Who is prepared for the new digital age?

Digitalisation is an enormous opportunity and challenge for the current generation. It is revolutionising the world of work, business structures and value chains as well as innovation and market structures.

The recent COVID-19 pandemic is a sombre reminder of the relevance and necessity of digital technology for a variety of businesses and sectors: from health to retail, from manufacturing to education.

Who is prepared for the new digital age? - Evidence from the EIB Investment Survey, a new report from the EIB, shows that European firms currently lag behind in adopting digital technologies, particularly in the construction sector and the Internet of Things (IoT). It also highlights the importance of adopting digital technologies as they can lead to large boosts in productivity and disproportionate dividends in terms of competitiveness for early adopters.

A number of leading digital technology companies today are based in the United States or China. The EU, it seems, has fallen behind in the digital services transformation race but it might be able to take up leading positions in new races. This will depend on Europe ‘s ability to seize the opportunities arising from automation, artificial intelligence and other emerging digital technologies.

The report draws from two unique sets of data: the EIB Investment Survey (EIBIS) 2019 and the EIBIS Start-up and Scale-up Survey 2019.

EU firms lag behind their US peers in terms of digitalisation activities. Only 66% of manufacturing firms in the EU report having adopted at least one digital technology, compared to 78% in the US. The difference is particularly large in the construction sector, where the share of digital firms is 40% in the EU and 61% in the US. The difference in adoption rates between EU and US firms is 13 percentage points in services and 11 percentage points in the infrastructure sector.

EU firms have lower adoption rates of “Internet of Things” (IoT) technology than in the US. Using data on specific digital technologies in four different sectors suggests that the gap in adoption rates between the EU and the US is driven by the lower adoption rates of IoT technologies, such as electronic devices that communicate with each other without assistance. In addition, firms in the US construction sector employ drones more often that in the EU.

The EIB Digitalisation Index allows us to group countries according to firms’ assessment of digitalisation. EU countries fall into four digitalisation groups, based on the Digitalisation Index score: frontrunners, strong, moderate and modest. Denmark is the 2019/2020 digitalisation frontrunner, followed by the Netherlands, the Czech Republic and Finland. Those countries rank even higher than the United States.

The EIB Digitalisation Index is a composed index that summarises indicators on firms’ digital technology adoption as well as firms’ assessment on digital infrastructure and investments. It is based on firm-level data collected by the European Investment Bank Investment Survey in 2019. The EIBIS Digitalisation Index consists of five components: digital intensity, digital infrastructure, investment in software and data, investments in organisational and business process improvements, and strategic monitoring system.

The key observations of the EIB Digitalisation Index are:

The EU falls short of the US. On average, European firms are less often fully digital, and are particularly lacking in the construction sector, dragging down the digital intensity score. Furthermore, US firms invest more in business process improvements compared to their EU counterparts. By contrast, firms in the EU and the US perceive digital infrastructure similarly.

The best performing EU countries, in selected areas of digitalisation, are:

• the Netherlands – digital intensity, as well as digital infrastructure;
• the Czech Republic – investments in software and data as well as in organisation and business process improvements;
• Finland – formal strategic business monitoring system.

Digital firms tend to have higher productivity and better management practices than non-digital firms, be more innovative, grow faster and create higher paying jobs. A major barrier specific to Europe is an unfavourable firm-size distribution. There are many small firms in the EU that do not invest in digital technologies. These firms consider labour market regulations, business regulations and the lack of external finance as major obstacles to investment, which may further exacerbate the delay in digital technology adoption.

Digital firms are more likely to have hired new employees over the past three years, both in the EU and the US, while a higher share of non-digital firms have reduced their employment or remained stable.

Firm culture matters for the adoption of digital technologies. Digital firms more often report that they use a formal strategic business monitoring system than non-digital companies, both in the EU and the US. Digital companies also tend to reward individual performance more often with higher pay – this difference is larger in the US than in the EU. By contrast, digital firms are less often owned or controlled by their chief executive (or family members of the chief executive) than non-digital firms.

Digital firms have higher median labour productivity (turnover divided by the number of employees) than non-digital firms. This difference is particularly large in the US and is apparent in all sectors. There is thus a productivity premium associated with digitalisation.

To catch up with peers, the EU will need to create better framework conditions to support innovation and digitalisation. Policy action should develop measures to fast-track the adoption of better management practices, improve the skills of workers through training and make it easier to finance investments in intangible and digital technologies. The fact that EU firms are, on average, smaller than in the US is thus likely to be a major disadvantage for fast-tracking the adoption of digital technologies.

There are many old and small firms in the EU that are not investing in digital technologies. Those firms are more likely to report less advanced management skills and more likely to consider the availability of finance as a major obstacle to investment, which may further exacerbate the delay in adoption rates. This suggests that policymakers should put more effort into measures to remove growth disincentives and reduce market fragmentation, in particular in the service sector, where the EU is still far from a single market.

Strong barriers to investment for new innovative market entrants in the EU and less dynamism as a result of lower rates of failure could cause a systemic innovation deficit for Europe, especially in the fast-growing technological and digital sectors. The EU needs to generate more new leaders in these sectors and give incentives to leading companies to continuously reinvent themselves so that they help push technological and digital frontiers. It is also critical to support fast-growing small and young innovative firms and frontload investment in digitalisation, to balance network effects and winner-takes-all dynamics. This calls for improvements to the functioning of product and labour markets and the implementation of the digital single market in the EU.

Read more in-depth findings and analysis for each European Union country.