. The importance of all other technologies varies

vastly from sector to sector. New facility management techniques are important for engineers

e.g. in developing new houses. Latest traffic technologies are – of course – crucial to the

transportation sector.

11 The list is more detailed than the technologies depicted in Table 2. In the case of information

technologies it considers the usage of mainframes, workstations, PCs, packaged standard soft-ware, data bases, high quality net works (e.g. ISDN) or multimedia technology. Environmentaltechnologies comprise e.g. recycling, energy saving techniques, pollution control measurement.

- 22 -

Table 2: Use of Different Technology for Services Sector Innovations 1996

As share of in-novating com-panies in 1996

IT Environ-mental

FacilityMan-

agement

Traffic Meas-urementand Con-

trol

LifeSci-

ences

Nutri-tion

Newmateri-

als

Others

Wholesale Trade 88% 45% 27% 49% 22% 6% 5% 21% 4%

Retail Trade 87% 51% 5% 25% 12% 4% 1% 10% 4%

Transport 94% 74% 14% 74% 3% 0% 0% 2% 0%

Telecom 100% 14% 14% 7% 14% 7% 0% 0% 7%

Banking/Insurance

95% 17% 10% 4% 3% 1% 0% 0% 3%

Software 97% 20% 4% 20% 13% 10% 3% 3% 9%

EngineeringServices

96% 44% 28% 16% 27% 9% 9% 24% 8%

Other BusinessServices

93% 42% 22% 23% 13% 2% 3% 10% 4%

Source: ZEW (1998): Mannheim Innovation Panel – Service Sector

The dominating role of IT becomes even more obvious when you look at the share of compa-

nies which do only declare other technologies but not IT to be important for their innovations.

Again retail trade stands out somewhat. However, even in retail trade only 7% of innovating

companies innovate using non-IT technologies, another 6% of retailers innovate without

adopting new technologies at all. A 57% majority of retailers use IT and any other technol-

ogy. Similar observations for the other sectors can be made with the help of Table 3. In the

most IT prone sectors like the financial services, Software and Telecom, innovation without

the use of IT seems almost impossible.12

12 However, the observation that IT and other technologies often occur in the same firm at the

same time is not necessarily an indicator for technology fusion It can well be the case that twoseparate innovations are made, one of them using IT and the other using e.g. environmentaltechnologies.

- 23 -

Table 3: Multiple Technologies in Use for Innovation in Service Sector

As share of all innovating com-panies in a given sector

IT only Only OtherTechnologies

IT andother Tech.

No NewTechnologies

Wholesale Trade 13% 4% 75% 8%

Retail Trade 31% 7% 57% 6%

Transport 5% 4% 89% 2%

Telecom 86% 0% 14% 0%

Banking/Insurance 70% 0% 25% 5%

Software 43% 0% 54% 3%

Engineering Services 28% 2% 68% 2%

Other Business Services 43% 4% 49% 3%

Source: ZEW (1998): Mannheim Innovation Panel – Service Sector

Service sector innovations and the adoption and use of new technologies in services takes

place, although R&D seems to play a much less significant role in services than in manufac-

turing. The German R&D statistics show that well under 10% of the business sector’s R&D is

spend by service sector firms. The question that arises is how service sector firms can main-

tain an equally large share of innovation companies. An obvious answer is that innovation in

service occurs mainly in the form of embodied technology stemming from manufacturing.

However, this is certainly not the whole story. More in-depth analyses show that the role of

human capital for the development of innovations is considerably more important in the serv-

ice sector. This can be highlighted by comparing the skill structure of innovating and non-

innovating companies.13

Table 4 shows the share of highly skilled, medium skilled and low skilled employees by sec-

tor. In all sectors the share of highly skilled employees in innovating firms is larger than in

13 The reverse causality – innovation influences the skill structure – is inferred in the next section

in more detail.

- 24 -

non-innovating companies. Moreover, in most sectors the share of the medium skilled is also

lower in non-innovating companies than in innovating ones.

Table 4: Skill Structure in Innovative and Non-innovative Firms

Non Innovative Firms Innovative Firms

Skill Level High Medium Low High Medium Low

Wholesale Trade 8% 65% 28% 12% 71% 17%

Retail Trade 5% 76% 19% 12% 72% 17%

Transport 3% 63% 36% 5% 58% 37%

Telecom n.a. n.a. n.a. 32% 67% 1%

Banking/Insurance 15% 75% 10% 18% 70% 13%

Software 32% 57% 11% 48% 49% 4%

Engineering Services 43% 46% 11% 47% 46% 8%

Other Business Services 13% 61% 26% 26% 54% 21%

High = University or Technical University Degree or Masters Degree; Medium = Vocational Training; Low =No formal education (except school)

Source: ZEW (1998): Mannheim Innovation Panel – Service Sector

Table 4 also shows that the share of highly qualified employees is largest in those sectors

which are more innovative and make more intensive use of IT for innovations. This seems to

be even more valid for innovating companies, which again points to the crucial role a suffi-

cient human capital base plays for innovation in services.

In addition, the share of companies which spend money on further vocational education and

vocational training of their employee is considerably higher in the sector with a larger share of

innovating firms (see last column of Table 1). Firms’ investment in the expansion of its hu-

man capital base is more important, the more crucial IT technologies are for firms. Moreover,

further education and training is also important for firms who do not innovate, but invest in

IT. Thus, to fully realize the benefits from investment in IT seems only possible with com-

plementary investment in human capital.

- 25 -

The crucial role of human capital for the adoption of new information technologies in services

is also evident when you look at the share of expenditure on training in total innovation ex-

penditure. This share considerably exceeds the share of spending on training in manufacturing

and amounts to nearly the same share that R&D has in manufacturing.

However, money spent by firms on the enlargement of the knowledge of their employees is

not equally distributed across all employees. Employees with higher secondary and tertiary

education levels receive more intense training opportunity than lower qualified workers (see

Licht and Fier 1999). And this can be viewed as additional evidence for the fact that the

adoption of IT also needs an increase of the initial skills at the level of employees. In turn, as

will be shown in the next section, low qualified employees represent the group of employees

which, as a result of the introduction of information technology in services, suffers most in

their employment prospect.

6 The Impacts of Innovation on the Demand for Skills in Services

6.1 Innovation, IT and Growth

Before dealing with the question whether innovation and new technology enhance the skill

requirement of the service sector, we will shortly deal with the growth of the service sector in

Germany and the role that innovation activity plays in enhancing service sector growth and

growth prospects. Firms will only enlarge their staff when growth prospects are positive. So,

when innovation enhances growth, this will result in additional employment. It is well known

from various papers that more innovative firms show more favorable sales and employment

- 26 -

growth. This is not only true with regard to manufacturing but also to services (see e.g. Janz

1999a and 1999b).14

In relation to this growth effect the efficiency enhancing aspects of innovation on the level

and the skill structure of employment - once the growth effect is accounted for - will be often

of second order or will be only visible if the growth effect is eliminated. Therefore, a separate

treatment of both effects is useful to understand this impact of innovation and technology on

employment.

Overall, the service sector and especially the technology-intensive and human capital inten-

sive service sectors showed above average growth value added and employment growth rates

in the last decade in Germany. This is also present in the innovation surveys which show that

a majority of firms in services have increased their workforce and expect to proceed this way

in the future. So, the growth trend in services will prevail. However, when comparing the ex-

pansion of the German service sector to the growth of services in other countries, we recog-

nize that Germany faces a less rapid expansion in service as most other countries. The main

reason for this is the sluggish growth in the overall economy, which also restricts the growth

prospects in services.

Moreover, growth rates differ between East- and West-Germany and between firms of differ-

ent sizes. West-German services grow much faster than East-German services, and the fre-

quency of decreases falls with growing size. Additionally, there are considerable differences

between the various branches. Banks and insurance companies in both regions have a high

sales growth. In the west of Germany, transportation and telecommunications perform

roughly as well as banks and insurance companies. Wholesalers and other business services

14 Data given in Appendix 2 show that this claim is not only true for Germany but also for other

- 27 -

lead the mid-field, with retailing a long way behind. In the east of Germany, it is the software

firms and the other service providers who follow the banks in the assessment rankings.

Bringing up the rear in this part of the country are the wholesalers, and then, again a long way

behind, the retailers. Another interesting fact is that firms operating abroad (exporters, oper-

ating through partners or subsidiaries abroad) have a significantly better sales trend. This is

even more true for innovating companies. By contrast, companies which expect foreign com-

petitors on the domestic market and already encounter them, report poorer sales trends than

firms without any international competitors. As innovation enhances export probability, this is

another channel for innovation to enhance the growth of a company. Of particular interest is

the question whether the companies using the various technologies covered by the survey

stand out from the rest of the companies with regard to their growth.

The multivariate analysis can shown that, irrespective of the degree of internationalization,

the size of the company, the particular branch of the economy involved, and the past sales

trend, companies which have recently been using high-performance IT grow faster than their

counterparts without intensive IT-use. In wide areas of the service sector the use of IT tech-

nologies appears to be a prevalent precondition for a positive sales trend.

6.2 Changes in the Skill Structure and the Role of Innovation and IT

In order to demonstrate the impact of innovation and IT on the demand of skills we use the

expected change in the skill structure instead of the actual demand for skill. The main reason

for this is that a highly qualified workforce is a main requirement for innovation activities.

Therefore, to address the problem of reverse causality we look at the expected change when

linking employment demand to past innovation activities and technology use. Moreover, em-

ployment expectations can only be meaningfully interpreted against the background of the

countries by taking the Netherlands as an example.

- 28 -

existing staff qualification. Here we use a more refined qualification classification. We distin-

guish between college/university graduates with degrees in scientific/technical subjects, col-

lege/university graduates with degrees in economics, sociology or the humanities, profes-

sional school graduates (‘technicians’ and Germany’s ‘master degree’ based on the vocational

apprenticeship system), employees with a vocational qualification, and other employees.

An initial overview of general employment expectations in the various staff qualification

categories is provided in Figure 1.15 For Germany as a whole, it can be seen that, with the

exception of "other employees", all qualification categories exhibit an upward trend. In each

of the qualification categories, the majority of employees work for firms who wish to expand

the category concerned. In the numerically most important category of employees, those with

a vocational qualification (see the preceding section), the proportion of employees affected by

a downward-trend expectation is greater than in the higher qualification categories. Nonethe-

less, the proportion of those who work in companies with rising employment prospects is

considerably larger.16

By contrast, prospects are gloomy for the "other employees", for a considerable number of

workers who are employed in companies which intend to downsize their payrolls. Conversely,

only a quarter of "other employees" work for companies which anticipate an increase in hiring

in this qualification category.

15 This figure is constructed in the following way. First, we calculated the share of employees in

each skill group who work for companies which expect to expand their workforce in this skillgroup. Then we calculated the skill group-specific share of employees working for companieswhich plan to contract the workforce in this skill group. Finally we net out the employment ex-pectation in each skill group by subtracting the number of employees in contracting firms fromthe number of employees in expanding firms. The resulting number is a good proxy for the ex-pected growth rates as evidence from the business cycle research has proven. Therefore, thelarger this number is, the higher is the expected employment growth.

16 Appendix 3 show similar evidence for Italy using a similar methodology.

- 29 -

This indicates that it is very likely that a proportion of unqualified jobs has been lost in the

service sector surveyed. And these are precisely those employees that are already affected by

above-average unemployment; the hope that an expanding service industry may provide com-

pensation is frequently expressed indeed, but it is obvious that few stimuli can be expected

from the sector of more company-oriented service providers.

More in-depth analyses based on regression analyses can provide some additional insight re-

garding the impact of innovation and IT use. First of all, our calculation expects differing

trends in the various size classes in the east and west of Germany. The three higher qualifica-

tion categories tend to exhibit improved prospects with rising size class in the west, whereas

in the east of the country the picture is precisely the reverse for graduates with a scien-

tific/technical degree, for example. No general trend emerges for the professional school

graduate grouping. The prospects for employees with a vocational school qualification are

best in both parts of Germany in firms with a workforce of 20 - 49, whereas firms with 50 -

249 on the payroll expect a lower rise in the number of staff with a vocational school qualifi-

cation. The negative expectations in the west of the country for employees with the poorest

qualifications result from the employment plans in large companies.

When employment prospects are considered separately for each branch, this shows that posi-

tive prospects are confined solely to the software industry and other business services. Scien-

tists have equally good expectations in all branches of activity, except in retailing, transporta-

tion and telecommunications. The economists and professional school graduates have equally

good prospects in all branches, except for in financial and engineering services. Employees

with a vocational qualification exhibit lower netted-out figures, though these are still positive

except for in the fields of engineering services. For the "other employees" grouping, the an-

ticipated payroll changes are particularly extreme in banking and insurance, and in wholesal-

- 30 -

ing/retailing. Apart from that, there are positive net figures only for the software and IT serv-

ices industry and the business services, i.e. only in these fields can expanded employment for

unqualified staff be anticipated.

In a further step and besides the distinguishing features that have already been considered

(branch, region, and size class), additional influencing factors are examined on the individual

level, like sales expectations, activities abroad, foreign competition, innovation status, use of

new technologies, and staff qualifications structure. The aim here is to analyze whether com-

pany-specific characteristics can explain the increase in employees in the individual employee

categories involved.17 To do this we set up labor demand equations for each skill-group ex-

plaining the expected change in labor demand by sales expectations, relative factor prices as

well as innovation activities and technology use. The results can be summarized as follows:

• Sales expectations play a dominant role for employment increase in all qualification lev-

els. Firms which expect rising sales are more likely to hire staff from all qualification

categories than otherwise equivalent firms that do not expect their sales to rise in the fu-

ture.

• Firms which have introduced at least one innovation during the past three years more fre-

quently plan to hire qualified personnel. Larger companies intend to increase their propor-

tion of qualified personnel more considerably than medium-sized and small companies.

17 This is done using separate order probit regression models for each skill group. Kaiser (1998)

uses a more refined econometric method that considers the correlation between the error termsof these equations and leads to more efficient estimates. His results confirm the interpretationmade here.

- 31 -

Figure 6: Distribution of Netted-out Employment Expectations by Industry and SkillGroups

Software

Transport

Retail TradeWholesale Trade

Software

TransportRetail Trade

Wholesale Trade

Software

TransportRetail Trade

Wholesale Trade

Software

Financialconsultants

TransportRetail Trade

Wholesale Trade

Other business servicesTechnical consultants

Software

TransportRetail Trade

Wholesale Trade

Financial consultantsBanking, Insurance

-80 -60 -40 -20 0 20 40 60 80

Persons withapprenticeship

Others

Graduates of colleges

Banking, Insurance

Banking, Insurance

Banking, Insurance

Banking, Insurance

Financial consultants

Financial consultants

Financial consultants

Technical consultants

Technical consultants

Other business services

Other business services

Other business services

Other business services

Graduates in naturalscience

Graduates in economicsand humanities

Technical consultants

Technical consultants

Netted-out indicator of expected employment change

Source: ZEW (1998): Mannheim Innovation Panel – Service Sector (based on Licht et. al 1997);Explanations see text.

- 32 -

• The higher the proportion of already employed qualified personnel, the more likely be-

comes the additional hiring of college graduates. The higher the existing proportion of

qualified personnel, the less probable becomes the hiring of staff with vocational qualifi-

cation and poorly qualified applicants.

• The difference between east and west is not so much based on different corporate struc-

tures and behavior patterns, but more on differing compositions of the branches concerned

in terms of company size, innovation status and staff qualifications structure.

• The use of new technologies per se exerts no direct influence on employment trends. This

does, however, also mean that new technologies can be expected to produce only slight

productivity-related effects. On the contrary: these productivity effects can be imple-

mented only in conjunction with the use of qualified employees. Firms with a more quali-

fied staff are more likely to use IT technologies which in turn increase the relative demand

for skilled employees. The sales growth manifested in the use of new technologies, how-

ever, will "trickle through" to employment trends as well’.

The results indicate a considerable shift in the service sectors’ staff qualification structure.

The more highly qualified staff an enterprise possesses, the less likely it is to hire unqualified

applicants. It cannot, however, be concluded that firms with higher employment expectations

for highly qualified personnel do simultaneously have declining employment prospects for

unqualified applicants. However, we observe a negative correlation between the employment

expectations for highly and poorly qualified staff. It is nonetheless advisable to devote greater

attention to these trends. If they intensify, this will have far-reaching consequences for the

labor market.

- 33 -

This is even more true for the present trend which shows that many companies’ provision of

continuing training and continuing education to employees is univocally in favor of highly

qualified and already skilled employees. Additionally, the innovation process is less markedly

de-coupled from other corporate performance processes than in the manufacturing sector.

Attention should accordingly not be confined to training expenditures directly linked to inno-

vation projects. The high degree of interactivity in the process of the goods/service creation

means that qualification levels and training become closely related to innovative activity and

technological/organizational change in the service sector as such. However, innovating com-

panies invest significantly more in staff training than non-innovating companies. This is also

true for companies with a high proportion of highly qualified personnel that spend more per

capita on training schemes. This means that a high level of qualification is a precondition for

further training/up-skilling measures in the companies.

The use of new technologies as well as the proportion of ICT-related investments in the over-

all investment budget exert a markedly positive effect on the level of training expenditures.

Therefore, it seems dangerous when mainly the already-qualified staff profits from training

(due to technological change). This implies that the unqualified employees will be perma-

nently excluded from the labor market, and the employment chances for the poorly qualified,

slight enough as they are, will deteriorate even further as technological change progresses.

Reforms of the educational systems are called for, especially since a good primary education

is the ticket for further vocational education and training.

- 34 -

7 Obstacles to Innovation in the Service Sector

Increasing demand for qualified labor (especially with IT related skills) is more and more

limited by the supply. Something that can be observed in innovation surveys is that innovat-

ing firms using IT are often restricted by the availability of IT workers. Although the lack of

skilled workers is not the most important obstacle to innovation in the services as a whole, it

certainly limits the expansion of knowledge intensive services.

Besides the impeding lack of qualified labor, innovative service providers see themselves as

being confronted with a number of obstacles to innovations which they cannot always suc-

cessfully overcome in the first attempt. These hampering factors delay projects, lead to the

termination of promising projects, or prevent the start of innovation projects in the first place.

In this context economic, technological and educational policies could reduce the amount of

obstacles to innovation.

Due to a lack of appropriate funding, many profitable innovation projects are not realized at

all. Therefore, efforts to facilitate access to participatory capital for innovative service provid-

ers are required. Unfortunately, the dynamic development of the German participatory capital

market in 1997 and 1998 has not fully reached the service sector yet. Time will tell whether or

not this development will widen the range of potential financing sources for service innova-

tions.

- 35 -

Engineers and IT specialists often lack business-administrative training, particularly in project

management. Organizational problems are therefore a frequent reason for the prolongation of

innovation projects. This deficit can be remedied by integrating elements of project manage-

ment into engineering studies. This would not only benefit already existing companies, but

also improve the initial situation for start-ups.

Particularly technical service providers state that long administrative and authorization proce-

dures are obstacles to innovation. These observations result in a demand for economic and

technological policies to work towards further improvement of the ability and possibility of

firms to calculate time frames needed for administrative and legal procedures. Even if the

frequently demanded reduction in administrative and legal procedures can be realized only

gradually, at least their duration should be made predictable in order to prevent unplanned

delays in project duration. Parallel to this, the systematic information of companies on the

Figure 7: Factors Hampering Innovation in Service – Germany 1997

lack of information on markets

lack of information on technology

lack of costumer responsiveness

lack of qualified personnel

fulfilling regulations, standards

long administrativeprocedures

organisational rigidities

lack of appropriate sources of finance

excessive perceived economic risks

innovation activity was hampered by ...

3,1

4,2

10,1

10,8

11,2

11,4

13,1

16,8

17,6

0 2 4 6 8 10 12 14 16 18share of all firms in %

0 2 4 6 8 10 12 14 16 18

hampering factor led to ...serious delay...prevention of start... ... of at least one projectabolishment ...

Source: ZEW (1998): Mannheim Innovation Panel − Service SectorComment: Multiple statements regarding the obstacles and the kind of effect per hampering factor were possible.

- 36 -

functional breakdown of governmental regulation could contribute to a more realistic evalua-

tion of how long these regulation procedures will take, since this has to be taken into account

when planning project terms. All of this would help to increase the efficiency of corporate

innovation activities.

8 Some Consequences for Innovation Policy

The innovation-political options for the support of innovations by service providers should be

directed towards the above facts. On one hand, human capital is the key factor for innovation

activities in a knowledge-intensive society. On the other, information and communication

technologies for the service sector are cross-section technologies which are far more impor-

tant than any other modern technology. For both, companies and employees, not only the ini-

tial investment in training has to pay off, but also the continually required re-investment for

the adjustment of human capital. However, particularly small and medium-sized companies in

traditional service sectors such as transport and forwarding as well as trade, often lack the

potential to exploit the opportunities which are offered by new technologies.

Nevertheless, the growing liberalization and internationalization of service markets calls for a

stronger utilization of information and communication technologies in order to maintain com-

petitiveness. Innovation policy should therefore aim to increase the absorption capacity of

small and medium-sized companies and thus stimulate the diffusion of new technologies in

the service sector.

In addition, new concepts of supportive measures for the service sector must take into account

both the heterogeneity of the sector and the dominance of small companies. A policy provid-

- 37 -

ing stable and calculable prevailing conditions is therefore of central importance for further

development in the service sector. Indirect promotional measures correspond better to the

heterogeneity and small-business structure than direct support concepts which aim towards

specific products and technologies.

Employment expectations can generally be rated as positive, at least for employees with a

vocational or higher qualification. In companies with innovative activities, more jobs will be

generated for qualified staff. There are also indications that the staff qualification structure is

going to shift towards favoring more highly qualified people. This highlights the role of hu-

man capital in the productive process of the service sector segments examined, and underlines

the necessity for helping the less well qualified by implementing training schemes and/or

changes in the education structure.

Corporate training schemes are aimed at keeping abreast of technological change. Companies

with a higher proportion of highly qualified staff and users of new technologies exhibit more

intensive efforts in terms of training. There are almost no discernible indications that compa-

nies are specifically attempting to familiarize poorly qualified staff with the utilization of new

technologies. It is more probable that the requisite technical know-how is rather acquired

through new hiring, and that in-house training schemes primarily benefit the qualified and

highly qualified staff. The differences in human capital among employees are thus reinforced

by training approaches during the course of ongoing technological change.

Information and communication technologies constitute the pre-eminent cross-section tech-

nology for the service sector, ahead of all other modern-day technologies. Small and medium-

sized enterprises of the service sector’s traditional segments (e.g. carriers, logistics and trade)

do often not possess the internal resources to exploit the opportunities these technologies of-

- 38 -

fer. On the one hand, technological acceleration also causes any accumulated know-how to

become rapidly obsolescent, while on the other hand increasing liberalization demands inten-

sified use of precisely these technologies in order to maintain competitiveness. This, however,

reinforces the difficulties SMEs face in coping with the diffusion of IT in traditional service

sectors. In addition, time pressure on the side of the key personnel in SMEs in the booming

business services prevent them from reinvesting in human capital in order to keep up with

technology. Innovation policies should accordingly aim at increasing these companies’ ab-

sorptive capabilities.

This can be exemplified by the transportation segment: following complete liberalization of

the transportation segment throughout the European Union in 1998, the networking of local,

national and international carriers, plus the more intensive use of I&C technologies, will attain

central importance for safeguarding competitive positions. The decline in prices for freight

services, already triggered by initial steps towards liberalization, is hitting the liquidity of me-

dium-size carriers, and is often preventing systematic efforts towards utilizing information

and communication technologies and the requisite restructuring programs.

The know-how available in public research institutions is important for many small and me-

dium-sized service enterprises planning to use new technologies. Formal arrangements for

cooperations between SMEs and research institutions, however, are relatively rare in most

segments. Since innovation research has found that cooperative arrangements constitute an

essential and frequently effective source for the transfer of know-how, the question is how

more such cooperative arrangements can be stimulated. The primary aim here is, as a result of

altered priorities, to develop appropriate options at universities and research institutes which,

in their R&D activities, still focus on industrial production/development processes. Consid-

eration must also be given to the question of how the often inherently intangible character of

- 39 -

service products could best be allowed for, since it is precisely for this reason that existing

programs tend to pass them by.

Many service companies possess excellent preconditions for cooperative arrangements with

research institutions. Thanks to the high qualification of their workforce, particularly software

companies and consulting engineers are often unaffected by the most important barrier to co-

operation with bodies from the public-sector infrastructure: unfamiliarity with the idiosyncra-

sies and customs of the university and academic communities. Formal and informal arrange-

ments for cooperation are thus encountered quite often in these branches. Service companies

of this kind are also excellently suited for acting as a driving force to expand the relationship

between public-sector research institutions and small or medium-size enterprises from the

manufacturing sector. When formulating promotional measures for SMEs in the manufactur-

ing sector, research and technology policies should attempt to exploit this function of service-

sector companies, and pay more attention to service companies’ technology transfer function.

In conjunction with a further diffusion of information and communication technologies, par-

ticularly, new service segments like information mediators will emerge.

Our results indicate that in other branches of the service sector as well, especially when small

and medium-sized enterprises are involved, there are substantial problems to overcome in

adapting modern I&C technologies. The start-up costs for these new technologies include not

only the capital investment directly required for this purpose, but also the substantial indirect

outlay for generating the requisite human capital.

In view of the exigent problems of unemployment in Europe, the development in the staff

qualification structure, as mentioned above, constitutes a central field of action. The transfor-

mation into a service society will entail a substantial expansion of jobs for qualified and

- 40 -

highly qualified employees. This growth of "good jobs" will by far exceed the increase in

"bad jobs", if there is any increase at all in the modern service. The change in the qualification

structure towards more highly qualified employees, well documented in the manufacturing

sector over recent years, is manifested as a similar process in the surveyed service segments.

Political measures for combating unemployment have to take account of this trend to ensure

that unemployment and underemployment do not increasingly become a permanent condition

for unqualified workers; not least because long-term unemployment and technical progress

will continue to devalue existing qualifications.

Efforts to improve employment chances for unqualified workers can address both the relative

prices for unqualified work and the options for increasing these workers’ productivity. Vari-

ous policies can be applied separately or in combination. Options to decrease the relative

prices for unqualified work include (1) reducing the non-wage labor costs to be paid by the

companies for these workers, e.g. by cutting mandatory social security contributions, or (2)

reducing earned income for unqualified work, a step whose effects on available income can be

cushioned by lower income taxes for low incomes.

Training schemes could enhance the productivity of the lower qualified employees. At pres-

ent, training schemes tend to benefit mainly the qualified employees. Expansion of corporate

training programs, however, simultaneously calls for improvements in the quality standards of

the schemes involved, so that the search for suitable bodies to sponsor training schemes is

facilitated both for companies (and here the SMEs in particular) and for employees. However,

it is hard to say whether a tighter regulation of corporate training efforts may be beneficial. In

view of the multi-faceted, fast-changing context entailed by new technologies, direct regula-

tion of training schemes would appear of limited assistance, involving as it does the risk of

restricting the required flexibility in the training options on offer.

- 41 -

In any case, an increase the educational attainment of employees is a key for modern econo-

mies to profit from the job engine represented by the knowledge base service economy.

Moreover, educational reform should be seen as an integral part of innovation policy and

should not be treated separately. As economists have recognized long ago (see e.g. Nelson

and Phelps 1966, Aghion and Howitt 1998), a well-educated workforce is an important driver

of productivity and employment growth at the macro-level and at the micro-level of firms. At

the individual level of employees and unemployment, investing in education and life-long

learning presents a first best strategy to drive down the expected individual unemployment

probabilities. Given this potential utilities involved for all parties we should start with chang-

ing the priorities. Lower the relative cost of education and vocational training (see OECD

1998 for comparisons of the rates of return on physical and human capital investment) will

certainly increase the investment in human capital financed by the individuals, the firms and

the government.

To sum up: Education and training policies are the central starting points for further promot-

ing the transformation into a knowledge-based service society. An increase in public and pri-

vate investment in human capital is the key to a further extension and expansion of an inno-

vation-based service society.

- 42 -

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- 44 -

Appendix 1: Industries Contained in the German Innovation Survey in

Services according to NACE, Rev. 1, 1993

G. WHOLESALE AND RETAIL TRADE; REPAIR OF MOTOR VEHICLES, MOTORCYCLES AND

PERSONAL AND HOUSEHOLD GOODS

51 Wholesale trade and commission trade, except of motor vehicles and motorcycles

52 Retail trade, except of motor vehicles and motorcycles; repair of personal and household goods

I. TRANSPORT, STORAGE AND COMMUNICATION

60 Land transport; transport via pipelines

61 Water transport

62 Air transport

63 Supporting and auxiliary transport activities; activities of travel agencies

64 Post and telecommunications

J. FINANCIAL INTERMEDIATION

65 Financial intermediation, except insurance and pension funding

66 Insurance and pension funding, except compulsory social security

67 Activities auxiliary to financial intermediation

K. REAL ESTATE, RENTING AND BUSINESS ACTIVITIES

70 Real estate activities

71 Renting of machinery and equipment without operator and of personal and household goods

72 Computer and related activities

74 Other business activities

- 45 -

Appendix 2: Innovation and Firm Growth in Netherlands 1994-96

Data based on the Dutch Innovation Survey

-2,0 0,0 2,0 4,0 6,0 8,0 10,0 12,0

Innovative

Non-Innovative

Innovative

Non-Innovative

Growth rates 1994-96

Other industriesServiceManufacturing

Sales Growth

Employment Growth

Source: Klomp and van Leeuven 1999; Table 4.2.1

- 46 -

Appendix 3: Impacts of Innovation on the Skill Structure

Evidence for Italian Service Industries 1993-95

-60 -40 -20 0 20 40 60

Banking

Advertising

Travel/Transport

Oth.Business S.

Insurance

Engineering

R&D Services

Tech. Consultancy

Software

Telecom

Normalised Differences (in %)

High-SkilledMedium-SkilledLow-Skilled

Source: Evangelista (1999a), Table 7.12

Remark: Normalised Differences = Difference between the share of firms expecting increas-

ing employment in a skill group and the share of firms expecting decreasing employment in

this skill group