How to close Europe’s digital divide?

The EU is putting a lot of emphasis on bridging the innovation divide between Western and Eastern Europe. Historically, the West has driven innovation through research and development (R&D) and the creation of new technologies. For new EU member states to catch up, more investments are needed to upgrade their infrastructure and support the adoption of existing technologies. The COVID-19 pandemic accelerated digitalization as firms across Europe significantly increased the uptake of digital technologies, including in regions still catching up. The question, however, is whether the gap is closing, and if not, what needs to be done.

Digitalization is a double-edged sword: It can either exacerbate or stem the innovation divide, depending on the type of technologies deployed. The framework in the World Bank’s 2020 flagship “Europe 4.0: Addressing the Digital Dilemma” report classifies digital technologies into three types: transactional, informational, and operational. Of these three, only transactional, such as e-commerce or other platforms, have the potential to advance all three European goals of competitiveness, market inclusion of small and young firms, and geographic cohesion. By contrast, operational industries, such as robotics, have high entry barriers for small firms and concentrate activities around preexisting European technological hubs. Informational technologies—for example, big data analytics—have not contributed to territorial cohesion either. As “catching-up” EU regions, such as Bulgaria, Croatia, Poland, and Romania, continue to promote their digital economies, they should take note of the technologies they support. Taking a nuanced approach will be critical.  

The World Bank studied recent public investments in these four countries. The results present opportunities for policymakers to realign their digital portfolios toward their own convergence objectives while promoting overall European competitiveness. Two dimensions are highlighted here: the composition of spending across innovation activities and the allocation across the different types of technologies. 

What kind of digitalization have the countries invested in so far?  

For Central Europe, catching up comes first. Over the last seven years, 1.5 billion euros from EU funds were dedicated to digitalization. Between 79 percent and 99 percent of digitalization funds were allotted toward technology adoption and infrastructure investments, such as providing broadband access and rolling out e-services. The remaining investments went toward technology creation (see Figure 1). Bulgaria has focused on infrastructure with relatively less investment on adoption, while Romania has invested relatively little in infrastructure but emphasized adoption. But across all four countries the focus has indeed reflected an emphasis on catch-up. 

Figure 1. Funding allocation for a digitalization portfolio of innovation activities in Bulgaria, Croatia, Poland, and Romania in 2014-2020 

Source: Authors’ analysis of the countries’ allocations in 2014-2020 EU financial perspectives. 

For catching-up countries, the allocation across digital technologies must ensure outcomes are inclusive and contributing to convergence. The contributions of the different types of digital technologies to the goals of competitiveness, inclusion, and convergence are indicated by the gray “+” and “-” (Figure 2) and are backed by empirical evidence. The allocation of resources across them will thus contribute differentially to these goals. Transactional technologies carry the greatest promise in delivering on all three goals. Romania, in particular, has targeted these technologies. If informational or operational technologies are supported, additional efforts must ensure that smaller firms and firms outside main production facilities can also benefit. 

Western Europe prioritizes operational and information technologies to advance their competitiveness vis-a-vis the U.S., Japan, and China; more investment in the transactional technologies could also bring more inclusive outcomes. 

Plain vanilla digitalization is a missed opportunity to support territorial cohesion and the inclusion of small young firms in the economy. Thus far, the four countries have spread support across all digital technologies. Such allocation is likely suboptimal. Furthermore, on transactional technologies, all countries showed missed opportunities for their own catching-up goals (Figure 2). 

Figure 2. Funding allocation for digitalization portfolio by EU objectives for Bulgaria, Croatia, Poland, and Romania in 2014-2020 

Source: Authors’ analysis and World Bank, “Europe 4.0: Addressing the Digital Dilemma.”  

Recommendations 

Three recommendations could help catching-up regions leverage digitalization better, by: 

1. Targeting the adoption of transactional technologies for regional convergence and inclusion of small firms. Romania, for example, observes serious disparities between Bucharest and the rest of the country. Despite a significant share of its funds—over 650 million euros—dedicated to transactional technologies, the country has directed only 30 percent toward market inclusion or cohesion targets. The analysis found that only a negligible share went to the private sector.  
2. Start engaging more in tech creation to drive long-term competitiveness.  Adopting existing technologies has been vital for industrial renewal and productivity growth in the post-transition period. It will remain absolutely essential for COVID-19 recovery. However, the new EU member states will need to balance tech adoption with policies to create new digital technologies to gain a seat at the pan-European and global innovation table. Poland, for example, has directed only 1 percent of its portfolio toward digital technology creation, leaving room for more targeted support for R&D, industry-academia collaborations, and robust technology transfer. 
3. Diversifying the instrument set to better support private sector digitalization. Grants were the dominant policy instruments of choice across all countries, especially for tech adoption. Bulgarian and Croatian firms were eligible primarily for grants and some incubator services. Thus, deploying a wider but relevant set of financial instruments for firms for R&D and tech creation, adoption, and managerial skills training will be essential to bolster firm productivity going forward.  

During the pandemic, firms in the new EU member states embraced digitalization, but so far mostly for basic functions of sales, marketing, and payments. The recovery presents a unique opportunity to drive deeper digitalization for productivity and convergence. Looking ahead, to bridge the innovation divide with the advanced member states, Bulgaria, Croatia, Poland, and Romania will also need to start increasing their R&D spending, while keeping a clear eye on technology adoption across the mix of technologies to meet its wider goals.