The role of ICTs as “enabling technologies” is also at the basis of the “reverse product cycle” model proposed by Barras (1986) to describe the dynamics of the innovation process in services. In this view, in the first stages of the reverse product cycle, services use ICT to enhance back-office efficiency. Subsequently, learning leads to process and product innovations. Finally, the industrial sector begins to use information technologies as they increase information-intensive activities. Information and communication technologies also allow for the increased transportability of service activities by making it possible for services to be produced in one place and consumed simultaneously in another (Soete, 1987; Miozzo and Soete, 2001) thus making provision of services independent from proximity to the final user.
The role of diffusion requires some further explanation as we introduce the space dimension.2 Domestic technology grows also to the extent that it can absorb technology produced in other regions or countries and in our model productivity growth results from innovation in different countries which is measured by patent citations in each country (a bilateral variable). In this respect our model follows Eaton and Kortum (1996).
However, as Peri (2004) shows in his discussion of the theoretical and empirical literature, the amount of foreign produced technology that can be used domestically is limited by two sets of factors: distance, which does not only carry a spatial dimension, and absorption capacity in the receiving country. We take both factors into account. As far as geographical factors are concerned we assume that the contribution of foreign technology to domestic technology accumulation grows as a negative function of distance from the countries from which flows of technology are acquired, while the impact of distance is allowed to vary over time to the extent that technological progress brings forward a reduction in the cost of technology diffusion. Bilateral citation flows, however, are not the only channel of innovation diffusion as technological accumulation also depends on imports of services.
Finally, we take into account the impact of regulation in the production and import of services, and hence on growth in two different ways. National regulation intensity depresses the production of services while uniform (and low) levels of regulation across countries favor production and import of services. Nicoletti and Scarpetta (2003) look at the impact of regulation on productivity and growth. We use their measure of product market regulation to investigate the impact of regulation on production and imports of business services. At the same time we can evaluate the positive impact on service growth of similar, and low, levels of regulation across countries. In fact services are an area where the European Commission is making large efforts to promote harmonization but is encountering several problems due to the densely regulated domestic services markets.