Business services and the changing structure of European economic growth

A pervasive trend that characterised the past two decades of European economic growth is that the share in the economy of commercial services, and particularly business services, grows monotonically, and this mainly to the expense of the manufacturing sector. The structural shift reflects a changing and increasingly complex social division of labour between economic sectors. The fabric of inter-industry relations is being woven in a new way due to the growing specialisation in knowledge services, the exploitation of scale economies for human capital, lowered costs of outsourcing in-house services, and the growing encapsulation of manufacturing products in a ‘service jacket’. Business services, which inter alia includes the software industry and other knowledge-intensive business services (KIBS), play a key role in many of these processes. We argue that in recent decades business services contributed heavily to European economic growth, in terms of employment, productivity and innovation. A direct growth contribution stems from the business-services sector’s own remarkably fast growth, while an indirect growth contribution was caused by the positive knowledge and productivity spill-overs from business services to other industries. The spill-overs come in three forms: from original innovations, from speeding up knowledge diffusion, and from the reduction of human capital indivisibilities at firm level. The external supply of knowledge and skill inputs exploits positive external scale economies and reduces the role of internal (firm-level) scale (dis)economies associated with these inputs. The relatively low productivity growth that characterises some business-services sectors may be a drag on the sector's direct contribution to overall economic growth. The paper argues that there is no reason to expect a “Baumol disease” effect as long as the productivity and growth spill-overs from KIBS to other economic sectors are large enough. Finally, the paper pinpoints some policy 'handles' that could be instrumental in boosting the future contribution of business services to overall European economic growth.