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    EPSC Strategic Notes are analytical papers on topics chosen by the President of the European Commission. They are produced by the European PoliticalStrategy Centre (EPSC), the European Commission’s in-house think tank.

    DisclaimerThe views expressed in the EPSC Strategic Notes series are those of the authors and do not necessarily correspond to those of the European Commission.

    Integration of Productsand ServicesTaking the Single Market into the 21st Century

    Issue 7 / 2015

    06 OctoberEPSC Strategic Notes

    Three factors combine to reshape the foundations of the modern economy. First, the digital revolutiondramatically augments the reach, exibility and agility of companies, big and small, creating new economicactors, such as ‘micro-multinationals’: technology-intensive companies that are born global. Second,international competition draws millions of new workers and consumers into what is increasingly a ‘raceto the top’, rather than a ‘race to the bottom’, with emerging countries becoming champions of innovation,engineering ingenuity and skills acquisition. Third, cultural and structural trends change the nature ofsocio-economic interactions by transforming people’s aspirations and preferences, such as the expectationof instant gratication oered by one-click services or the seamless interoperability between products andelectronic devices.

    Blurring Lines Between Productsand Services

    A pronounced distinction between product andservice markets is ctitious: value creation

    and innovation increasingly take place at theirintersection. Business-related services are oen

    decisive in making products attractive to theconsumer and they generate most of the valueadded in growth and employment.

    Introducing the

    Interoperable EconomyA new, horizontal economy is emergingbeyond traditional value chains, opening novelopportunities for those who master a more‘systemic’ presence across sectors such as energyprovision, modern transport and mobility, foodproduction or travel facilities. Interoperable datawill be the ‘glue’ that connects the dierent elds,

    while platforms will be the ‘bridge’ betweenproviders and users.

    A New Paradigm for InvestmentInvestment patterns and value creation are changingprofoundly: business expenditure in intangible assets– databases, soware, design, training or branding –

    grows signicantly in size and importance compared to

    tangible assets - such as machines, buildings or land.Within intangible investments, innovation levers needto be supported: scientic R&D for instance accounts

    for only 17% of rm investment in innovation, inviting

    policy makers to recognise and encourage other types ofinvestments (Figure 5, p. 5).

    A Single Market for Global AdvantageA modernised single market can place Europea step ahead of its global competitors bymore quickly removing barriers to cross-borderexchanges of products and services. But to matchthe demands of the new economy, the singlemarket needs to become more dynamic and agile,shi the focus from producer to consumer and

    drive disruptive innovation.

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    A Hyperconnected Economy:

    The New Landscape

    Deindustrialisation has moved hand in hand with an increasing

    importance of services in advanced economies. When incomesrise, demand for services grows at a more than proportionalrate. The manufacturing sector, however, remains important:1

    • as a source of productivity growth, which is higher thanin other sectors in most countries;

    • as an engine for R&D and innovation, since mostR&D investments are concentrated in manufacturing

    (Figure 1);

    • as a strong factor behind the internationalisation of

    economies through trade and investment.

    The EU goal of increasing the share of manufacturing to20% of GDP by 2020 is a vivid reminder of the importance

    that policy makers attribute to industry.

    What is less oen realised is that achieving this

    target is inherently dependent on making Europe’s

    services sector more dynamic, productive and

    integrated. More than ever before, the highest valueadded of a product comes from service integration(Figure 2). The OECD, for instance, has shown that

    an increase of 1% in business services content inmanufacturing exports is associated with an increase of6 to 7.5% in prices.2

    Future historians may well look at our time as equally determinant in redesigning the economic rulesof the game as the 19th century industrial revolution. The consumer and user is ever more central tothe new economy, by virtue of being more active and responsive, hence shaping the manufacturingvalue chain and leading the way towards tailor-made, personalised ‘production on demand’ and the

    emergence of hyperconnected services. If the industrial age was marked by standardisation, thedigital era is about customisation. These tectonic shis go hand in hand with other developments ofseismic proportions: the blurring distinction between products and services; the birth of the ‘prosumer’who combines elements of consumption and production; and the growing importance of investments in

    intangibles – such as soware or design - which increasingly outstrip investments in tangibles - such asmachines or buildings - in the leading economies.

    Manufacturing Services

       B   e   l   g   i   u   m

       C   z

       e   c   h   R   e   p   u   b   l   i   c

       D   e   n   m   a   r   k

       E   s   t   o   n   i   a

       F   i   n   l   a   n   d

       F   r   a   n   c   e

       G   e   r   m   a   n   y

       H   u   n   g   a   r   y

       I   t   a   l   y

       N   e   t   h   e   r   l   a   n   d   s

       N   o   r   w   a   y

       P   o   l   a   n   d

       P   o   r   t   u   g   a   l

       S   l   o

       v   a   k   R   e   p   u   b   l   i   c

       S   l   o   v   e   n   i   a

       S   p   a   i   n

       S   w   e   d   e   n

       U   n   i   t   e   d   K   i   n   g   d   o   m

    0

    20

    40

    60

    80

    100

       A   u   s   t   r   i   a

    Figure 1: Share of Manufacturing and

    Services in Total Business R&D, 2012

    Source: STAN Research and Development Expenditure in IndustryDatabase, OECD.

    0   5 10   15   20 25   30   35   40 45

    Belgium

    Czech Republic

    Denmark

    Estonia

    Finland

    IndiaSweden

    Hungary

    Italy

    Netherlands

    Norway

    PolandPortugal

    Slovakia

    Slovenia

    Spain

    Iceland

    United Kingdom

    Austria

    United States

    RussiaCyprus

    Luxembourg

    GreeceLithuaniaGermany

    Latvia

    MaltaFrance

    Ireland

    Brazil

    RomaniaBulgaria

    China

    Croatia

    Switzerland

    1995 2011

    Figure 2: Service Value Added Embodied in

    Manufacturing GoodsPercentage of value added of manufacturing goods in nal demand

    Source: Trade in Value Added (TiVA) 2015 Database, OECD

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    With the blurring line between goods and services,international and national, on- and oine, an entirely

    new economic paradigm is emerging, powered by threetransformative developments.

    Technological Revolution

    The internet and digital communications are generalpurpose technologies, transforming economies asprofoundly as the printing press, steam engine orelectricity have done in the past. Against this backdrop,it is important to understand that there is no suchthing as a ‘digital economy’ – the economy

    is digital. Far from being the exclusive domain oftechnology startups, every company, particularly intraditional industries, needs to prepare for digitisation.

    Yet, on balance, European companies have been slow toadapt: 41% of enterprises are still classiable as ‘non-digital’ – meaning they do not use digital technologiesand have no digital strategy – while only 2% take fulladvantage of digital opportunities.3 

    The slow adoption and use of digital technologies hasbeen a drag on Europe’s productivity growth, not tomention its ability to innovate and move up the globalvalue chain. And it has impacted manufacturing and

    services alike, particularly the integrated, high value-added segment. But the EU is starting to address thischallenge: completing the Digital Single Market will

    incentivise technology adoption through higher networkeects, while prioritising areas where competitive

    advantages can still be reaped, such as Industry 4.0. Atthe same time, formulating a unied data framework

    for a market of half a billion consumers can set a globalstandard, provided it is user-friendly and workable.Speed of delivery and implementation is of utmostimportance if Europe is to regain lost ground, andthe high-end nexus of integrated manufacturing and

    services is of particular importance for future growth,sustained innovation and quality jobs.

    Cars have become computers on wheels. Soware

    is revolutionising the car industry, until recently oneof the most traditional and hierarchically organised

    industries in the world. For example, Tesla - acompany founded as recently as 2003 - has shownthat there is no reason why a technology companycannot become a car company, with the designcoming from California, modules being deliveredby suppliers from around the world and the nal

    product being put together in contract factories.Electronics and automation have become keycomponents of the assembly line.

    The cost of the electronic parts of each vehicleare expected to rise from 20% in 2004 to 40%this year, Boston Consulting Group estimates,4 

    with a premium class car now containing 100microprocessors and running on 100m lines ofsoware code. In the future, a car will likely be

    a combination of mobile oce and source of

    entertainment. The vehicle will interact seamlesslyand exchange data with the driver’s electronicdevices, and possibly also with the manufacturer orinsurance company if the driver wants to documentsafe driving.

    Competition in the

    Higher Value-Added SegmentIn spite of the slowdown of growth in emerging markets,the next decades are likely to be marked by a continuedconvergence process. As emerging countries moveup the value chain, they increasingly rival

    producers and service suppliers from advanced

    economies. Instead of developing powerful industrialsectors locally, they can now leapfrog more advancedeconomies by adopting the latest technologies andsourcing products and services globally. As a result,OECD countries’ share in world manufacturing dropped

    from 82% in 1990 to 56% in 2013 (Figure 3, p. 4).

    Tellingly, China’s 12th Five-Year Plan for 2011-2015explicitly shis the focus to R&D and high-end

    manufacturing and services. This means that China andEurope will increasingly compete in the same markets,such as clean energy, aerospace, telecom equipmentor broadband networks. Studies have shown that thecomplementarity of European and Chinese export oers

    has dropped from 85% in 2000 to 65% in 2010, whichmeans that 35% of exports tended to overlap, comparedto only 15% ten years earlier.5 Intensifying globalcompetition means that competitive advantages are moreuid than they used to be, requiring dynamic approaches

    to competitiveness and productivity.

    The Digital Car

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    Behavioural and Structural Change

    The rationale of the emerging new economy is greatlyinuenced by ongoing cultural and structural shis, some

    of which are induced by technology, while others resultfrom broader societal trends. Their eect is profound,

    from the changing nature of work and its growing uidityto the emergence of a sharing economy. In particular, theconsumer and user perspectives – already central to

    current economic relations – will become dominant even in business-to-business transactions.

    Products are increasingly tailored to individualconsumers’ needs and desires through processes suchas ‘additive manufacturing’. Consumers will move frombeing objects of economic exchanges to active agents.This trend is already underway, as exemplied by the

    growing importance of ‘prosumers’. To illustrate, the

    energy system is shiing from a centralised, supply-side approach to a demand-oriented model. Newdigital products and technologies are progressivelymodernising the energy system by easing the wayfor a novel nexus between production, transportation,distribution and consumption. Increasingly, energy willbecome a service and not just a supplied commodity,providing new opportunities for energy serviceproviders and aggregators, and giving life to new digitalproducts, such as smart meters. These developmentswill transform the business model of energy utilities,bringing new, innovative and disruptive companies tothe fore.

    These three factors – digitisation, globalisation andsocio-cultural transformations – combine to produce amore versatile, creative and interactive economy where value increasingly lies in the interoperabilitybetween products and services. Combining products andservices has become the new normal as design, marketing,insurance and aer-sale servicing are inseparable parts

    of the oering that the consumer demands and expects.

    As a result, manufacturing rms have incorporated strong

    service components into the way they operate whileservices rms have sought to benet from economies of

    scale, traditionally more characteristic of the manufacturingworld. Business models that contribute to the integrationof products and services are increasingly crucial forcompetitiveness and productivity (Figure 4).

    Implications:

    Disrupt or Be Distrupted

    From Static to Interactive

    The fusion of product and service markets will continueto have a profound impact. The world economy willmove from static products and services to smartand interactive ones. This means that new ways needto be explored with respect to the design and labellingof products. Products are becoming ‘smarter’, morecapable of autonomously addressing and respondingto evolving consumers’ needs. ‘Smart’ coee machines,

    for example, have built-in sensors that automatically

    signal to the local brand store the need for repair. Theuser therefore does not only purchase a product – acoee machine – but also a service, the promise of

    maintenance whenever necessary.

    OECD EU

    ChinaUnited States

    Other Asia and Oceania

    Japan

    1990 2013

    33%

    23%

    17%

    9%

    5%  4%

    2%

    4%3%

    20%

    23%11%

    8%

    11%

    5%

    2%3%

    17%

    Other OECD

    South and Central AmericaOther Europe

    Africa

    Figure 3: Share in World Manufacturing

    Value Added

    Source: United Nations Statistics Division

    -6 -4 -2 0 2 4 6-4

    -2

    0

    2

    4

    6

    8

    10

    12

    Miscellaneousmanufacturing

    Apparel andleather products

    Transport equipment 

       A   n   n   u   a   l   i   z   e   d   g   r   o   w   t   h   i   n   m   u   l   t   i   f   a   c   t   o   r   p   r   o   d   u   c   t   i   v   i   t   y

    Change in business services intermediate inputs

    14

    -8-10

    Computer andelectronic products

    Figure 4: US Manufacturing Sectors That

    Buy More Business Services Record Greater

    Productivity GrowthPercentage, 2002-2011 average

    Source: United States International Trade Commission

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    New business models will develop with packaged oers

    combining the provision of both goods and services inever more hybrid forms. Network eects will become

    more important as a result. ‘The sharing economy’ and‘the circular economy’ are two emerging concepts whichreect the interactive character of modern economic

    exchanges. They are part of the broader phenomenon ofhyperconnectivity, in which dierent segments interact

    and many products and services prove complementary.

    Technologies such as virtual reality have the potentialto radically transform entire industries through theremote discovery of products and services: the abilityto ‘touch’ and ‘feel’ products in a virtual store from yourliving room may well disrupt the sector by making pricecomparison easy, enabling 24-hour online shopping andcompelling companies to oer delivery services.

    From Tangible to Intangible Investment

    The move from a bricks-and-mortar economy, markedby incremental innovation, towards a hyperconnectedworld, characterised by disruptive innovation, is mirrored

    in investment patterns (Figure 6, p. 6). Oen referred toas Knowledge-Based Capital, these hitherto marginalareas are becoming key features of corporate success:design, soware, data, organisational capital, rm-

    specic skills and branding and marketing, to name but

    a few. Within intangible investments, new innovationlevers need to be supported: scientic R&D, for instance,

    accounts for only 17% of rm investment in innovation,6 inviting policy makers to recognise and encourage othertypes of investments (Figure 5).

    The overriding goal of intangible investments is to live

    up to a new ‘constant innovation paradigm’ in whichenterprises reinvent themselves on a continuous basis tokeep track of the technological frontier, user preferencesand developments in global value chains. Successfulrms make the interplay between constant innovation

    and targeted investment in Knowledge-Based Capitala key feature of their business models. It becomespart and parcel of their day-to-day operations, withmanagers persistently ne-tuning processes to ensure

    that the rm operates at the leading edge in comparison

    with global competitors. Understanding the centralityof Knowledge-Based Capital is crucial, especially forEuropean policymakers, given the traditional bias ofpublic investment towards physical infrastructure.

    From Macro- to Micro-Multinationals

    Today’s small and medium-sized companies are oen

    in a dierent league from their predecessors. Born

    global thanks to the internet, which gives them instantaccess to world markets, enterprises no longer have togo through the traditional trajectory of slowly buildingup a local presence and then expanding over the course

    The ‘Learning’ Thermostat

    When home appliances company Nest was acquiredby Google for $3.2 billion in 2014, there was muchhype about the ‘learning thermostat’, one of itsagship products. But did the value really lie in thethermostat? Hardly, one might conclude, as the realworth that warranted the exorbitant price tag layin the sensor-driven, Wi-Fi enabled, self-learningand programmable devices the company produces.The interoperability between the device and theinternet, as well as a user’s smartphone and tablet,is key to making these types of manufacturedgoods attractive and can oer considerable rst-mover advantage to the pioneering company.Europe, with its sizable single market and strongtradition in manufacturing state of the artproducts, could be the perfect breeding ground forinnovative companies, using the Internet of Thingsto make devices smarter, more user-centered andinteractive.

    0 100

    134   17%

    133

    98

    21

    13

    56

    33

    95

    194

    777

    200 300 400 500 600 700 800

    Scientific R&D

    Computer sostware

    New architectural and engineering designs

    Entertainment, artistic and literary originals + mineral explorations

    New product development costs in the financial industry

    Advertising expenditure

    Market research

    Training

    Organisational capital

    Total

    Figure 5: Investment in Innovation by European Firms, 2010

    Billion euro

    Source: INTAN-Invest

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    of decades into a global rm. This fundamentally

    alters the rules of the game and the very architectureof the corporation – with a denite competitive edge

    for younger rms, which are oen better at pursuing

    disruptive innovations, not bound by organisationallegacy, allowing them to exibly shi from one business

    model to the next. The relentless pursuit of productivity

    and the closer proximity to users complete the pictureand explain why many large corporations, especiallyin manufacturing and industry, feel threatened andinsecure about their place in the 21st century economy.

    Slow to adapt to the new paradigm of the digital age,many macro-multinationals are now actively pursuingrelations with younger rms, hunting for new ideas

    and trying to import new skills and entrepreneurialtalent by acquiring startups. This is not a marginalphenomenon, nor is it an altruistic act on the side ofthe large companies. More than policy makers realise,

    the relationship between large, industrial rms andyoung, tech-savvy startups is becoming symbiotic andof crucial importance for Europe to sustain a globallead in innovation. That is why a modern industrialpolicy needs to put technology adoption and an

    innovation-friendly ecosystem at the forefront, a denite departure from the more traditional

    conceptions. The German Chancellor Angela Merkelpicked up on this theme when she used a recent speechat the Day of German Family Firms to warn against‘digital anxiety’, especially in using big data, and calledon participants to occupy the ‘intersection betweenconsumers and the product. That’s where future prot

    will be made’.7

    Policy Opportunities:

    Walk the Talk – and Fast 

    Traditional policy tools are oen obsolete in the face of

    market integration of products and services. The singlemarket has lost none of its importance – if anything, thegrowing value of cross-border markets, given product-service integration, makes it all the more valuable.But the single market alone will not guarantee futuresuccess. Broader framework conditions - ranging fromthe ease with which companies can switch from onebusiness model to the next to the user-friendliness ofthe emerging data protection regime - are under carefulscrutiny by companies that have more choice than ever:digitisation gives companies agility in terms of location,outsourcing, and using global value chains to theirmaximum advantage.

    The single market must not be seen in isolation. TheEuropean Commission’s agship initiatives already

    underway - such as the Energy Union, Capital MarketsUnion and the Digital Single Market - all add up to

    more than the sum of its parts. Provided that Europesucceeds in making a quantum leap in unleashing

    the potential of its product and service markets,

    there are numerous opportunities to be reaped.

    Reshoring of Manufacturing

    3D printing – also referred to as ‘additive

    manufacturing’ – could lead to reshoring or nearshoringof industry, as it increases production speed whilereducing costs and meeting consumer demand withmore speed and greater inuence over production. Both

    can make production at or near headquarters cheaperthan production overseas. What it calls for are decisivepolicy actions that incentivise technology adoption by allcorporate players competing internationally. The picturewill not be black or white, since reshoring will take

    place alongside continued outsourcing and relocationto emerging markets. However, the reshoring of somehigh-end production processes is likely in connectionwith building a stronger product-services nexus.

    Develop Not-Easy-to-Replicate

    Innovations

    Adding sophisticated business services to advancedmanufactured goods leads to innovations that are noteasy to replicate by competitors and therefore givessignicant competitive advantage. In comparison,

    it would be dicult to maintain such a competitive

    advantage with a standard manufactured good void ofan additional service component. This story also plays out

    Investment in KBC Investment in tangibles

            1        9        7        2

            1        9        7        5

            1        9        7        8

            1        9        8        1

            1        9        8        4

            1        9        8        7

            1        9        9        0

            1        9        9        3

            1        9        9        6

            1        9        9        9

            2        0        0        2

            2        0        0        5

            2        0        0        8

            2        0        1        1

    18%

    16%

    14%

    12%

    10%

    8%

    4%

    6%

    Figure 6: Business Investment in Tangibles

    and Intangible Assets in the United StatesPercentage of GDP

    Source: Unpublished update on Corrado, C.A. and C.R. Hulten (2010),‘How do you Measure a ‘Technological Revolution?’

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    Services Manufacturing

    -4

    -2

    0

    2

    4

    6

    8

       I   c   e   l   a   n   d

       S   p   a   i   n

       S   l   o   v   e   n   i   a

       I   r   e   l   a   n   d

       L   u   x   e   m   b   o   u   r   g

       C   a   n   a   d   a

       P   o   r   t   u   g   a   l

       N   o   r   w   a   y

       A   u   s   t   r   a   l   i   a

       I   t   a   l   y

       S   w   i   t   z   e   r   l   a   n   d

       D   e   n   m   a   r   k

       G   r   e   e   c   e

       F   r   a   n   c   e

       S   w   e   d   e   n

       B   e   l   g   i   u   m

       A   u   s   t   r   i   a

       U   n   i   t   e   d   K   i   n   g   d   o   m 

       U   n   i   t   e   d   S   t   a   t   e   s

       G   e   r   m   a   n   y

       H   u   n   g   a   r   y

       C   z   e   c   h   R   e   p   u   b   l   i   c

       N   e   t   h   e   r   l   a   n   d   s

       E   s   t   o   n   i   a

       F   i   n   l   a   n   d

       S   l   o   v   a   k   R   e   p   u   b   l   i   c

       J   a   p   a   n

    Figure 7: High Skills in Services and

    ManufacturingAnnual growth rate, average 1998-2008

    Note: Slovenia: 1997-2007; Sweden: 1997-2007; USA: 2003-08;Japan: 2003-08.

    Source: ANSKILL Database 2011, OECD

    on the jobs front: in advanced economies 30 to 55% ofmanufacturing jobs have become service functions, and20 to 25% of manufacturing output is represented byservice inputs.8 In the pursuit of high-quality jobs,the nexus between manufacturing and services oers

    many opportunities, especially in countries that haveworld-class training and apprenticeship systems gearedtowards industry.

    Productivity Growth and High-Skilled

    Jobs in Services

    For a long time, services have been perceived as inferiorin comparison to manufacturing. Weak in productivitygrowth vis-à-vis industry, and with jobs that are oen

    seen as low in quality, the service sector has beenprioritised by few countries in Europe. Yet, the potentialis enormous. Precisely because productivity in servicesis comparatively low, quick wins could be reaped interms of growth and innovation by integrating marketsand increasing cross-border competition, for instancein business services. And far from being the domain ofthe low-skilled, the service sector actually employs morehighly skilled workers than manufacturing (Figure 7). Forpolicy makers, it is time to understand that a healthy andthriving industry sector is inherently dependent on thequality and integration of Europe’s service markets.

    First Mover Advantage Up for Grabs

    in Key Sectors

    While there is much moaning in Europe about lost

    dominance in certain areas, there are many elds whereEuropean companies can lead globally by operating atthe intersection of products and services. Industry 4.0is commonly known, but other areas are up for grabsas well: medical technology, smart cities, the circulareconomy, ‘learning’ home appliances, and intelligenttransport systems. The integration of goods and servicesis almost always powered by data and enabled byinteroperability, making technology adoption by allcompanies, including in traditional sectors, an urgentpolicy priority.

    Conclusion

    Europe has everything going for it in this new,hyperconnected, interoperable economy: traditionalstrength in manufacturing must now urgently be

    complemented by world-class services.

    As the European Commission ponders the future of thesingle market, a more holistic and all-encompassing viewmust guide the upcoming strategy. Building on the globalreputation that European goods are superior in quality,there is a unique opportunity to provide additional value– and gain international competitive advantage –by accelerating the integration of technology, servicesand design.

    It is the only way that Europe can succeed and excelin the ‘race to the top’ that leading competitors arepursuing in a quest for sustainable prosperity and high-quality jobs.

    Are ‘Great Depression Statistics’Fit for the Digital Age?

    At the behest of Chancellor George Osborne,the United Kingdom is currently undertaking acomprehensive review of its economic statistics.It is led by former Deputy Governor of the Bank of

    England Sir Charlie Bean, who remarked that theframework of current accounts ‘was developed inthe aermath of the Great Depression’. Using Rolls-

    Royce, which is ostensibly a manufacturer but in

    reality generates most revenue with services, as an

    example, Sir Charlie concluded that speaking aboutmanufacturing and services as distinct concepts‘is oen not a helpful way to think about economic

    activity.’ 9

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    Notes

    1. OECD Publishing, ‘Manufacturing or Services – That is (not) the

    Question’, Policy Paper No. 19.2. Nordas and Kim, ‘The Role of Services in Competitiveness in

    Manufacturing’, OECD Trade Policy Papers, 2013.

    3. European Commission, Enterprise and Industry, ‘Digital

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