Paper to be presented at the DRUID Summer Conference 2006 on

KNOWLEDGE, INNOVATION AND COMPETITIVENESS: DYNAMICS OF FIRMS, NETWORKS, REGIONS AND INSTITUTIONS
Copenhagen, Denmark, June 18-20, 2006

Track D: Innovative Regions and Growth

THE IMPACT OF ICT ON THE GROWTH OF THE SERVICE INDUSTRY

Koson Sapprasert Center for Technology, Innovation and culture (TIK) University of Oslo PO Box 1108, Blindern N-0317 Oslo, Norway koson@kth.se

May, 2006

This paper explores the productive relationship between ICT and services. The firmlevel data is pursued to examine how ICT as a technological innovation combined with non-technological factors affect economic performance of the firm. The study develops an argument that ICT is the key success factor for firms in this era, particularly service firms. The results demonstrate that the presence and intensity of ICT could be used to explain the higher growth in productivity and profitability of firms in services. The effect is even more palpable when ICT is undertaken jointly with non-technological innovations. Keywords: Information and Communication Technology (ICT), Innovation in Services, Techno-economic paradigm, Productivity and Profitability Growth, Firm-level Analysis. JEL Classification: O32
*I would like to express my indebted gratitude towards Statistics Norway for the permission to access the data source as well as Jan Fagerberg, Tommy Clausen, Fulvio Castellacci and colleagues at TIK for the great support that shaped this paper.

The impact of ICT on the growth of the service industry

KOSON SAPPRASERT1
-May, 2006-

ABSTRACT

This paper exploits a novel dataset integrated from CIS3, R&D survey and annual accounts of the Norwegian firms to explore the productive relationship between Information and Communication Technology (ICT) and services. The firm-level data is pursued to examine how ICT as a technological innovation combined with non-technological factors affect firms economic performance. The study develops an argument that ICT is one of the key success factors for firms in this techno-economic paradigm, particularly service firms. The results demonstrate that the presence and intensity of ICT could be used to explain the higher growth experienced by service firms in the last few decades. Both productivity and profitability growth are found to be significantly linked to the level of ICT intensity in service firms especially when undertaken jointly with non-technological innovations. The impact of ICT on service firms is assessed in detail while manufacturing and other innovation activities also serve as a benchmark.

Keywords: Information and Communication Technology (ICT), Innovation in Services, Techno-economic paradigm, Productivity and Profitability Growth, Firm-level Analysis. JEL Classification: O32 *Preliminary version prepared for a presentation at DRUID Summer Conference 2006
1
Center for Technology, Innovation and Culture (TIK), University of Oslo, Norway. Postbox 1108 Blindern, N0317 Oslo, Norway, email: kosons@student.sv.uio.no, Tel: +47 950 52 795. The paper is funded by and contributed to the research project Innovation, Policy and Path Dependency (IPP) commissioned by TIK center, University of Oslo, Norway.

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1. INTRODUCTION The service industry is now a major component in the world economy especially in most developed countries. By the turn of the twenty-first century, while there had been a downturn to manufacturing, the service industry had contributed more than two-thirds of the value added in OECD countries and shows no sign of slumping (Eurostat, 2003). This fact calls for serious attention to discovering the driving force behind the successful growth of the service industry. Following the neo-Schumpeterian literature, innovation could be seen as the main driving force behind economic performance and a number of scholars (See Gershuny and Miles, 1983; Barras, 1990; Evangelista, 2000; Miles, 2004) have found the productive bond between innovation and growth in services, ranging from micro to macro level. Despite other indispensable factors, both technological innovations such as Information and Communication Technology (ICT) and non-technological innovations such as organizational changes have fruitfully been used to explain the outstanding upswing of the service industry. Freeman and Perez (1988) identify ICT as an important innovation in our epoch that is regarded as one of the main players responsible for the impressive growth of the service industry (Miles, 2004). Accordingly, the main hypothesis of this investigation is that Information and Communication Technology (ICT), as the chief economic driver in the present era, is one of the key success factors for the rise of the service industry. This study focuses on how ICT combined with non-technological innovations affect the growth of the service industry using the Norwegian firm-level data as analysis. This paper is organized in five sections. Following the introduction, the second section continues with the main hypothesis, theories and explanation on how ICT leads to the outstanding growth of the service industry by emphasizing on the techno-economic paradigm concept combined with a juxtaposition between characteristics of ICT and services (Freeman and Perez, 1988). The section ends with a discussion of earlier studies on the effect of ICT on economic performance. The third section presents the integrated dataset and analytical framework for this analysis. The fourth section explores the role played by ICT in explaining the growth of service firms through the use of descriptive statistics as well as regression models in an econometric analysis. The fifth section discusses empirical findings and ends with conclusions drawn from the research. 2. THEORETICAL OVERVIEW AND PRIOR STUDIES 2.1 ICT as the key technology for the Innovation and Growth in Services Since the industrial revolution in the 1840s, the manufacturing industry was the major role player in the world economy. The service industry took its place as the main contributor to the economy during the 1960s and innovation in services has consequently been of crucial

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interest among economists and scholars of technological change (Barras, 1986; Andersen et al., 2000; Metcafe and Miles, 2000). It gained the greater attention and was more palpable when, in the 1990s, a large number of major research projects on service innovation were launched (Miles, 2004). In addition, some services started to be included in Research and Development (R&D), and Innovation Surveys. This increased coverage of service firms has hitherto been fostering the study of innovation in services which leads precise understanding in this area. Gallouj (2002) classifies a growing literature on service innovation into three main categories: (i) Technologist approach, which concerns innovation with the introduction and diffusion of new technologies into services that may improve, for example, productivity and economic performance; (ii) Service oriented approach which argues that innovation in service and manufacturing industries are distinctly different and emphasizes on the peculiarity of services such as non-technological innovation; and (iii) Integrative approach investigates the boundary between goods and services, and develops a framework to bridge the dichotomous gap between them. Most of recent works take account of technological perspective since the supportive technology does certainly have a great impact on services (Gallouj, 1994). Correspondingly, this paper mainly takes the route of the technologist approach and particularly considers that one of the major reasons for the surprising upsurge of the service industry in the last few decades could be related to the degree of innovation in services paralleled with the rise of the 2 information society (Castells, 1998). A number of scholars such as Barras (1986, 1990), Evangelista (2000) and Miles (2004) regard innovation in services as an interesting area of research judging by the amount of attention this industry has received. Evidences illustrate that most services are actively engaged in innovation and many of them have been found to be greatly innovative. In addition, it can be said that a great extent of innovation in services has been enabling and fostering an emergence of the service economy in the last few decades. The valuable efforts to this research strand include, for example, Fuchs (1968), Gershuny (1978), 3 Stanback (1979) and Gershuny and Miles (1983). Despite their different views on service innovation, all these fruitful attempts most importantly point out that, on the one hand, most services are becoming an important component in the innovation system while on the other hand; innovation in services is recognized as a decisive factor for the competitiveness and flourishing growth of the service industry.

However, since non-technological innovations in the Service oriented approach are of great importance as far as innovation in services is concerned, the analysis in this paper additionally investigates the impact of this intangible factor on the growth of service firms. See below in Section 3. 3 See also Hauknes (1996) for a discussion on analytic approaches of service economy.

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The important question is, why have the results only shown up in the last few decades? The answer to this lies in the identities and characteristics of sectors (services) and their key driver (ICT, as described by Licht et al. (1999) as the most important technology for service innovation). Following the study of sectoral systems of innovation (Malerba, 2004), a considerable difference in the sectoral growth and performance can be explained by the fact that sectors differ significantly in terms of characteristics, types of innovation, the link and relationship among actors involved, and relevant institutions. The hypothesis of this study is accordingly based on the compatible characteristics between the specific type of innovation (ICT) and specific sectors (services) that complement each other and lead to the outstanding growth of the service industry. As pointed out by Miles (2004), services are typically interactive, involving immense communication between service suppliers and clients in all phases of service activity. Most of service sectors are information intensive, with a preponderance of communicative and transactional operations. Thus, innovations may focus on this interaction as much as on conventional product and process features. This ICT-friendly atmosphere is an important characteristic of the service industry and the result has clearly presented the rapid growth of services after they have having merged with ICT in the last few decades. As Gershuny and Miles (1983) point out, ICT changes services cost, output and quality, owing to information components of most services, which were the ideal breeding ground for the exploitation of ICT. This is also supported by the evidence from OECD (2000) in that services are major users and adopters of new technologies especially ICT seen as the chief enabler of their enormous improvement. Therefore, ICT could be regarded as the most important technology for service innovation which has consequently resulted in better economic performance of the service industry (Licht et al., 1999). Reference is made to a study of the successive long wave of technological change originally developed by Schumpeter (1939) that is especially relevant here as it might fill the gap and complete the hypothesis. Freeman and Perez (1988) have further refined the long wave theory and point out the fundamental concept of introduction and diffusion of new key technologies as a techno-economic paradigm that occurs and follows the same pattern over time. Such paradigm in a different period relies on the diffusion and utilization of the new core technology input in many products and processes throughout the economic system. The growth is based on this key factor that stimulates the rise of new product and process innovation as well as of the new industry. ICT has been compared to other great innovations in previous paradigms like the steam engine (1840s-1890s) and electricity (1890s-1940s). Momentously, the fourth wave of technical change (1940s-1990s), which was characterized as the regime of mass production, was the golden age of the manufacturing industry. By the end of the 1990s, it gave way to the upswing of the fifth successive wave of technological paradigm that came with the innovation of ICT. It would seem that this was the time when the

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manufacturing industry took a back seat to the service industry that has arisen by the ICT 4 revolution in the age of mass servuction. ICT in the age of mass servuction duly supports characteristics of the service industry. As Evangelista (2000) points out, the information-based characteristics of services give to the generation and use of ICT a central role in firms innovation activities and their performances. ICT could be seen as one of the most essential technologies for service innovation as, first, it has presented a major driving force which has led to the service industry reducing their productivity gap (and nowadays even outperforming) vis--vis the manufacturing industry (OECD, 1996). Second, ICT forms a technological platform upon which new innovation in services can also be designed and implemented (Barras, 1986). Although other factors are also essential for the performance, competitiveness and growth of firms and industries, it is argued in this paper that this reliance can also be placed on the dynamic capabilities to catch up and adapt to the waves of technological innovation. The main idea proposed in this paper is that Information and Communication Technology (ICT), as the main driving force of the present techno-economic paradigm, is one of the key success factors for the rise of the service industry. 2.2 Prior Research on the Effect of ICT on Economic Performance Several countries display impressive economic growth with the aid of ICT as illustrated hereon. Prior research concerning ICT and global economy growth (Vu, 2004) demonstrates the contribution of ICT to output growth as being very remarkable for economies during the periods 1990-1995 and 1996-2000. For example, regarding results obtained from the US (Jorgenson and Stiroh, 2000; Council of Economic Advisors, 2001; Oliner and Sichel, 2001), labor productivity revived in the 1990s with a significant acceleration during the period 1995-2000, and ICT capital input accounted for more than one fifth of GDP growth throughout the decade. The impact of ICT on growth was also significant in Australia (Parham et al., 2001), Canada (Armstrong et al., 2002), Korea (Kim, 2002), United Kingdom (Oulton, 2002), Finland (Jalava and Pohjola, 2001) and the Netherlands (Van der Wiel, 2001a). Recent work by the OECD also substantiates ICT as one of the key drivers of the rapid growth for economies, and the service industry is the main consumer of ICT (OECD, 2001). Evidence from this study also underscores the relationship between the growing economic importance of ICT and mounting demand for ICT-intensive services, which is seen as one of the factors driving the increasing weight of services in the economy. The relevance of ICT is due to the fact that many services process and diffuse information in abundance, such as the
4

As mass production has been applied as a characteristic of the previous (1940s-1990s) techno-economic paradigm (Freeman, 1996), this study introduces and applies the term mass servuction for the present paradigm which bears a characteristic as the mass degree of service production.

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financial service and telecommunication sector. So advances in ICT that allow more information to be codified and transferred, and the increasing move into knowledge technologies have expanded the scope for ICT use in many services (Pilat, 2001). One of the strongest evidences for the impact of ICT has been illustrated as coming from the firm-level analysis that is confirmed to a number of developed countries (OECD, 2003). Most of these studies use a combination of growth accounting methods and econometric models to examine samples of industries and firms. For example, Gretton et al. (2002), studying firm-level data from the Australian Business Longitudinal Survey, found positive and significant links between the use of ICT and growth in both manufacturing and service industry. Brynjolfsson and Hitt (2003), investigating US firm-level data, proved that ICT has a solid impact on productivity. Pilat and Wolfl (2004) examined the role of ICTproducer and key ICT-consumer sectors in explaining overall productivity growth in OECD countries; they found that the impact of ICT-producer sectors is most significant in Finland, Ireland, and Korea whereas ICT-consumer sectors in some countries, remarkably US and Australia, had an impressive growth in the second half of the 1990s. Hempell et al. (2004) analyzed comparable panel data of the Dutch and German firms in the service industry and found that ICT capital deepening and innovation have complementary impact on productivity. Prior researches illustrated above highlights evidences which suggest that ICT might have a vital role in supporting growth and performance of all sectors, including manufacturing and service. However, specific research on how ICT particularly affects the service industry at the firm-level is still scarce, especially in Scandinavian countries such as Norway. This paper is therefore devoted to study the relationship between ICT and performance of the service industry. Emphasis is placed on the analysis of the growth of service firms in consequence of ICT intensity. Other non-technological factors are taken into account and manufacturing firms also serve as a benchmark in order to obtain a more comprehensive analysis. The question as to what extent ICT as well as other types of innovation play a role in explaining the growth of firms in the service industry still needs a sturdy empirical evidence to answer. To the best of my knowledge, this paper is one among the few analyses in the area of service innovation and, arguably, the first in Norway that investigates the impact of ICT on the growth of the service industry on a basis of firm-level data. The firm-level approach applied in this paper aspires to add to existing literature in this field the evidence regarding the effect of ICT on the productivity and profitability growth of the Norwegian service firms. 3. ANALYTICAL FRAMEWORK This study aims to highlight the effect that ICT has on the growth of the service industry using a quantitative analysis of the novel dataset of firms in Norway. The empirical data for the research is an integration of the Norwegian Community Innovation Survey (the Norwegian CIS3 data), annual accounts of firms and the R&D survey from Statistics Norway

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(1998-2003). CIS3 provides records regarding innovation activities and categorical information such as firm size and sector. Annual accounts of the Norwegian firms allow this study to attain expected economic indicators, which are productivity and profitability growth. Data from the R&D survey illustrates the most crucial part, namely, ICT intensity. These three statistical data sources are successfully integrated and used to analyze how ICT leads to the growth of firms in the Norwegian service industry. Prior researches measured ICT intensity in different ways, i.e., share of ICT over total investment (for example, Dunne et al., 2001; Doms et al., 2004), ICT expenditure per employee (for example, Cainelli et al., 2004), share of labor equipped with ICT (for example, Maliranta and Rouvinen, 2004). Rather, this study applies the share of ICT in R&D expenditure in the analysis as corresponding to prior works that investigate the productive relationship between innovation and growth by analyzing R&D data. Since Solows (1957) decomposition of economic growth, many studies have similarly emphasized on the factors that underline the productivity residual, that part of output growth not explained by changes in factor inputs. R&D investment is seen as one of the key factors and the analyses of the relationship between R&D and firms performance have played a vital role in the economic growth literature (Griliches, 1988; Grossman and Helpman, 1991; Coe and Helpman, 1995). The relevance of R&D could also be explained by the fact that many firms invest in R&D even when the majority of fruitful findings already spills out in the public domain (Cohen and Levinthal, 1989). This is because, on the one hand, R&D allows the firm to gain a first mover advantage in exploiting technologies. It may also allow firms to be rapid followers in the face of spillovers from competitors innovations. Accordingly, it would seem that R&D effort might be seen as one of the most essential factors for the successful development of the firm which, as a result leads to the firms growth and better performance. This argument stresses that data on R&D expenditure could be considered as a good source for assessing the impact of ICT on the firms economic performance. On the output side, the unique integrated dataset of CIS3, R&D survey and annual accounts of the Norwegian firms allows this study a good measurement for firms economic performance, namely productivity and profitability growth. As commonly applied in prior 5 research, productivity and profitability are calculated from turnover and profit divided by the number of employee, respectively. Furthermore, non-technological factors are taken into account for a more comprehensive analytical approach. As Bresnahan et al. (2002) point out, firms can not simply plug in computers and achieve service quality or efficiency gains. On contrary, they must go through a process of reorganization and launch considerable changes to their products and processes. Success could be obtained by implementing ICT jointly with
5

Earlier studies also use productivity and profitability growth as proxies to determine the economic performance, i.e., Krugman (1994), Cameron (1999), Baldwin and Sabourin (2001), Ball and Moffitt (2001), Oulton (2002).

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the reinforcement of organizational changes (Brynjolfsson et al., 1997). This study therefore takes advantage of firm-level data as it has remarkable measurement advantages for examining intangible organizational investments and service innovation associated with ICT. As Brynjolfsson and Hitt (2000) argue, these non-technological factors could not be well captured by traditional macroeconomic measurements. In contrast, their economic contributions are more likely to be understated in the micro level. This analysis accordingly includes essential non-technological innovation factors which are: (i) Strategic innovation refers to an implementation of new or significantly changed corporate strategies; (ii) Managerial innovation means to carry out advanced management techniques within the enterprise; (iii) Organizational innovation denotes an implementation of new or significantly changed organizational structure; (iv) Marketing innovation represents a significant change in enterprises marketing concepts/strategies; and (v) Aesthetic innovation characterizes significant change in the aesthetic appearance or design or other subjective changes in the product. Variables for all these five non-technological innovations have been obtained from the CIS3 data and the results of these supporting factors are demonstrated in the next section.6 4. EMPIRICAL ANALYSIS 4.1 Descriptive Statistics Table 1 demonstrates descriptive statistics for ICT intensity and economic performance indicators of firms in service and manufacturing industry. It reports a sample size with valid answers, minimum and maximum, mean, and standard deviation. The dataset covers 1,464 service and 1,927 manufacturing firms in that the majority of firms have a valid answer for categorical information such as sector and size. However, the sample size was reduced as the analysis was restricted to firms with sufficient information for measuring ICT intensity in 1999-2001 and economic performance in 2001-2003. In the final cleansing of samples, firms those have invalid answers for calculating growth and other main variables required in each equation were also excluded. The resulting samples comprise around two thousand firms in total representing service and manufacturing industries. The preliminary descriptive investigation of the role played by ICT on the firms economic performance is done by comparing the growth of ICT-intensive firms and non-ICT firms, and of firms that had ICT intensity above and below sectoral average (in both 7 manufacturing and service industry). The issues empirically addressed are the following:
6

These five non-technological innovation variables denote the significant creative improvement activities referred in the Norwegain CIS3 survey. Since innovation is defined in the survey as a new or significantly improved product or process, this paper accordingly adopts this definition to other non-technological factors included in the same questionnaire. 7 ICT-intensive firms denote firms that have a share of ICT in R&D expenditure (ICTINTE) above zero while non-ICT firms are defined as firms whose ICTINTE equals zero.

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Whether, and the extent to which, ICT-intensive firms during the period 1999-2001 have shown better economic performance in the following three years (2001-2003) when compared with non-ICT firms; Whether, and the extent to which, service firms that have a higher level (above the sectoral average) of ICT intensity in 1999-2001, have grown in the subsequent period (2001-2003) faster vis--vis those which have less (below the sectoral average); Whether, and the extent to which, ICT-intensive service firms have grown in the period 2001-2003 faster than ICT-intensive manufacturing firms when comparing by the difference in economic performance between firms which have a higher level of ICT intensity (above the sectoral average) vis--vis those which have less (below the sectoral average).
TABLE 1 ICT INTENSITY AND ECONOMIC PERFORMANCE INDICATORS Descriptive Statistics Variables N Minimum Maximum Mean

Std. Dev.

Service firms
Average growth rate of productivity (20012003) GPR0103 963 -2.64 3.18 0.0328 0.78828

Average growth rate of profitability (20012003) GPF0103

861

-5.09

3.43

0.0713

0.99974

ICT Intensity ICTINTE

933

0.00

30.99

0.1100

1.37056

Manufacturing firms
Average growth rate of productivity (20012003) GPR0103 1474 -3.82 3.44 0.0662 0.69980

Average growth rate of profitability (20012003) GPF0103

1213

-4.03

3.96

0.1139

0.93599

ICT Intensity ICTINTE

1343

0.00

3.88

0.0116

0.14615

Source: Calculations based on a novel integration of CIS3 data, R&D survey and annual accounts of firms in Norway, Statistics Norway.

Preliminary assessment begins with a comparison between ICT-intensive and non-ICT service firms across sectors and firm sizes on the basis of growths in productivity (GPR0103) and profitability (GPF0103) during the period 2001-2003. Overall, the evaluation illustrates that ICT-intensive service firms have shown greater economic performance regardless of what

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growth indicator is employed. Apart from size1, firms that invested in ICT during 1999-2001 enjoyed superior productivity and profitability growth in the subsequent three years (20012003). ICT-intensive service firms in Size2, 3 and 4 have grown 0.09, 0.41 and 0.72 per cent, respectively, faster than non-ICT firms in terms of productivity. They also have more rapid growth in profitability at approximately 0.12, 0.08 and 0.46 per cent for firms in Size2, 3 and 4, respectively. The effect of ICT is more apparent for service firms when compared across sectors. ICT-intensive firms performed better than non-ICT firms in more than half of all sectors considered. The results with both economic performance indicators are consistent in most sectors, except non-ICT service firms in Telecommunication sector that show higher growth using both indicators, and those in the Data Processing sector which display a small difference in profitability growth.
TABLE 2 THE ECONOMIC PERFORMANCE OF ICT-INTENSIVE AND NON-ICT FIRMS IN SERVICE INDUSTRY GPR0103 Non-ICT
0.0882 0.2045 -0.0207 0.3739 -0.0029 -0.0219 0.5026 -0.0139

ICT-intensive
Wholesale trade Sea Transportation Transportation and travel service Insurance and Pension Services for Financial Service Business service Telecommunication Data Processing 0.2208 0.7020 0.0849 1.9400 0.1907 0.0553 -0.5668 0.1354

Dif.
0.1326 0.4975 0.1056 1.5661 0.1936 0.0772 -1.0694 0.1493

ICT-intensive
0.7158 0.4924 -0.1129 2.3100 0.4104 0.1964 -0.2791 -0.0239

GPF0103 Non-ICT
0.1282 0.2272 -0.1365 0.0340 0.3489 -0.1341 0.3929 0.0780

Dif.
0.5876 0.2652 0.0236 2.2760 0.0615 0.3305 -0.6720 -0.1019

Firm size (classes of employees)

Size 1 Size 2 Size 3 Size 4 Total -0.5823 0.0960 0.5777 1.4155 0.0566 -0.2415 0.0041 0.1707 0.6998 0.0316 -0.3408 0.0919 0.4070 0.7157 0.0250 -0.6449 0.0329 0.3802 1.0181 0.1568 -0.2401 -0.0840 0.3010 0.5563 0.0847 -0.4048 0.1169 0.0792 0.4618 0.0721

The data from Table 2 suggests that ICT enhances the economic performance of most firms in the Norwegian service industry. Table 3 confirms this argument by further revealing that service firms whose ICT intensity is above sectoral average enjoy when compared to less ICT-intensive service firms (devotion to ICT below the sectoral average) higher growths in both productivity and profitability irrespective of firm size. The magnitude of growth differences between most and least ICT-intensive service firms are all positive and considerable, especially for the firms with more than 250 employees (Size4). This data - 10 -

demonstrates that the higher the level of ICT intensity, the faster the growth of service firms. In other words, firms which had a higher level (above the sectoral average) of ICT intensity have grown faster vis--vis those which have less (below the sectoral average) regardless of the firm size and with no exception to the economic performance indicator.
TABLE 3 THE ECONOMIC PERFORMANCE OF THE MOST AND THE LEAST ICT-INTENSIVE FIRMS MEASURED BY PRODUCTIVITY AND PROFITABILITY GROWTH (GPR0103 & GPF0103) Services Manufacturing ICTINTE > Ave. Productivity Growth
Size 1 Size 2 Size 3 Size 4 Total -0.4933 0.1583 0.8529 1.9276 0.2051 -0.8140 -0.3620 0.1168 0.1084 -0.2942 0.3207 0.5203 0.7361 1.8192 0.4993 -0.3348 0.3176 0.3349 1.5568 0.3966 -0.3155 0.0442 0.1537 0.0305 0.0643 -0.0193 0.2734 0.1812 1.5263 0.3323

ICTINTE < Ave.

Dif.

ICTINTE > Ave.

ICTINTE < Ave.

Dif.

Profitability Growth
Size 1 Size 2 Size 3 Size 4 -0.3857 0.2005 0.4605 1.8098 -0.8478 -0.6321 0.3546 0.0386 0.4621 0.8326 0.1059 1.7712 -0.1959 0.6613 0.1683 1.6258 0.7819 -1.0313 0.3393 0.1874 -0.9778 1.6926 -0.1710 1.4384

Total 0.3293 -0.1380 0.4673 0.4361 0.1757 0.2604 1) Above average ICTINTE is defined as the firm that has a share of ICT in R&D expenditure over total expenditure exceeds the median value of total firms in the sector. 2) Below average ICTINTE is defined as the firm whose share of ICT in R&D expenditure over total expenditure is lower than the median value of total firms in the sector.

The statistics in Table 3 endeavor to answer the final question in this section. Consistent with theories outlined earlier, this descriptive evidence confirms that, with the aid of ICT (during 1999 - 2001), most ICT-intensive service firms had performed better than those in manufacturing in the period 2001 - 2003 irrespective of growth indicator used. The average total profitability growth difference among most and least ICT-intensive firms in the service industry is almost double compared to the difference among those in the manufacturing industry. The difference is more obvious when comparing across the firm size. Apart from only highly ICT-intensive manufacturing firms in Size2 that show somewhat faster profitability growth, all figures in Table 3 demonstrate that ICT is more beneficial to

Instead of using mean, median value is applied to computing the averages for ICT intensity and growth in productivity. This is because the mean value seems unsuitable as it is heavily affected by extreme values of outliers.

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service firms by the greater difference in economic performance between most and least ICTintensive firms in the service industry when compared to that in manufacturing. In summary the descriptive evidence confirms and underlines the productive relationship between ICT and the Norwegian service firms. It has been shown that service firms who invested in ICT experienced faster growth (in both productivity and profitability) and, moreover, those who did more intensely enjoyed significantly better economic performance. In addition, the statistics confirm prior researches and theories outlined earlier (i.e., OECD, 1996; Evangelista, 2000; Hempell et al., 2004) by pointing out that most ICTintensive service firms, when compared with less ICT-intensive firms, depict better growth rate than that found in the manufacturing industry. 4.2 Econometric Analysis The previous section demonstrates that ICT undertaken during 1999 - 2001 did certainly have a substantial impact on the growth of the Norwegian service firms in the next three years (2001 - 2003). In the last section, the effect of ICT on the growth of the Norwegian firms is examined in a regression framework using four equations. First, the economic performance measured in terms of growth in productivity is used to evaluate the impact of ICT and other innovation activities on service and manufacturing firms. The first equation is constructed as: Yi,t = 0 + (1 Xi,t-1) + (a1 pi) + (a2 nt) + (a3 si) + ui,t Where: Yi,t is the economic performance of firm i at time t; Xi,t-1 is the ICT intensity of firm i at time t - 1; pi is a vector of product and process innovation dummies; nt is a vector of non-technological innovation dummies; si is a vector of size dummies; aj (j=1,2,3) are vectors of unknown coefficients; ui,t are random error terms with the usual assumptions. The effect of ICT on productivity growth formalized in Equation 1 is in line with previous literature that examines the impact of innovation on economic performance in services (Cainelli et al., 2004). The productive relationship between innovation and economic performance was found in the analysis of data of service firms in Italy (the Italian CIS2 data). Three variables were used to measure the economic performance of firms: growth rates of sales; growth rates of employment; and labor productivity calculated in terms of sales per employee. Then different types of innovation activities were used as regressors in the equation one at a time in order to determine elasticity coefficients. (1)

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The model that was previously used for assessing the impact of innovation in services has been modified to suit the more specific analysis of how ICT affects economic growth of the Norwegian firms in this research. The time span of the dataset enables this investigation to measure the impact that ICT intensity undertaken during 1999-2001 has had on the firms 9 growth in the subsequent three years (2001-2003). The econometric specification in the equation 1 uses ICT intensity which denotes the share of ICT in R&D expenditure over total expenditure in the period 1999-2001 (ICTINTE) as the main independent variable (Xi,t-1). On the output side, the annual average growth of labor productivity calculated in terms of sales per employee in the period 2001-2003 (GPR0103) is employed as a dependent variable. In addition, firm size (si) and non-technological innovations (nt) namely, strategic innovation (STINNO), managerial innovation (MNINNO), organizational innovation 10 (OGINNO), marketing innovation (MKINNO) and aesthetic innovation (ASINNO) , are used in the form of dichotomous variable in equation 1 in order to measure their effect on the firms growth. Furthermore, the control variable for product and process innovation (pi) during the current period (1999-2001) is taken into account in order to avoid an 11 overestimation of ICT impact on productivity growth (GPR0103). The control variable pi is employed owing to the fact that it could also be the factor that affects the firms performance in the subsequent period (2001-2003). Similar to dummy variables for firm size and nontechnological innovations, pi is used in the form of a dichotomous variable which has a value equal to one if a firm undertakes such innovation activity, and zero otherwise. Table 4 demonstrates the regression result carried out using an econometric estimation in Equation 1. The result fully corroborates the descriptive evidence and theories outlined earlier that ICT matters extensively for the growth of firms, particularly in the service industry (Miles, 2000; OECD, 2001). The coefficient for ICT intensity of service firms is positive and statistically significant especially when compared to that of manufacturing firms. In addition, the coefficients of size dummy (a3) are considered to be consistent with the descriptive statistics shown in the previous section. The econometric result again confirms the high growth of large service firms especially for firms with more than 250 employees (Size4) from which one may conclude that larger firms are commonly more able to innovate and improve their productivity (Schumpeter, 1950). Moreover, the coefficients of additional control variables for other types of innovation show that the effect of ICT is not considered spurious since there is no significant positive effect from product and process innovation
9

The time lag of two years in this analysis is in line with Pakes and Schankerman (1984) in that the lag of contribution of R&D project to the productivity is approximately two years. 10 The first four variables are also used as non-technological innovation variables in Hempell et al. (2004) to examine their impact on firms in the Netherlands. See section 3 for more explanation on these non-technological innovation variables. 11 For example, Hempell et al. (2004) also employed product and process innovation as a proxy for technological innovation to measure its effect on productivity of firms in Germany and the Netherlands.

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(PDINNO and PCINNO) as well as non-technological innovations (STINNO, MNINNO, 12 OGINNO, MKINNO and ASINNO) on growth in productivity (GPR0103) of service firms. In trying to explain this evidence, it could be interpreted that remarkable productivity growth of service firms during 20012003 is as a result of ICT R&D than other types of innovation since ICT is the most important technology for the innovation in services (Licht et al., 1999).
TABLE 4 THE EFFECT OF ICT AND OTHER TYPES OF INNOVATIONS ON PRODUCTIVITY GROWTH (GPR0103) Services
(Constant) ICT intensity ICTINTE Firm size (classes of employees) Size 1 Size 2 Size 3 Size 4 Control Innovation variables PDINNO PCINNO Non-technological Innovation STINNO MNINNO OGINNO MKINNO ASINNO -0.123* (.071) -0.007 (.076) 0.039 (.063) 0.003 (.067) -0.124 (.080) 0.013 (.049) -0.014 (.056) -0.004 (.047) 0.023 (.051) 0.067 (.051) -0.003 (.065) 0.032 (.074) -0.007 (.060) 9.35E-005 (.060) Ref. 0.306*** (.065) 0.729*** (.062) 1.257*** (.082) Ref. 0.259*** (.051) 0.606*** (.048) 1.085*** (.071) 0.068*** (.025) 0.184 (.115) -0.373*** (.048)

Manufacturing
-0.380*** (.040)

No. of Observations 674 1119 R2 0.331 [.320] 0.230 [.223] *, **, *** significant on 10, 5 and 1 percent level. Standard errors and adjusted R2 are represented in ( ) and [ ], respectively.

The results from Table 4 illustrate that firms in the service industry certainly grow faster with the use of ICT especially when compared to manufacturing firms. The effect of ICT particularly on service firms is further explored using both productivity growth (GPR0103) and profitability growth measured in terms of profit per employee during 20012003 (GPF0103) as dependent variables in Equation 2. The model is as follows: Yi,t = 0 + (1 Xi,t-1) + (a1 pi) + (a2 nt) + (a3 si) + (a4 se) + ui,t Where: Yi,t is the economic performance of firm i at time t; Xi,t-1 is the ICT intensity of firm i at time t - 1;
12

(2)

One may also interpret that the coefficients of PDINNO and PCINNO are not significant because of the unclear distinction between product and process innovation.

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pi is a vector of product and process innovation dummies; nt is a vector of non-technological innovation dummies; si is a vector of size dummies; se is a vector of sector dummies; aj (j=1,2,3,4) are vectors of unknown coefficients; ui,t are random error terms with the usual assumptions. Besides ICT intensity (Xi,t-1), non-technological innovation variables (nt) and other control variables that are similarly applied as in Equation 1, Equation 2 employs both productivity and profitability growths of service firms during 2001-2003 as dependent variables (Yi,t). Each of these economic performance indicators for the firm at time t is used 13 one at a time in the equation. Furthermore, sector dummy (se) is additionally taken into account in Equation 2 in order to control the effect of sector-specific factors on the growth of service firms. The regression results using econometric estimation of Equation 2 are demonstrated in Table 5. It is shown again in this table (irrespective of the indicator used) the essence of ICT as a key success factor of service firms (Gershuny and Miles, 1983; Evangelista, 2000; Miles, 2000; OECD, 2001). The coefficients of growths and ICT intensity are statistically significant in terms of both productivity and profitability growth (0.068 and 0.053, at .01 and .05 percent level of significance, respectively). Besides, it is worth noting that the results of other variables are still all consistent with the same samples used. The regression results additionally show no significant sector-specific effect as far as a sector dummy is concerned. In other words, it implies that the benefit from ICT is not only limited to some service sectors. This finding underscores the pervasiveness of ICT as a general purpose technology which is compatible with most types of service firms (Bresnahan and Trajtenberg, 1995). Evidences from the first two models prove that ICT intensity certainly brings about positive impact on the firms growth. Nevertheless, there is no considerable effect from non14 technological innovation factors, though strategic innovation shows negative effect on growths that are not highly significant. The last two econometric models are pursued to further explore the joint impact of ICT and non-technological innovations on productivity growth of service firms as theoretically outlined earlier such that ICT and significant changes in an organization might be complementarily essential for the firms competitiveness and growth (Bresnahan et al., 2002).
13 14

Time t-1 and t denote the period of 19992001 and 20012003, respectively.

These results somewhat contradict the evidence by Van der Wiel (2001b) in which the Dutch business services that implement only non-technological innovations could obtain higher productivity growth than noninnovating firms.

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TABLE 5 THE EFFECT OF INNOVATION ON ECONOMIC PERFORMANCE OF SERVICE FIRMS (GPR0103 AND GPF0103)
(Constant) ICT intensity ICTINTE Control Innovation variables PDINNO PCINNO Firm size (classes of employees) Size 1 Size 2 Size 3 Size 4 Sector dummy Wholesale Trade Transportation Sea Transportation Transportation and Travel Service Business Service Financial Service Insurance and Pension Services for Financial Service Data Processing (Computer Service) Telecommunication Non-technological Innovation STINNO MNINNO OGINNO MKINNO ASINNO -0.136* (.072) -0.002 (.076) 0.028 (.064) 0.006 (.068) -0.135* (.082) -0.193** (.095) 0.076 (.101) 0.071 (.087) -0.106 (.092) -0.127 (.105) 0.024 (.198) 0.065 (.216) 0.015 (.210) -0.097 (.201) 6.98E-005 (.201) 0.144 (.256) 0.305 (.259) -0.034 (.234) 0.045 (.201) -0.029 (.244) -0.254 (.252) -0.386 (.276) -0.427 (.269) -0.359 (.256) -0.290 (.255) -0.264 (.260) 0.023 (.321) -0.170 (.309) -0.217 (.256) -0.323 (.314) Ref. 0.309*** (.066) 0.727*** (.064) 1.242*** (.086) Ref. 0.300*** (.092) 0.743*** (.086) 1.251*** (.117) -0.012 (.068) 0.036 (.075) -0.027 (.096) 0.077 (.101) 0.068*** (.026) 0.053** (.026) GPR0103 -0.371* (.196) GPF0103 -0.057 (.248)

No. of Observations 674 689 R2 0.338 [.371] 0.227 [.203] *, **, *** significant on 10, 5 and 1 percent level. Standard errors and adjusted R2 are represented in ( ) and [ ], respectively.

Corresponding to previous attempts by Brynjolfsson et al. (2002) and Hempell et al. (2004), Equation 3 is added with a variable that is used as a proxy for all non-technological innovations (ORN). A value of ORN equals one if the firm has undertaken at least one type of
15

Brynjolfsson et al. (2002) find that ICT and non-technological innovations are complementary for firms in the U.S. whereas the result from the Netherlands (Hempell et al., 2004) contradicts the former such that the joint impact of ICT and non-technological innovations is insignificant.

15

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non-technological innovations (STINNO, MNINNO, OGINNO, MKINNO and ASINNO), 16 and zero otherwise. The model is constructed as: Yi,t = 0 + (1 Xi,t-1) + (a1 ORN) + (a2 pi) + (a3 si) + (a4 se) + ui,t Where: Yi,t is the economic performance of firm i at time t; Xi,t-1 is the ICT intensity of firm i at time t - 1; ORN is a vector of proxy for all non-technological innovation dummies; pi is a vector of product and process innovation dummies; si is a vector of size dummies; se is a vector of sector dummies; aj (j=1,2,3,4) are vectors of unknown coefficients; ui,t are random error terms with the usual assumptions. The purpose of further constructing Equation 3 is to explore the consistency of the impact of ICT (ICTINTE) as well as to demonstrate the effect of sole non-technological innovations (ORN). Equation 4 is constructed to particularly examine the joint impact of ICT and non-technological innovations (ICT*ORN) on the firms growth and compare it with that of sole non-technological innovations (ORN) as: Yi,t = 0 + (1 Xi,t-1) + (2 ICT*ORNi,t-1) + (a1 ORN) + (a2 pi) + (a3 si) + (a4 se) + ui,t (4) (3)

Where: Yi,t is the economic performance of firm i at time t; Xi,t-1 is the ICT intensity of firm i at time t - 1; ICT*ORNi,t-1 is the interaction term for ICT and non-technological innovations for firm i at time t - 1; ORN is a vector of proxy for all non-technological innovation dummies; pi is a vector of product and process innovation dummies; si is a vector of size dummies; se is a vector of sector dummies; aj (j=1,2,3,4) are vectors of unknown coefficients; ui,t are random error terms with the usual assumptions.

Hempell et al. (2004) previously employed the same estimation for non-technological innovations but only four types of them were taken into account namely, strategy, marketing, organizational and management innovation.

16

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Similar to previous models, all control variables are also included and growth in productivity is used as a proxy for the firms economic performance. Besides, the variable for joint contribution of ICT and non-technological innovations (ICT*ORN) is employed to further analyze whether, and to what extent, a combination of ICT and non-technological innovations have greater impact when compared to ICT intensity (ICTINTE) and/or nontechnological innovations (ORN) alone on the productivity growth of service firms. ICT*ORN is calculated by multiplying ICT intensity to the dichotomous value of all nontechnological innovations (ICTINTE * ORN) and is used to represent the difference between the elasticity of joint contribution between ICT and non-technological innovations vis--vis that of sole non-technological innovations (ORN). The final result displayed in Table 6 shows the joint effect of ICT and nontechnological innovations. This study additionally finds that most Norwegian service firms could experience higher growth if they invest in ICT in line with non-technological innovations. The coefficient of growth in productivity (GPR0103) and the interaction term for ICT and non-technological innovations (ICT*ORN) is positive and statistically significant especially when compared with non-technological innovations alone (ORN) considering both models (Equation 3 and 4). It is therefore important to note that the joint impact of ICT and non-technological innovations instigates much greater growth than sole non-technological innovations (STINNO, MNINNO, OGINNO, MKINNO, and ASINNO by ORN proxy). This finding draws parallels with Brynjolfsson et al. (1997) and Brynjolfsson et al. (2002) who found that, in order to be successful, firms crucially need to be reinforced with a combination of both ICT and non-technological innovations. In addition to the finding that ICT and non-technological innovations are complementary measures of growth in service firms, the coefficients of all variables used in all equations are entirely consistent by the same sample set examined throughout the econometric analysis (as shown in Table 4 6). The size of firm bears influence on the firms economic performance and ICT has shown a positive impact on the Norwegian service firms growth rates regardless of sector-specific characteristics. Furthermore, other types of innovation do not show the same consistent growth as displayed by ICT and, hence, it might be deduced again that ICT is the most important technology for service innovation (Licht et al., 1999). All in all, the regression results in a variety of models in the final part of analysis fruitfully complete this investigation by offering a number of valuable empirical findings and, most importantly, proving that ICT leads to the growth of firms in the Norwegian service industry.

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TABLE 6 THE JOINT IMPACT OF ICT AND NON-TECHNOLOGICAL INNOVATIONS ON GROWTH IN PRODUCTIVITY ORN
(Constant) ICT intensity ICTINTE Joint contribution of ICT and non-technological Innovations ICT*ORN ORN Control Innovation variables PDINNO PCINNO Firm size (classes of employees) Size 1 Size 2 Size 3 Size 4 Sector Dummy Wholesale Trade Transportation Sea Transportation Transportation and Travel Service Business Service Financial Service Insurance and Pension Services for Financial Service Data Processing (Computer Service) Telecommunication 0.039 (.198) 0.069 (.217) 0.045 (.211) -0.082 (.202) 0.013 (.201) 0.154 (.255) 0.311 (.259) -0.011 (.235) 0.023 (.201) 0.016 (.243) 0.037 (.198) 0.066 (.216) 0.042 (.211) -0.087 (.202) 0.009 (.201) 0.155 (.255) 0.305 (.258) -0.013 (.234) 0.005 (.201) 0.042 (.243) Ref. 0.325*** (.067) 0.737*** (.064) 1.244*** (.085) Ref. 0.312*** (.066) 0.733*** (.064) 1.228*** (.086) -0.027 (.078) 0.027 (.074) -0.040 (.069) 0.035 (.074) -0.062 (.054) 0.134** (.067) -0.065 (.054) 0.066*** (.026) 0.042 (.028) -0.394** (.198)

ICT*ORN vs. ORN

-0.384* (.198)

No. of Observations 674 674 R2 0.330 [.313] 0.334 [.316] *, **, *** significant on 10, 5 and 1 percent level. Standard errors and adjusted R2 are represented in ( ) and [ ], respectively. (1) ICT*ORN represents an interaction variable determining the extent to which firms have jointly undertaken ICT and non-technological innovations during 19992001. (2) ORN denotes the presence of at least one type of non-technological innovations in the organization during 19992001.

5. MAJOR FINDINGS AND CONCLUDING REMARKS This study empirically explores a relationship between the chief innovation activities and economic performance of firms in Norway. The robust bond between ICT and growth of service firms is the major concern while manufacturing industry is used as a benchmark. Nontechnological innovations are not neglected and have also been included in the analysis for a more comprehensive estimation. The unique dataset for the analysis is a result of the novel integration of three vital sources, namely CIS3, R&D survey and annual accounts of the Norwegian firms. The

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research therefore shows the under-discovered productive link between ICT and service firms in Norway. As shown in the analysis, both descriptive and econometric evidences prove the merit of ICT to the competitiveness and superior growth in services. This investigation finds that most ICT-intensive service firms outperform non-ICT service firms in terms of both productivity and profitability growth. Moreover, service firms whose ICT intensity exceeds a sectoral average experience higher growth irrespective of economic performance indicator concerned. The empirical result also verifies the main hypothesis of this paper and outlined theories by demonstrating the wider gap of economic performance of service firms when compared to that of manufacturing firms between those who have invested more heavily in ICT vis--vis those who have less. Thus, it could be said that these results corroborate theories such that ICT is seen as one of the major driving forces that lead to the superior economic performance of the service industry in the present techno-economic paradigm (Gershuny and Miles, 1983; Freeman and Perez, 1988). This is due to the fact that information-based characteristics of services give to ICT a central role in firms innovation activities which results in an impressive growth of service firms (Evangelista, 2000; OECD, 1996). Several notable findings are also supplied in the econometric analysis part. The elasticity coefficients between ICT intensity, productivity and profitability growth are positive and statistically significant for service firms while less respectable for firms in the manufacturing industry. It appears that these consistent evidences validate the hypothesis that ICT certainly has the substantial impact on firms in the service industry. In addition, firms in most service sectors could benefit from using ICT regardless of their sector-specific factor. This evidence underscores the pervasiveness of ICT as a general purpose technology which is supportive and compatible to most services (Bresnahan and Trajtenberg, 1995). Besides the presence and intensity of ICT in firms that display positive economic impact on service firms, non-technological factors are also crucial for the firms growth and competitiveness in which the superior outcome in growth is even more effective for the firm that undertakes ICT R&D jointly with non-technological innovations. This supplementary finding is considered supportive to the argument that firms cannot simply invest heavily in ICT to achieve better economic performance (Bresnahan and Trajtenberg, 1995; Bresnahan et al., 2002). On the other hand, the joint contribution of ICT and non-technological innovations is a compulsory recipe for true success (Brynjolfsson et al., 1997).

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