British industry will struggle to get ahead in the single market

Diane Coyle on BREACHING THE EUROPEAN BOUNDARIES

The odds on Europe's single currency actually going ahead are improving steadily as the weeks go by. If nothing else, this is generating rapid growth in the business of holding conferences about the implications of EMU. Some of these are thought-provoking indeed. For the closer 1 January 1999 gets, the more likely it looks that there will be dramatic changes in Europe's industrial structure.

The trigger for this restructuring will be the creation of a true single market. As the example of the US-Canadian border shows, this is something that does not come into being without a single currency no matter how minuscule the trade barriers or how intertwined the economies.

The switch from being a group of close trading partners to being one big market will open companies' eyes to the possibilities of exploiting bigger economies of scale. This is precisely why EMU has the potential to boost long-term economic growth.

Most economic theory has ignored the possibility of economies of scale - one example of "increasing returns", whereby the amount of output per unit of inputs rises the more is produced, and average costs fall as the scale of production increases. In practise, however, increasing returns are widespread and becoming steadily more pervasive in modern economies.

Some examples are obvious. The research and design costs make building the first aircraft far more expensive than subsequent ones. There is really room for only one commercial aircraft manufacturer in Europe. Research costs in pharmaceuticals make the same true of new drugs.

In fact, there are increasing returns in any industry where a high initial investment is needed for reasons of design or infrastructure, such as telecommunications or cars.

There are also examples that are less obvious but turn out to be widespread across the weightless industries. Take "people" businesses such as consultancy, advertising or the media, all accounting for a growing share of the economy.

Mostly, these can be done on a small scale; it only takes one or two people to write an advertising jingle. But in all these cases people prefer to collect together in agencies, in order to generate ideas, brainstorm, keep an ear to the ground about work prospects and so on. There are additional benefits to be gained from the larger scale.

This is true, as well, wherever ideas and intellectual capital are important, including software or biotechnology. In software, especially, it is important to be big enough to capture "network" gains, the fact that a programme becomes more useful the more lots of other people use it.

One of the consequences of industries characterised by increasing returns is that chance events deliver the bulk of the market share to one company. It is a winner-takes-all world. To become the winner it is often enough just to be first. There are countless examples of one company or one place dominating an entire market, especially when one technology is able to drive out others. The VHS standard for videos or Microsoft's operating system for personal computers are good examples.

But it is not always a question of getting a technological lead. Writers such as Michael Porter, John Kay and Paul Krugman have documented the strong tendency towards agglomeration in business, mainly as a result of accidents of history.

Concentration is the norm rather than the exception. But whereas industry in the US is very concentrated and individual states specialise in only a few products, most European countries produce a wide range of goods and services.

Breaching the boundaries that have divided Europe into separate markets will stimulate a new wave of agglomeration. Economists at City investment bank Dresdner Kleinwort Benson have tried to figure out from past trade patterns which British industries have enough of a comparative advantage to scoop the European pot, and their report makes slightly alarming reading.

The good news is that the UK advantage lies in services (other than tourism) which are taking a growing share of all modern economies, rather than goods, whose share is shrinking. Britain also has a clear advantage in telecommunications, and a less pronounced lead in science-intensive areas such as pharmaceuticals, advanced instruments, computers and power-generating equipment.

Luckily, these are the right areas in which to have a head start. But apart from these cutting-edge areas, the chances of British manufacturing industry look dim.

The UK is at an overwhelming disadvantage in almost every other area, including food manufacture, plastics, textiles and much of the engineering sector, for instance.

These might be on the decline, but they still produce a lot of goods and employ a lot of people.

A separate report this week from management consultants KPMG points out that, quite apart from any large-scale redrawing of the industrial map, pan-European companies will do a lot of internal reshuffling anyway.

KPMG's Rory Colfer predicts that many will concentrate their accounting, treasury or purchasing operations on one site in single centres serving the entire company. This will be a matter, not of centralisation, but of increasing efficiency made possible by technology and triggered by the introduction of the Euro. "We are looking at the biggest changes in company structures since the 1970s," he says.

There is a final issue, which is that the pattern of production in a world of increasing returns is often unstable. One company can dominate an industry for decades and then, seemingly overnight, be toppled by another.

IBM used to be the titan of the computer industry; Microsoft will no doubt share its fate one day.

All in all, joining the single currency implies for all potential members an extraordinary degree of industrial restructuring in order to deliver the long-run economic benefits of a true single market.

At a guess, the EU will end up with one country making cars, another producing pharmaceuticals, another manufacturing Europe's textiles and clothing. Britain will lose two of these; we will not be home to Europe's Motown.

It doesn't mean EMU shouldn't go ahead, but it would be nice to believe Europe's politicians had thought about the economic consequences of what they were getting into.

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