Growth challenges for the Dutch business services industry; international comparison and policy issues.

In employment terms, it is almost as big as the Dutch manufacturing industry. Two issues for concern are the hardly improving labour productivity of the business industry, and the relatively low innovation expenditures of the industry. Remedying both problems can be done, inter alia, by encouraging foreign competition, and by enhancing market transparency.

These findings emerge from the Special CPB Publication 'Growth challenges for the Dutch business services industry: international comparison and policy issues', to be released today. The report analyses the growth factors and growth perspectives of the business services industry. Through international benchmarking, the study assesses strengths and weaknesses of Dutch business services industry. The report concludes with policy options for strengthening the contribution of the business services industry to the Dutch economy as a whole.

A heterogeneous and dynamic sector....
Business services industry includes branches as different as software houses, accountancy firms, temporary work agencies, and industrial cleaning firms. They have in common that most of their services are delivered to other firms. Some branches provide rather standardised services, while other branches supply services that are tailor-made for specific clients. Between 1990 and 2000, the business services industry accounted for one-quarter of production growth in the Dutch market sector, and one-third of total employment growth. Can such a growth pace be kept up? For the period 2001-2010 two growth scenarios are investigated. In the optimistic Powerhouse scenario, annual production growth in business services industry amounts to 5,75 per cent, while 6,5 per cent during 1996-2000. In the pessimistic Mediocrity scenario, the annual production growth even drops to half the growth rate during 1996-2000. Lower growth of GDP and labour supply explain most of the growth deceleration.

...with particular strengths
The business services industry has a core position in the Dutch knowledge infrastructure for firms. Through knowledge diffusion and own innovations, this industry contributes to more efficiency of client firms, in competence areas as different as automation, product design, human resources management, and organisation structure. Compared to other countries, the strengths of the Dutch business services industry are its growth dynamics and its relative openness to foreign competition. Production and employment growth during the last decade were higher than in any of the OECD benchmark countries. Dutch industries went through a fast catch-up process as to the use of business services per unit of production. The Netherlands and Ireland are considered to be the most open markets, according to a panel of EU business service providers.

... and weaknesses
In terms of productivity growth and innovation expenditures, the Dutch business services industry is found in the lower sections of the international league. Short supply of high-skilled personnel appeared more a growth bottleneck in the Netherlands than in other countries.

Small scale rules
The overwhelming part of firms in business services is very small. Some ninety per cent of firms employs less than ten workers. The industry also consists of many self-employed entrepreneurs. Starting a new firm in business services is relatively easy, but growing to a larger scale seems to be more difficult.
Many knowledge-intensive business services are credence goods. The client lacks information on the service quality before he buys it, and sometimes even shortly after the purchase. Clients solve this information problem by resorting to established market reputations of service providers. This leads to segmented markets, in which small firms without an established reputation may find it difficult to grow beyond their market segment. Moreover, the reputation 'compartments' in the market limit price- and cost-based competition. Market segmentation may also explain why the strong inflow of new firms in the market did not result in overall intensified competition and ensuing productivity improvement.

Policy options
The report analyses market failures in business services markets and sketches policy options in four areas:

Facilitate firm growth and more scale economies
The most productive firms appear to be those with 20 to 50 employees. Since 90 per cent of firms now has less than 10 employees, efficiency gains can probably be realised by growing average firm size. New entrants appear to lower average productivity. By lowering administrative burdens for growing firms and by creating more scope for intellectual property rights (copyrights, patents, brand names) on innovative service activities, average firm size may grow.

Improving market transparency
By creating a system of voluntary quality certification, in co-operation with industry organisations, the government might lower the role of reputation-based market barriers. It will enhance the growth perspective of small and innovative firms.

Giving more policy attention to non-technological innovations
At present, innovation policies are mainly oriented towards technological innovations. This may be fine for manufacturing industry. However, suppliers of business services are more engaged in non-technological innovations, in areas like product design, administrative organisation, PR, company strategy, marketing, and personnel management. The problem is that such innovations are often quite easy to be imitated. To prevent an under-provision of innovation efforts in these areas, more policy incentives for non-technological innovations may be helpful.

Encourage foreign competition
Large international disparities and opacity of national market regulations in business services form a drag on foreign competition in this industry. They create information barriers that especially affect small and medium-sized firms. European harmonisation of market regulations for professional business services is expected to yield welfare gains. Moreover, as an upbeat for a new and more comprehensive WTO agreement on international trade in services, it seems worthwhile to remove regulations that unnecessarily or unintended hinder foreign imports and the establishment of foreign subsidiaries.