Making U.S. industry more competitive: myths and realities.

Can America compete? Can U.S. manufacturing come back? Is America deindustrializing? These are the headlines which are frequently seen in major newspapers and business journals. American companies in fact continue to lose ground in some global industries. To take an example, Fortune (August, 1995)

lists only three U.S. companies among ten world's largest companies in terms of global revenues, while it lists six Japanese companies and one European company. Many American observers attribute the decline of U.S. industries in global markets to the unfair trade practices of foreign countries and to the inappropriate or inadequate response of the U.S. government.

While all the economics textbooks still say that free trade, based on the principle of comparative advantage, is the best for both trading partners, some economists wonder whether free trade may now be passe (Krugman, 1990.) Industry leaders and politicians argue that this world is not perfectly competitive. They see some multinationals in Japan and the Asian Newly Industrialized Countries (NICs), and even some European competitors, as unfairly subsidized and protected by their governments. Why can't the U.S. export its agricultural products and machine tools to Japan, since made-in-Japan cars and electronic products are sold so widely in the U.S.? If trade barriers (tariffs, quotas and internal regulations on foreign products) of these other countries seem too high, they argue, we may have to erect our own barriers against them. If their export prices are low, we also may look to reduce our export prices by devaluing our currency. In this respect, these two policies - high import barriers and keeping the dollar low against foreign currencies - may appear to make sense. In fact, these two have been major U.S. policies in international trade for the last two decades. However, the U.S. is still recording a huge trade deficit of around $100 billion each year. While the deficit narrowed somewhat during the 1980s and the 1990s during periods where the dollar was down, it shows signs of returning to record levels. This suggests that we must reexamine these two policies.

Myths of Protectionism

In spite of a general ideology of free trade, if a specific industry is in trouble, the U.S. government has leaned towards protective measures such as tariffs and quotas. The main arguments for protection from foreign competition are threefold. First, without protection U.S. workers will lose jobs. Second, the "infant industry" argument - a given sector can become fully competitive with imports only if it is protected and helped by the government while it has a chance to develop. Finally, some key industries such as steel manufacturing are seen as strategically important. These industries should be protected no matter how competitive they are, to keep them from falling under foreign control.

However, counter-arguments are in order. First, protective measures are in fact a hidden tax on consumers, whether they are tariffs, quotas or voluntary export restraints. During three years (1982-1985) of the original export restraints of Japanese automobiles, for instance, the average Japanese import increased in price by $2600, and about $1000 of this amount was due to import restraints. The cost of jobs saved in the auto industry was high; the net cost to the economy of each job created by the automobile import restrictions was estimated as $110,000 to $145,000.

Second, it is hard to conceive of the automobile industry, for example, which started here around the turn of the century and has until recently been dominated by U.S. companies, as an infant industry. In the ten years since Japan "voluntarily" agreed to restrict its exports of cars to this country, Japanese autos have increased their share of the market and the major Japanese automakers all established plants here in the U.S. The eight assembly plants that the Japanese built in the U.S. during the 1980s have put precisely that many Big Three car factories out of business in the same period (Ingrassia, 1990). By moving from exporting cars to the U.S. to building them in the American heartland, the Japanese are steadily making inroads in the American auto industry. One might ask the question, how long do U.S. firms need to catch up?

Finally, there is the strategic industry argument. While one might quibble about automobiles, there is little disagreement on the strategic importance of the steel industry. The question is, can it ever become fully competitive if it is protected? The argument that a given industry has "strategic importance" and must be protected has been used for sectors as disparate as agribusiness, textiles and even shoes. We may eventually have to ask the question: which industry is strategically unimportant?

It is generally agreed that the effect of protective commercial policy is to protect producers at the expense of consumer benefits. It should be noted, however, that producers may also be hurt by protection in the long run. Levinson (1987), for instance, points out that the very grant of relief often creates new competitive disadvantages by sending the wrong signals to both employees and investors. He argues that with protection, employees, anticipating a rise in company profits, naturally demand a higher wage. Employers, being offered the prospects of continued relief from foreign competition, are constrained in the pursuit of new, more competitive strategies. Lawrence and Litan (1987) found that of 16 major U.S. industries receiving some type of shelter since 1950, only one - the bicycle industry - expanded after the protection lapsed. And even in this instance, protection failed to save many of the jobs existing when it was granted.

Another problem here is the "linkage effect." If the steel industry, for instance, is not efficient in terms of price and quality because of protection, the big users of steel such as the automotive industry will be hurt. The automobile industry will have to buy foreign steel in order to maintain its competitive position. Otherwise, consumers will buy imported cars. If an industry is protected, foreign imports in that industry may be reduced. However, exports of related industries may also be reduced because of the reduced efficiency. It is thus hard to say that protection improves a country's net trade balance.

Finally, protection is becoming less meaningful as multinational companies increase offshore production. American consumers may think Pontiac LeMans and Ford Festiva are as American as apple pie, but these are Korean-made cars. They may also not realize that the Geo models of General Motors such as Geo Prism and Geo Metro are products of GM's agreement with Japanese auto producers, or that nowadays five out of every eight Chrysler products sold have Mitsubishi engines. As multinationals venture further into international production and "outsourcing" for parts as well as materials, the question arises, "Who Is Us?" (Reich, 1990).

U.S. firms are continually transplanting their production abroad seeking low labor costs or access to new technologies. An example of this comes through in the fact that one-third of Taiwan's notorious trade surplus with the U.S. comes from U.S. companies producing abroad. When these products come back into the U.S. market, they are not protected. At the same time, foreign companies are transferring their production facilities to the U.S. where they are protected against future import restrictions. Nowadays, multinational firms can easily get around almost any kind of national tariffs or content restrictions. Protectionism, based on an economic theory assuming international factor immobility, does not apply very well to today's global business, where so many transactions that cross borders are parts of deals made between related enterprises.

The Limits to Macroeconomics: Devaluation and Budget-Balancing

Where experts criticize efforts to help particular industries, they often favor macroeconomic efforts designed to help the U.S. economy as a whole become more competitive. One popular idea here is to devalue the dollar to make the prices of U.S. exports cheaper, and thus reduce the trade imbalance. With devaluation, export prices become cheaper, but import prices become more expensive. If you buy a foreign product, say a Toyota Camry, you have to pay more dollars. Policy makers argue that devaluation works to reduce imports and improve out trade balance. However, this seldom works in practice - indeed, the dollar fell during 1994-95 but the U.S. trade deficit continued to increase! Common sense as well as economic analysis suggests that price increases will not dissuade U.S. consumers from purchasing a Lexus or BMW, as long as these products are unique in quality or design. To make matters worse, the U.S. has already abandoned many sectors of consumer goods such as cameras and VCR's. Here Americans have no choice but to buy imports. On the other hand, higher import prices do have a spill-over effect on domestic prices. The result is thus little impact on the import side, but inflationary pressure on the domestic market.

What about the export side? Can America export more with dollar devaluation? The two U.S. industries in the world's top exporters are aircraft and computers. Will foreigners buy more Boeing 747's and Apple computers if these products become cheaper? Will foreigners buy more U.S. industrial products such as die cutting machines and food-processing equipment? Will foreigners buy more agricultural products? Probably not, because many U.S. export items, from computer chips to movie videos, are not very sensitive to the dollar's change. In much of the manufacturing sector, trade balances are the sum total of two-way or intra-industry trade, where we both import and export similar products in the same industry. In the case of agricultural products, foreign government policies such as tariffs are more likely to affect price than the marketplace.

One side effect of devaluation which is not anticipated by policy makers is cause for concern. Cheaper U.S. money leads not only to cheaper U.S. exports, but also to cheaper U.S. property and assets valued in dollars. The result is often a shopping spree by foreigners who are buying up U.S. real estate and companies. When we hear that Matsushita has acquired a traditionally American firm like Universal Studios, or that large portions of U.S. farmland are owned by foreign companies, it does not seem that letting the dollar float lower has helped stem the tide of foreign competition.

Other economists believe that reductions in the government deficit are the key to lowering the trade deficit. If the economy is at full employment, and the government seeks to increase its expenditures, either the private sector will have to consume less or the goods will have to be obtained from abroad. Thus in the absence of a change in private spending patterns, a greater government deficit at full employment will lead to a greater trade deficit. According to this perspective, the appropriate tools are macroeconomic policies such as changes in taxes and government expenditures. However there are some problems with this view.

It may be true that the trade balance reflects macroeconomic spending patterns. From the national accounting equation, which is very popular in most economics textbooks (see Shapiro, 1994, for example), the relationship can be expressed as follows: (S-[I.sub.d]) + (T - G) = (X - M), where S is national savings; [I.sub.d], domestic investment; T, taxes; G, government spending; X, exports; and M, imports. According to this equation (or identity), international trade sector (X - M) just reflects domestic private sector (S - [I.sub.d]) and government sector (T - G). In other words, a nation's trade balance is identically equal to the private savings-investment balance plus the government taxes-spending balance. Assuming the absence of a change in private spending patterns [i.e., assuming (S - [I.sub.d]) constant] the appropriate policy to change the trade deficit [i.e., to increase (X - M)] is to reduce the government deficit [i.e., to increase (T - G)].

However, it may be undesirable as well as difficult to change taxes and government spending priorities just to improve this international trade position. Indeed, changing macroeconomic policies are still more a response to domestic conditions than efforts to improve one's trade balance. Even with its increasing relative importance, the external trade sector is a relatively small portion of the entire U.S. economy. It is also very difficult to pursue these policies. Even if we had the political will to do so, government attempts to raise taxes and reduce spending can contribute to a recession, and create other political and social problems.

While it may be difficult to conquer the budgetary deficit, other economists believe that the U.S. trade balance can be ameliorated by improving the savings rate and lowering consumption. From the above equation, given the continuing federal budget deficit [i.e., assuming (T - G) constant], the appropriate policy to reduce the trade deficit [i.e., to increase (X - M)] is to raise the savings rate (s) and/or to lower domestic expenditure ([I.sub.d]). This is why some economists believe that the trade deficit with Japan is primarily due to low savings rates in the U.S. and high savings rates in Japan. But how can the U.S. savings rate be increased? Increasing interest rates can lead to recession and dollar appreciation which will in turn negatively affect the balance of trade. Giving tax breaks for interest earnings on savings involves further tinkering with an already complicated budgetary situation. In fact private spending and savings patterns are influenced by a whole host of variables, some of them deeply rooted. This may make them even more difficult to change than government spending patterns.

One possible explanation for the decline in personal savings in the U.S. is that Social Security benefits expanded greatly during the 1970s. U.S. personal savings, which averaged about 8 percent of disposable income in the 1970s, slid to about 3 percent in early 1990s. In contrast, the high savings rate in Japan is attributed to the lack of a social security system, together with extremely high housing costs. This left the Japanese little choice but to save money for their retirement years - or for the dream of home ownership, which has been very strong (one-hundred-year mortgage plans have now been introduced in Japan). There is little doubt that in any poll the American people would prefer a better protected social security system and inexpensive housing to the extent that giving these things up meant reducing the trade deficit.

In today's highly integrated economy (and the U.S. economy is probably the supreme example), the effect of one economic variable cannot be isolated without affecting the entire system. Experience has often shown that the more radical the economic prescription, the more serious the problems it may produce. For this reason, it may not be wise to tamper with the whole set of macroeconomic variables in order to improve just the external sector which is still such a small portion of the overall economy.

Furthermore, macroeconomic policies have no direct ties to increasing international competitiveness (Porter, 1990). Indeed, recent studies suggest that competitiveness is more a function of firm-specific variables such as product quality and market share. It is more associated with the success of individual firms; in this sense, it is more a micro than a macro problem (Moon and Peery, 1995). It depends on how management can internalize the nation's country specific advantages into sets of firm specific advantages.

Sources of American Competitiveness

The stimulus to innovation is typically provided by some threat or promise in the market. Historically, U.S. firms have been pioneers in innovations to respond to the labor-scarce and high-income conditions of the U.S. market. For example, Henry Ford reduced the labor time used in making a Model T from twelve and one-half man hours to one hour and thirty-three minutes, by installing the moving assembly line in 1913. Andrew Carnegie was able to reduce the cost of making steel rails by the new Bessemer steel process from $100 a ton in the early 1870s to $12 by the late 1890s (Chandler, 1986).

The U.S. rose to world dominance in many areas through the application of a series of innovations. Large U.S. companies, such as General Motors, IBM, and Xerox developed research laboratories with groups of innovative scientists who provided a continual flow of new ideas. It was this application of research and development coupled with mass manufacturing improvements that allowed the U.S. to supply the war material in the 1940s and dominate world markets through the 1960s (Spencer, 1990).

In the 1950s and 1960s, American manufacturers derided most Japanese products as junk. In the 1970s, the Japanese started to make things cheaper and better. However, Americans still held the lead in creativity and new ideas. No longer; Japan is now struggling to pass the U.S. in new technologies. For example, according to a report (Business Week, August 3, 1992), Japanese companies have taken the lead in winning U.S. patents. The top three companies are now all Japanese (Toshiba, Hitachi, and Canon). While the Japanese have been spending more on R&D, American commercial R&D is stagnating, and at some important companies, even declining. A recent Boston Consulting Group/Wall Street Journal poll of senior executives finds that the U.S. is more complacent about R&D than Japan is. To ensure success, more Japanese managers see the need to increase their budgets and human resources during the next five years, especially in the area of R&D. On the other hand, only a minority of U.S. managers feel their companies are hurrying to catch up on technological developments.

The question is then, why the stimulus to innovation is declining in the U.S. One possible explanation is that the linkage between commercial and government-sponsored innovation has weakened over time. U.S. technological assistance has often taken the form of spending and procurement policies which in effect singled out certain industries and firms for subsidy and growth. In effect, American manufacturers have held the "home field advantage" in getting defense and other contracts, but this is changing as these programs have gotten less popular and the Cold War spending on new systems has wound down.

In the past, the space and military programs of NASA and the Defense Department had some spillover to nonmilitary applications. This helped prop up the aircraft and shipbuilding industries after the post-WWII demobilization. But the increasing specialization of military hardware makes civilian application more difficult; whereas the bombers of the 1940s and 1950s could be adapted eventually to commercial aircraft needs, the ICBMs of the 1980s offered no analogous possibilities (Vernon, 1986). Originally, government dollars for defense and space programs underwrote the development of computers, electronics and telecommunications and other high-tech R&D. However, the closed market with just one customer - the U.S. government - also produced wasteful habits that dulled the competitive edge of manufacturers.

Now, many of these same U.S. firms must compete in global markets where foreign competition is much tougher and they have no "inside track." In addition, U.S. military programs reduced the availability of engineers and technicians for commercial enterprise; industrial innovation has become more costly. Furthermore, the average size of R&D expenditure has grown as commercial technologies became more sophisticated. This must be amortized over an ever shorter product life cycle, and with the clear possibility for the firm that introduced the new technology that it will soon be copied by foreign competitors. In such an environment, while the importance of gaining a technological lead becomes paramount, the risks become ever greater.

Vernon (1986), the author of the product cycle hypothesis, argues that if the fruits of U.S. technology are to be shared, the U.S. has to get beyond its national security hangups and encourage joint national programs in the stimulation of technology rather than unilateral national efforts. However, Vernon fails to consider implications for possible short-term monopolistic profits for the innovator. As Vernon (1979) himself points out, the real competitive advantage of U.S. firms is in the introduction stage of the product life cycle, where an innovative product can enjoy a monopolistic position until a foreign competitor catches up. If the U.S. shares innovation with foreign countries, the U.S. firms participating in such joint efforts will stand to lose some of their competitive base. Nevertheless, both industry and government-backed consortia such as SEMATECH are likely to expand due to the increasing costs of R&D and the importance of industry-specific technology to competitiveness.

Since the U.S. has disadvantages in other business factors such as labor costs, the best competitiveness strategy for U.S. business seems to lie in climbing to ever higher levels of technology productivity, and staying ahead. This would be the ultimate refuge and enduring weapon. If you have higher levels of technology, you can keep the edge on the competition and charge higher prices on your products, to help pay for ever-increasing research and development costs. To the extent that U.S. industrial products were technically superior, they would also be more desirable - and the more foreigners want the made-in-U.S.A. products, the less the U.S. government needs to resort to dollar manipulation and protection.

In addition to innovation, another source of American competitiveness has been its huge domestic market. In automobiles in 1929, for example, when General Motors produced 1.6 million and Ford 1.5 million cars, only one German car company made more than 10,000 and that firm, Adam Opel, which produced 25,000, had just become a General Motors subsidiary (Chandler, 1986). This meant the U.S. firms could enjoy significant economies of scale, keeping prices low.

In the past, the U.S. market had no equivalent on the other side of the world. Nowadays there are three economic regions, North America, Europe and Japan (Ohmae, 1985). U.S. firms do not have advantages even in our large domestic market any longer. The concept of market share needs to be changed from domestic to global, while U.S. policymakers and managers must respond to the rapidly changing pace of global markets.

It is very important for U.S. firms to capture a larger share in these changing global markets. Larger market share has in fact more strategic implications than many managers may think. If you can capture a larger market share than your foreign competitors, you can achieve larger scale economies. Larger scale economies are associated with lower average costs of production and can lead to significant production efficiencies important in a price-sensitive market. This is to say, you can improve your competitive position, even if you do not possess higher levels of technology than your competitors. The two basic business strategies are thus to enhance technology and to enlarge market share.

Innovation or Global Market Strategy?

There is disagreement among national strategists on the importance of technology as a source of competitiveness. Newly emerging countries such as Indonesia, for example, face a difficult choice - whether to concentrate on becoming a low-wage exporter of labor-intensive products, as other Asian countries did, or to try leaping ahead to more capital-intensive, high-technology goods, as nearby NICs such as Korea have done (Brauchli, 1993). Others suggest that the emphasis on technology varies according to industry and that the overriding emphasis should be on the need for global market strategy. However, there is an inevitable vulnerability of global market strategy without technological leadership. Moreover, encouraging technological innovation may be an especially important component of U.S. competitiveness since the most important comparative advantage of the U.S. is its high-tech "edge," based on a history of entrepreneurism and inventiveness, and supported by an abundance of risk capital, superior graduate-school education and an inflow of foreign scientific brainpower (King, 1994).

As previously noted, Japan is now becoming more successful in introducing new products as well as in improving the quality of existing products in many areas. Obviously America cannot compete with Japan (or a revitalized Europe) if American industry just pushes global market strategy, but neglects to improve the product quality and to introduce new products. It took decades for Japan to beat Made-in-USA products and to establish its own brands. It will also take time for the U.S. to reestablish Made-in-USA brands in world markets. To do so, however, the U.S. has to encourage new product development and technological innovations.

It seems clear that the emphasis given to global market strategy or innovation will change over time, as a nation's competitive position changes. To take Japan's example again, Japan focused more on export-led, global market strategies in the early period of its industrial development (1950s through mid-1970s) and then on innovation strategy in the later period (late 1970s through the mid 1990s). In the early period, the most important comparative advantage of Japan was well-trained and relatively cheap labor. Since this country had little technological lead, its strategy was to increase international market share in order to achieve desirable economies of scale which would in turn increase its competitiveness in terms of costs. In the later period, Japan's comparative advantage has changed, along with its competitive position. Labor became more expensive, foreign competition increased and many international markets became saturated due to overproduction. However, even as the explosive growth rate of Japanese industry was slowing down, Japan focused on a new comparative advantage - learning experience. Relying on its increasingly sophisticated workforce, government assistance to industrialized R&D, and a tremendous increase in corporate spending and acquisition of foreign research and technology, Japan has attempted to transform itself from imitator to innovator. The strategic shift is thus toward technological innovation and attuned to Japan's changing comparative advantage.

In contrast, the comparative advantages of the U.S. have not been much changed over time. Its two most important assets are still a deep pool of scientific and managerial resources and a huge domestic market. Since the strategic choice of a country should center on finding a way to strengthen its comparative advantages, the U.S. may need to pursue both approaches - innovation and market strategy - with approximately equal weights.

Conclusion

There are several implications here for U.S. firms and policymakers. The most profound is that the policies of the past, based on bailing out ailing industries through protectionist measures and hoping to improve trade balances as the dollar falls against foreign currencies, are not going to work to improve competitiveness or to increase world market share for U.S. products. Many U.S. firms continue to ask for government support and legal protection from import competition. As noted, however, today's protectionist solution is tomorrow's strategic problem. Trade protection and dollar devaluation may offer breathing space to managers, but cannot solve the fundamental problems.

At the same time, a recognition that U.S. firms are less competitive does not necessarily require government planning or intervention. The real problems lie in the fact that U.S. is losing its two traditional advantages - innovation and a large domestic market - while large parts of the world have "caught up" to U.S. industries and have expanded their own global market share. The U.S. needs to redefine the concept of commercial policy. This involves a strategic shift away form protecting U.S. firms' place in the domestic market toward encouraging innovation and pushing global markets. In fact, the two are closely intertwined. Achieving global market share is crucial to lowering production costs and generating the dollars for R&D advances. In the new, "idea-based" international economy, there is an important connection between the size of a market and the value of innovative ideas. That is, the marginal cost of making additional copies of a conceptual product, a new software application, for instance, is low compared with producing additional tons of steel. And since "...it costs about the same to create a compelling idea whether it is sold on one country or many, the rewards of widening global trade are large" (Zachary 1995), To make sure that U.S. companies are able to compete in the future, it is more important than ever to integrate the largest economy in the world, the U.S., into the rapidly globalizing world of business.

References

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H. Chang Moon is Associate Professor of International Business, and James A. Goodrich is Professor of International Business and Director, Westgate Center for Management Development, Eberhardt School of Business, University of the Pacific, Stockton, CA.