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DIGITAL TRANSFORMATION AND ITS INFLUENCE ON GDP

Ljubiša Mićić
University of Banja Luka, Faculty of Economics, Bosnia and Herzegovina

date of paper receipt: date of sending to review: date of review receipt:

22.11.2017. 30.11.2017. 04.12.2017.

Review paper doi: 10.1515/eoik-2017-0028 UDK: 338.1:330.554]:004.738.5

SUMMARY

Digital transformation as integration of digital technology into business results in fundamental

changes of way world does business, communicate and develops on national and international
level. There is increase of high-tech public spending which is connected with increase of need for
high-tech as well as importance and benefits that it brings to development of economy. This so
called digital or high-tech sector is one of the strategic sectors in the leading world economies,
starting from the US and the European Union. EU recognized it in strategic document “Europe
2020” which sees this sector as key factor in smart growth based on tech knowledge and innovation.
Europe, especially western and northern Europe, is trying to keep its competitiveness in global tech
arena with USA and fast developing countries such as China and India as well as Asian tech giants
such are Japan, South Korea and Singapore.
There is increase of European countries investment in digital transformation through private and
public ICT sector development which usually has positive impact on economic growth as well as
key indicators such are GDP, productivity and employment.
This paper provides basic review of digital transformation and high-tech sector in Europe as well as
comparison between EU and Western Balkan countries. Additionally, there is analysis of influence
of ICT spending on GDP growth. Paper could serve as basic for further research in area of influence
of tech investment on key macroeconomics indicators.

Keywords: digital transformation, ICT spending, GDP

INTRODUCTION

Digital transformation as a new and modern term in business and technological literature is usually
defined as integration of digital technology into business that results in, sometimes fundamental,
changes in business operation and delivery of value to customers. It is affecting not just operational
work but also has influence on working culture, human relations and speed of change, on
microeconomic as well as macroeconomics level. World is witnessing growth challenges and
constant political shocks which sometimes cause hard times for countries’ government in dealing
with everyday issues as well as development problems. That is forcing countries to look for policies
that will stimulate growth and create new jobs – make their economies stronger. Information and

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Communications Technologies (ICT further in this paper) is without doubt significant sector in job
creation and economy development. However, there is still a certain level of doubt if ICT spending
(government as well as private capital spending) has significant or any influence of GDP growth.
This doubt is even more important for developing countries in regions with high potential. South
East Europe is definitely one of those high potential regions but ICT spending is not on the level of
European Union (EU further in this paper) and especially Western Europe and USA level.
ICT is sometimes misinterpreted and mixed with term IT (Information Technology). IT is just
one, maybe more important, part of ICT. Second is Telecommunications. ICT is consisted of
set of different product and service technologies as well as telecommunication technologies and
functionalities. It is not just one of the most important innovation “creators” but also a cause
of cultural, economic, political and educational changes. OECD defines it as a “combination of
manufacturing and service industries, whose products electronically capture, transmit or display
data and information. The production (goods and services) of a candidate industry must primarily
be intended to fulfill or enable the function of information processing and communication by
electronic means, including transmission and display” (OECD, 2009). For the purposes of this
paper, the 2007 OECD ICT sector definition (ISIC Rev. 4) will be used. OECD defines different
categories of ICT products: (1) Computers and peripheral equipment; (2) Communication
equipment; (3) Consumer electronic equipment; (4) Miscellaneous ICT components and goods; (5)
Manufacturing services for ICT equipment; (6) Business and productivity software and licensing
services; (7) Information technology consultancy and services; (8) Telecommunications services;
(9) Leasing or rental services for ICT equipment and (10) Other ICT services (OECD, 2002).
Therefore, investment in ICT should be considered not just as private sector investment but also
a public spending in ICT sector and having in mind OECD product categories it is increasingly
important sector.
Elena Kvochko, manager of Information Technology Industry at World Economic Forum has
identified five common economic effects of ICT (Kvochko, 2013):
Direct job creation
Contribution to GDP growth
Emergence of new services and industries
Workforce transformation
Business innovation
As stated, World Economic Forum has identified ICT sector as one of the sectors that contribute
GDP growth. Same article suggest that ICT sector, in the US alone, is expected to aggregate growth
of 22% in number of jobs up to 2020, which is more than significant number, and it goes almost
up to 760000 new jobs. In Australia, the case is quite similar and it goes around 25000 of new jobs
annually created in this sector. Additionally, it will have influence on GDP growth from 1.4% in
emerging markets up to 2.5 in China (Kvochko, 2013).

EUROPEAN TECH SECTOR

Based on Atomico report „The State of European Tech 2016: the future is being invented in Europe“,
tech is changing economy in general and sifting not just focus on ICT investment but also on
connection between ICT and other industries (ATOMICO, 2016). This report states that Europe
tech industry has several characteristics. Since 2011 the number of tech-based startups which are
founded in Europe has grown more than three times and just in 2015 tech investment was 2.3bn
USD. Europe is becoming recognized by its tech hubs such are London, Berlin or Stockholm.
Additional are rising and one of those is without doubt Munich, Zurich, Lisbon and Copenhagen.
However, mentioned report does not mention any of East-European cities and definitely none of
Southeast-European tech capitals. Furthermore, report states that existing business are investing in

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their tech companies and sometimes even acquiring those.
European tech market is quite divided between west and north on one side and south and
especially east on another side. Based on European tech funding report 2015 more than 50% of
all founding rounds raised by European tech companies happened in just two countries: UK and
Germany and three the most active investors in European technology companies were, two from
Germany (Gründerfonds and Index Ventures) and one from Nordics’ Northzone VC (Wauters,
2016). However, European technology startups raised approximately 12 billion euros in 2015 with
the most startups in fintech and e-commerce verticals. George Whiteread from Octopus Ventures
predicts that European tech market, especially tech startups will continue to record growth in 2016.
In his article “The European investment and technology industry trends in 2016” he notices that
sectors as fintech will have continuation of growth and that West Europe, leaded by UK, Germany,
Nordics as well as rising France will continue to dominate European tech market supported by
adequate public policies that supports this industry (Whitehead, 2016). There is significant data
that proves that tech sector in Europe is very important and considered as one of the key industries
for European governments.

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HIGH-TECH STATISTICS IN EUROPE – ECONOMIC DATA

High-tech industry is becoming more and more important for global race and European Union as
well as other European developed countries (such are Switzerland and Norway) have recognized
this industry as potential economic competitiveness factor. EU has recognized this sector as driver
for economic growth and productivity and sector that provides high value-added and well-paid
employment which has high value for European governments.
Based on Eurostat statistics from 2014 there are almost 46000 enterprises in high tech manufacturing
and even more in high-tech knowledge-intensive service sector (Eurostat, 2014). However even
statistics prove that there is division between strongly developed West and less developed East
and new EU countries. Four countries, Germany, UK, Italy and Poland together have more that
53% of the high-tech manufactures in EU-28 and in high-tech, knowledge-intensive service sector
difference is even higher: UK has 180257 enterprises; France 141647 and Germany 112570. As
obvious, Poland is exemption but also a model for East and “new EU” countries and represents
good example for other east European countries to follow in their tech-developing strategies
and policies. Turnover is proven higher in high-tech knowledge-intensive service sector than in
high tech manufacturing sector however, there are some exceptions (Eurostat, 2014). Germany’s
high-tech manufacturing turnover was in 2014 121 billion euros, followed by France (68 billion
euros) and Italy (44 billion euros). Knowledge-intensive services are proved to generate a value of
production at least 300% higher than high-tech manufacturing in the several countries such are
UK, Portugal, Lithuania, Greece, Spain and Romania. Once more, rich west countries such are UK,
Germany, France and Italy are proved leaders in this sector, which is obvious in table with full data
from Eurostat statistics.

Table 1 Economic statistics on high-tech sectors in 2014 in EU and some EFTA countries Source:
(Eurostat, 2014)

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The high tech products industry represents 17% of the value of all exports from EU-28 in 2014,
which proves to be extremely important sector. Percentage ranges from 35.3% share in Malta to
just 2.9% share in Greece. Again, in a trade sector, Germany is again a leading economy of EU
and the most important exporter to the rest for the world in 2015, followed by some other also
west European countries such are Netherlands, France, UK. However, although Eurostat notices
that in 2015 more than 2/3 of the countries recorded increase of their high-tech export from 2014
levels, EU has recorded deficit with imports around 22 billion euros higher than exports which still
emphasis importance of further investments in this sector (Eurostat, 2014).

Figure 1 High-tech exports by high-technology group of products, EU-28 and selected countries,
2015, in %. Source: (Eurostat, 2014)

EU has recognized importance of Research and Development (R&D in further text) for tech sector.
Based on Eurostat R&D spending has increased by an average of 4% in year 2015/2014 reaching
182 billion in 2014. Again, western countries such are Germany, France and UK accounted for
more than half of total R&D spending in 2014 with especially noticeable Germany’s 11.5 billion
Euros or 20% of its total R&D spending (Eurostat, 2014). UK was leading nation in R&D spending
in 2014 with 14 billion euros.

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Figure 2 Average annual growth rate of R&D expenditure in business enterprises, 2005-2014
(Eurostat, 2015)

It is also interesting to analyze venture capital investments (VCI in further text) in EU. Based on
Eurostat data in 2015 VCI has reached level of around 45 billion of euros per year (Eurostat, 2015).
However, VCI represents less than 1% of GDP in each country except UK in 2007, 2008, 2010 and
2011 and in Luxembourg in 2008. However, level of 45 billion euros is significantly smaller than
70nillion in 2007 before the economic crisis.

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Table 2 Total venture capital investment (VCI), in millions of euros. Source: (Eurostat, 2015)

EU POLICIES IN ORDER TO DEVELOP TECH SECTOR

EU has developed several policies in order to develop tech sector in Europe and to make it make it
less dependent on products and service from US and other global player’s economies. In 2010 EU
has developed strategic document “Europe 2020”, a strategy which sets out a vision of social market
economy in Europe in 21st century. It writes about three reinforcing priorities:
smart growth — developing an economy based on knowledge and innovation;
sustainable growth — promoting a more resource-efficient, ‘greener’ and more competitive
economy;
inclusive growth — fostering a high-employment economy, delivering social and geographical
cohesion.
Strategy is developed by the European Commission and it has strengthened by seven flagship
initiative of which for the tech sector the most important is “smart growth”. Additionally, European
Commission Communication published “Regional Policy contributing to smart growth in Europe
2020” which highlights regional contribution and funding to innovation in all regions. A main
element of this document it to encourage national and regional government in identification of
the key resources in order to identify their own best assents and with focus on limited number
of priorities that will ensure the most effective use of public funding but also private investment.
Additionally, European Council has published a Communication on “Measuring Innovation output:
towards a new indicator” which has a main aim to measures the extent to which innovations are able
to reach market in reality and in which amount it makes Europe more competitive. The indicator
has been using some of Eurostat’s science, technology and innovation (so-called STI) statistics and
concepts. It all contributes in strategy development as well as measurements of initiatives in The
Europe 2020 strategy as strategy for sectors of the future among tech sector plays important role.
ICT spending per capita in Europe
One of the key data in understanding tech and especially ICT market in Europe is ICT spending

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per capita. It is data that shows how much money is spent for ICT per capita which is respectful
data because it takes to account number of citizen. For example in Europe in 2013 the leading
country is UK with 1912 euros per capita spending on ICT which is quite above EU average for
the same year (1182 euros). Germany and France are following UK with 1476 and 1413 euros,
respectfully. After them, there is Spain with 904 and Italy with 876 euros (Bitkom Research, 2015).
But Europe is still losing this battle compared to US market where average is 2468 euros per capita
of ICT spending which still makes US as a global leader in tech sector, not just as a manufacturer/
service provider but also as a tech market. Germany as a leading economy is additionally interested
for comparison of how this ICT spending per capita is distributed among two parts of ICT. 52% of
this spending is spent on IT and 48 on Telecommunication which is quite similar in other western
economies. It is different in emerging and fast growing markets such are China and Brazil where is
still significantly more percentage spent on telecommunications: more than 70% in both countries
(Bitkom Research, 2015).

Figure 3 Distrubution of ICT spending per capita on IT and telecomunication in 2014 (Bitkom
Research, 2015)

But not just that ICT spending per capita has a growth. It is noticable that general ICT spending
has a growth which si promising for this industry. Statista predicts that ICT spending from 2015
to 2020 will continue to grow. In 2015 their research confirmed growth by 2.9% on worlwide level
(Statista, 2015).

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Figure 4 percentage of year on year growth of ICT spending by segments (Statista, 2015)

ICT spending and GDP per capita in Europe: correlation between ICT investment and GPD per
capita growth
Based on Eurostat statistics and research “ICT in Serbia - At a Glance” Europe is quite divided in
technological industry. When we compare two above mentioned parameters it is more than obvious
that leading western EU countries, such are Germany, UK and France, are far away from western
Balkan countries such are Serbia, Bosnia and Herzegovina, Macedonia and Albania (Matijevic &
Solaja, 2015). Based on so called Technological map of Europe (which compares GDP per capita
and ICT spending) it is easy noticeable that there from four possible quadrants there are only two
filled with countries: one where countries have high GDP per capita and ICT spending and another
one, where are some of the western countries too, which is quadrat of low ICT spending and low
GDP per capita (Matijevic & Solaja, 2015).
Technological map of Europe, comparison of GDP per capita and ICT spending, identifies six tiers
(Matijevic & Solaja, 2015):
Tier 1: UK, Germany and France
Tier 2: Denmark, Sweden, Nederland, Finland, Austria and Belgium
Tier 3: Italy and Spain
Tier 4: Greece, Portugal and Slovenia
Tier 5: Central and Eastern Europe
Tier 6: Baltic and West Balkan Countries
It also takes to account how big IT market is based on the size of the circle: from 1 billion to 70
billion.
Matijevic and Solaja identify some of the key points of this map:
North and west European countries, part of tiers 1 and 2, have high GDP per capita but also a
significant ICT investments,
It is different when we look at south Mediterranean countries such are Portugal, Spain, Italy and
Greece which have significantly smaller GDP per capita but also significantly smaller ICT spending,
All so called “new members” with maybe except of Slovenia are in the third league and difference
in ICT investment is really strong.

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Balkans and Baltics are far away from EU average and there is huge need for significant ICT
investments in order to catch up with EU average (Matijevic & Solaja, 2015).
Matijevic even suggests that “The Serbian economy and society will avoid further drop to even
deeper crisis if the IT investments from present <1% of GDP growth to 2% of GDP in the period
2011-2015”. To jump the EU bandwagon, it is necessary to triple IT investments in Serbia in the
same period” (Matijevic & Solaja, 2015).

Figure 5 Technological map of Europe, comparison of GDP per capita and ICT spending (Matijevic
& Solaja, 2015)

Based on above mentioned technological map it is easy to notice that countries with significantly
higher ICT spending are those with greater GDP per capita. There are two possible conclusions for
this: they have more need for ICT investment due to greater ICT penetration in business as well as
in everyday life, or they want, based on public policies and strategic orientation, to develop their
ICT sector and make it more leading sector than it is now. Based on this map it is also notable
that there are three groups of countries: rich west and north with higher GDP per capita and
higher ICT investment, medium Mediterranean countries and less developed eastern and south-
eastern countries with strong lag compared to their European neighbors. In the same report it was
emphasized for Serbia, which could be almost fully applied to all the other SEE countries, that
crucial investment is expected from government spending and investment in order to achieve EU
level of IT usage in education, health, public and other sectors. Having in mind that Serbia, as well
as other western Balkan countries, is willing to apply for EU membership so therefore, it should
has ICT spending on minimum level of EU10 when they joined EU. That minimum is 1 billion of
euros (Matijevic & Solaja, 2015) which is cca 150 euros per capita (when we divide it with number
of Serbian population). But based on current data for 2015 which tell us that ICT market is only on
level of 413 million of euros it leads us that Serbian market should have a rise of more than 10% per
year in order to be close to desired level before 2023.

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Figure 6 Trends and Potentials – New IT Goal for the Period 2015-2020 in Serbia (Matijevic &
Solaja, 2015)

However, same report predicts that in order to achieve that level of EU10 in 2004 (level of 1 billion
of ICT spending) it should be government top priority and should be one of the key sector for not
just investments but also for a policy and strategy support.

Farhadi and group of authors in paper “Information and Communication Technology Use and
Economic Growth” have proved that there is a positive relationship between growth rate of real
GDP per capita and ICT use index (as measured by the number of internet users, fixed broadband
internet subscribers and the number of mobile subscription per 100 inhabitants) using Generalized
Method of Moments (GMM) estimator within the framework of a dynamic panel data approach
and applies it to 159 countries over the period 2000 to 2009 (Farhadi, Ismail, & Fooladi1, 2012).
They have also found that the effect of ICT use on economic growth is higher in high income and
richer countries rather than other (Farhadi, Ismail, & Fooladi1, 2012).
Dedrick and group of authors also state that ICT investment should not be consider as pure
investment in hardware but also investment in telecommunications as well as related software and
services (Dedrick, Gurbaxani, & Kraemer, 2003).
Different researcher had focus on influence of ICT investment on GDP growth. Jalava and Pohjola
have stated that that ICT is one of two the most important factors in US economic growth in the
1990s. Additionally, they prove that ICT boosts growth in Finland from 0.3% to 0.7% in 1990s
(Jalava & Pohjola, 2002).
Schreyer stats that impact of ICT capital to economic growth of some European countries, the
United States, Canada, and Japan during 1990–1996 is about 0.17–0.29% (Schreyer, 2000). Daveri
expand mentioned Schreyer’s research to additional European and five others countries and proves
significantly higher impact of ICT on GDP growth. But both researchers agree it is smaller influence
than in the USA (Daveri, 2000). Some authors have doubts regarding influence of ICT investment
in less developed or developing countries. Therefore, group of authors suggest that this influence
is significantly smaller in developing economies which they suggest is influenced by human
capital, knowledge-based structures and small previous IT investment which are prerequisite for
productivity of current ICT investment (Dewan & Kraemer, 2000). Some researchers, for example
Kiley, state that impact of ICT on economic growth is even negative due to adjustment cost (Kiley,
1999). He suggests that introduction of new technology is imposing large adjustment costs for
the economy and decrease economic growth (Kiley, 1999). However, this statement is considered
outdated and cannot be taken seriously based on date when it was concluded.

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Digital economy and influence of the information and communication technologies to economic
growth
Digital economy should be one of the key sectors for economic growth and booster for new
employment. In one of his papers Mastilo identifies four key impacts of the digital economy on
today’s global economy: it created a new use-value of products and services, it has a destructive
impact which threatens traditional business, it created a new way of communication and it a chance
for creation of new jobs (Mastilo, 2017). In the USA it has influenced in creation of 500000 new jobs
which could be also a role model and example for economies of the Southeast European countries
(Mastilo, 2017). Some authors stated that the increase of the IT production in economic output
may increase the overall level of productivity of a country (Albers, 2006). Some research showed
that 22% of the global economy is actually digital economy which proves that countries as well
as business and individual should invest more in ICT as a development potential area (Mastilo,
2017). Additionally, same paper quotes Oxford study in 2016 which predicts that the development
of the digital economy by 2020 would contribute to the economic growth of 25% (Mastilo, 2017).
However, all this requires further research in order to prove that investment in ICT and digital
economy can have significant effect to GDP and economic growth.

CONCLUSION

Forbes has indentified that change in area of digital transformation is going to happen whether you
pursue it or not. Government as well as companies and individual should do all they can in order
to gain benefits from it in key economic indicators. Real digital transformation requires financial
investments and public spending in order to achieve adequate level on development and to have
some positive impact on macroeconomic indicators. Although there are researches, reports and
studies that correlate high GDP per capita with high ICT investment and spending there is no
adequate study which completely confirms that hypothesis. Based on that, this correlation could be
result of other economic processes and public policies. Therefore, there is a reasonable level of doubt
that high ICT investment has unreasonable impact on GDP per capita. However, technological map
of Europe identifies that those countries with high level of ICT investment are those countries that
also have high GDP per capita. Therefore, further increase of ICT investments and development of
ICT industry should be one of the key priorities in south-east Europe in order not just to achieve
level of EU10 countries in 2004 but also to join group of the countries in central Europe with
medium GDP per capita and more developed economies. Further investments in high tech sector
can just improve digital transformation and with proper use has positive effects on macroeconomic
indicators.

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