Can Industry Survive the Welfare State?

The recession dogging the U.S. economy is only symptomatic of the long-term decline suffered by many of our industries since the beginning of the 1970s. The evidence is everywhere, from sagging profitability—and even bankruptcy—of once-dynamic companies to chronic unemployment that reaches far beyond the 10 % level for certain areas of the country and population segments. Furthermore, the same symptoms afflict all the other major economies of the North Atlantic area. In this article, Bruce Scott argues that despite the degree of decline, no government has proposed a substantive or workable plan to reverse it. Using comparative economic analysis, he shows how the newly industrialized nations of East Asia have prospered just as the industrialized West has declined. Then he explains how the United States can begin the often-painful process of revitalization—not simply by implementing an industrial policy but by adopting a new way of thinking about a country’s economic strategy in much the same way a company thinks about its strategy. The idea is revolutionary because, to make it work, government and labor will have to concede certain ground gained in the welfare reforms promulgated since the Great Depression. And for their part, corporations will have to take back some of the responsibility for the rights and security of their employees. Stagflation has affected the North Atlantic area for almost ten years. We may be able to explain continuous inflation at historically high levels in the face of slack demand in terms of successive oil price shocks, wage settlements that far outpace productivity gains, and excessive money creation (particularly U.S. dollars). But what about economic stagnation? The “oil tax” levied by OPEC is part of the explanation. A slowdown in technological innovation may also be a contributing cause. But in addition to these exogenous or noncontrollable developments, it may be that the economic policies of the industrial countries themselves bear a major responsibility. We cannot ignore the growing tax take of the welfare state, particularly when the state uses those revenues for social welfare programs and transfer payments that are “entitlements” unconnected to any productive contribution to society. Deficit financing of these programs makes government an increasingly important competitor for public savings, crowding out more directly productive investments. Despite the possibility that government policy may have been a major cause of the stagflation problem, a growing sense exists that governments can and should “solve” it. And it is no coincidence that, since 1976, voters have rejected all major Western governments except that of Chancellor Schmidt. New governments are experimenting with radically different programs from supply-side economics in the United States and the United Kingdom to more socialism in France. Each can look to its share of economic experts for support. Consensus on the diagnosis seems almost as elusive as on the most appropriate remedies. Understandably, much of the attention thus far has focused on the obvious symptoms of unemployment and inflation. But it is time the policymakers of the major countries in the North Atlantic area turned their attention to the more fundamental problems of: (1) weakened industrial performance (declines in the growth of investments, productivity, jobs, and trade balances), (2) the shifting distribution of income that preceded it (toward wages and away from profits), and (3) the increasing vulnerability of the traditional industrial countries to the unprecedented challenge from Japan and the four “new Japans” of East Asia-Hong Kong, Korea, Singapore, and Taiwan. One important aspect of the new competition is the speed with which it has developed. Japan started to industrialize little more than 100 years ago, while the others began only 30 years ago. But more significant, none of the newcomers has a base of natural resources on which to build an industrial society, and Japan is the only one with a large home market. They have succeeded by mobilizing human and financial resources through different policies and institutions. While the North Atlantic countries have viewed economic growth in terms of exploitation of natural resources enhanced by trade, the East Asians have created a model that does not require any significant endowment of natural resources. Unwilling to accept the conventional Western idea that their role is to specialize in goods based on cheap labor (their major resource), the East Asians have forged a dynamic theory of comparative advantage that allows them to allocate human and financial resources toward jobs with high value added in growing industries and, for example, to succeed in steel despite a lack of both coal and iron. This new industrial competition is the most important challenge facing the entire North Atlantic area. Whether economic growth recovers somewhat in the 1980s, the traditional industrial nations will continue to lose industrial competitiveness and industrial jobs unless they respond to it. A successful response will include policy changes to promote increased investment, more rapid adaptation by industry, and increased mobility of labor. These changes will require recognition of the disincentives to work, save, and invest that have become the hallmarks of the welfare state. And in the United States, we must address a special set of problems ascribed to an “adversarial relationship” between business and government. None of these changes will come easily. Nor should the challenge be a pretext for turning the economic clock back to nineteenth-century private enterprise capitalism. Just as we need to rethink the goals and policies of the welfare state we need also to rethink the governance process of the corporation. If we expect government to revive its commitment to the value of work, saving, and investment, business must recognize investments made by employees as well as shareholders and accept a governance process that effectively reflects the essential rights of both. Strategies of Economic Growth Before accepting this “gloomy” or “challenging” diagnosis, we should review comparative performance data to check the severity of the alleged symptoms. The sidebar details the economic reality. In terms of rising incomes and an improvement in distribution of wealth on a worldwide basis, the rapid rise of the East Asians is a positive development. Stagnation in the North Atlantic area, on the other hand, is not, particularly as we witness unemployment rates at levels unheard of since the 1930s. Continued weakness in the industrial sector threatens the loss not only of vital exports but also of highly productive jobs in mass production industries. Some observers seem to regard industrial decline as a step forward toward a service-based “postindustrial” society. While it is important to recognize the growing importance of the service sector, the vision of a postindustrial society may well turn out to have been an elegant rationalization for failure to maintain a competitive industrial base. Before accepting industrial decline as an inevitable sign of sophistication and progress, we should reexamine how it has happened and the extent to which it may have been caused by differences in economic strategies among countries rather than by inevitable historical forces. Classical economics has long taught that economic growth was built on the rational use of resources, with each country building on comparative advantage through trade. Worked out by Ricardo in the early 1800s, when competitive advantages were based on natural resources, the theory was essentially static. The advantages were “given”; there was little room or need for a strategy. This static notion of comparative advantage has had a profound influence on economic thought throughout the North Atlantic area. Americans, in particular, are not used to thinking of government as needing an explicit economic strategy. The American economy became the most productive in the world without one. Blessed with the world’s first “common market” and some of its richest resources, the United States grew by conquering the frontier via private enterprise, without an active government strategy. At least that is what we think. We should not forget that one of the critical elements of success was the Interstate Commerce Clause of the Constitution that prohibited trade barriers among the states; another was the use of land grants to speed the opening of the West via the transcontinental railroads. Even the United States had a strategy of sorts. Today, however, the static notion of comparative advantage is no longer relevant. The United States still has rich and abundant farmland and is the world’s number one exporter of agricultural goods. But the United States no longer has an advantage in the size of its market. Europe has a market of roughly the same size, and Japan’s is almost half as large. Raw materials have been found around the globe, and for many applications it is cheaper to import foreign ores than to exploit domestic ones. As a result, most of the natural advantages that were the sources of American economic strength are no longer of critical importance. Increasingly the vital resources are those we create through the organized exploitation of various technologies. American experts misperceived post-war Japan’s potential in large part because of the notion of static comparative advantage. In the 1950s it led Edwin Reischauer to conclude that “Japan’s situation is basically similar to England’s, but infinitely worse. She is far less richly endowed with the vital resources of coal and iron… She is far less highly industrialized. She has no overseas empire to aid her …and she has almost twice the population of Great Britain to support on her more meager resources!”1 In the 30 years since Reischauer made this assessment, Japan has grown at a rate roughly triple that of the United Kingdom. Economists now recognize that Japan’s greatest resource is its population; yet that largely misses the point. India and China have larger populations but have not generated economic performance that is remotely comparable. The Japanese have created a strategy and a set of institutional relationships to implement it. Mobility of capital has been one key, labor mobility another. By promoting savings and investing in the most modem technologies, Japan and the other countries of East Asia have shown that countries can create comparative advantages in almost any industry they choose. Their capacity to abandon older industries as they create new ones shows that a trained, disciplined, and relatively mobile labor force can be a nation’s most important real resource. In contrast, labor mobility and discipline of the older industrial states are declining. Unemployment benefits and various forms of adjustment assistance, however meritorious on other grounds, give added support to individuals who refuse to relocate, while increasingly generous health insurance plans—particularly in Europe—allow employees to be absent from work at almost no cost to themselves. Meanwhile, a variety of subsidies, such as “safe harbor leasing,” help prop up losing ventures. Taxes to finance these programs become an added burden on all companies located in these countries and another competitive disadvantage. As growth industries, such as electronics, become more knowledge intensive and as companies transfer technology anywhere on the globe, a nation’s economic success hinges on the way it manages its human and financial resources. Under these circumstances, where the key to successful performance is mobility of capital and labor, Ricardo’s theory no longer provides much of a framework for formulating public policy. Recent experience in Korea, Taiwan, Hong Kong, and Singapore demonstrates that Japan is not unique. Without significant natural resources, these countries have achieved rapid growth by developing efficient, specialized manufacturing organizations backed by a system of social and economic incentives designed to promote work, saving, risk taking, investment, and labor mobility. Like Japan, they have built success by organizing human and financial resources and by not banking on the good fortune of natural resources. Their rapid industrialization has grown out of an economic strategy designed to promote productivity while sharply limiting the development of the welfare state. Welfare vs. Productivity Strategies Like companies, countries have strategies, or goals and policies, to orient the actions of their respective “managers.” Some strategies are more explicit, some more coherent, some more effective. Because the United States is an extreme example of an implicit rather than explicit strategy and at times has a political rhetoric that proclaims the virtues of a government with no economic strategy at all, it may help to use the Japanese example as a starting point. The goal of the Japanese has long been to catch and then surpass all others in economic performance. To achieve that goal, they have created a strategy to generate rising incomes by using the latest technology and equipment and employing mass production and marketing techniques to reach world markets. The Japanese strategy requires a high level of investment, hence access to a high level of savings. Rejecting Western advice about borrowing heavily or inviting foreign capital, they have chosen to finance their investment from domestic savings. For some years the Japanese have saved roughly 20 % of personal disposable income (the current American rate is 5 % ). They save not because of high interest rates on bank deposits; indeed, when adjusted for inflation the rates have been negative through most of the 1970s. The Japanese save because they must if they are to make major purchases and provide for old age. The government restricts consumer credit. And pensions are only a fraction of American levels. The Japanese receive greater deductions for interest income than Americans, but they receive no tax deductions for interest payments. Japanese banks receive the savings, and because they cannot easily lend to consumers, they must lend to industry if they are to grow. The Japanese have shaped their policies in housing, banking, and social welfare to support a strategy of raising the standard of living by raising savings, investment, and productivity. Labor policy is part of the strategy. Lifetime employment in large companies means employees share the productivity gains rather than being displaced by them. ‘No strategy is good strategy.’ The problem in the United States is that our strategy is largely implicit and forged in reaction to economic misfortunes. Until the Great Depression, the goal was a rising standard of living based on the Yankee virtues of work, saving, and investment. The government allowed companies a reasonable chance to compete and refereed the competition as it unfolded. Americans raised their standard of living both as producers and as consumers of goods and services delivered at reasonable prices in a competitive system. The Depression led not only to a new economics of demand management based on Keynes’s ideas but also to a gradual, steady shift in the economic strategies of all the North Atlantic countries. The priorities shifted toward short-term consumer welfare. Productivity was downgraded, however implicitly The Employment Act of 1946 committed the U.S. government to use its powers to stimulate demand to ensure a high level of employment. Subsequent legislation established penalty taxes on interest and dividends to help redistribute income from the rich to the poor. Taxes on consumption (sales or excise taxes) were rejected as regressive, and the federal government was financed largely by personal and corporate income taxes and social security contributions. Although a nominal amount of interest and dividend income went tax free, interest payments on homes, consumer durables, and even credit card purchases became tax deductible. In this way, the United States promoted a higher standard of living through subsidies to consumption. Progressive income taxes designed in part to redistribute the income eroded traditional incentives to work, save, and invest. Ever-increasing levels of entitlements support short-term consumer welfare at the expense of those who work and pay taxes. The result is a system that takes productivity for granted and tries to promote rising levels of consumption. We can compare the welfare strategies of the North Atlantic area with the productivity strategies found in East Asia using a simple matrix (see Exhibit I). The East Asians place high priority on productivity and deliberately limit the growth of the welfare state. The North Atlantic countries have done the reverse. Many of the less-developed countries have done little of either, so they are positioned at the lower right. Exhibit I Strategy matrix by country The box at the upper left, though blank, suggests a strategy promoting both productivity and welfare. Until recently, Germany would be one country in the upper left box. After World War II, Germany exempted overtime earnings from taxation and gave tax exemptions both for savings and for interest income. On the other hand, it began creating a welfare state under Bismarck. With the victory of the Social Democrats in 1969, the Germans shifted in favor of the welfare state and now belong in the lower left-hand box, even if they are less firmly entrenched there than in Belgium, Holland, the Scandinavian countries, or the United Kingdom. Worldwide prospects If you use this conceptual scheme both to compare economic strategies and to think about the prospects for industries throughout the world, the implications are not reassuring. Unless strategies change, the welfare states of the North Atlantic are likely to be increasingly less competitive with the productivity-oriented countries of East Asia. They will suffer from lower levels of saving and investment and from a variety of disincentives to work. Entitlements, progressive income taxes, and subsidies for consumption will make them increasingly less competitive as locations for any industries where product values allow international trade. The problem is not so much with themselves as with the newly industrialized countries (NICs). More important, today’s NICs will not be alone for long. Since the continuing success of the East Asians does not require any natural resources, or even a large home market, other less-developed countries can copy it. Indeed, Malaysia and Thailand appear to be moving toward similar strategies, and a related process has brought rapid progress to Brazil. A Dynamic Theory of Comparative Advantage The implications of the world economic picture are clear. In industrial terms, the star performers of the last 30 years are a group of countries whose critical resources are not land or minerals but rather people and savings—and the policies and institutions to mobilize and periodically redirect both. To be able to direct our own economic strategy in the United States, we need to construct a way of thinking that will foster this mobility. It will help to postulate that countries, like companies, have “portfolios” of businesses or industries. They can influence not only the mix in the portfolio at any time but also the rate of new business development, the redeployment of human and capital resources to growth sectors, and the withdrawal of those same resources from declining sectors. In fact, dynamic industrial policy should promote all three. Several schemes have been developed for corporations looking at their portfolios of businesses. The Boston Consulting Group pioneered in this field, and I think governments would find a variant of its growth-share matrix useful (see Exhibit II). Based on industry growth rate and corporate market share, the original matrix related high market share to increased output, cumulative experience, and lower costs. For comparable products, lower costs mean higher margins. Exhibit II Growth-share matrix A Source: Boston Consulting Group. The lower left-hand comer of the matrix symbolizes high share in a slow-growth industry that should generate high returns; low growth should not require high levels of investment. Businesses in the lower left should generate cash, while those in the upper left grow so rapidly that they require additional cash despite their presumably high profit margins. New ventures in the upper right may need additional cash to support fast growth on low margins. If we think of a given portfolio of businesses, the scheme highlights the “mix” in terms of prospective growth, profitability, and cash flow. Of greater interest, however, is its dynamic aspect. A new product or business ideally moves from upper right to upper left to lower left over its life cycle. Cash from businesses in the lower left finances new entries in the upper right and likewise battles for market share and a hoped-for position in the upper left. Theoretically, a company balances the businesses in its portfolio by building some in the upper half, avoiding excess investment in the lower left, and considering disinvestment in the lower right (see Exhibit III). Exhibit III Growth-share matrix B Source: Boston Consulting Group Obviously, the growth-share concept has limits. First, strategies of technical and/or service differentiation do not fit in well. Second, low cost and rising share correlate, but the correlation may be either circular or even the reverse of the original hypothesis.2 Third, there is a great deal more to running a business than managing a portfolio—that is, there are people, products, technologies, and so forth. Finally, a corporate strategy is more than simply the sum of the portfolio decisions affecting separate business ends; corporate strategy refers to the corporation as a whole.3 If we keep these limitations in mind, however, we can use the growth-share matrix as a comprehensive way to think about industry dynamics and as a more appropriate framework for forging an industrial policy. How Should We Think About Industrial Policy? Industrial policy is only one element, however important, of a country’s total economic strategy. A government must formulate and implement industrial policy through institutions that are competent, committed, and able to wield political clout. Otherwise the risk is high that the process will yield a narrow technical exercise in portfolio analysis or, worse still, a new rationale for liberal bureaucrats to apply their noncompetitive values and theories. With these caveats, let’s look at a more general framework for industrial policy (see Exhibit IV), which would focus attention on opportunities to: (1) promote new undertakings in the upper right, (2) foster successful transitions in the upper left, (3) avoid excessive investment in the lower half [particularly the lower right quadrant), and (4) abandon businesses in the lower right unless special circumstances allow profitable operation. On the other hand, industrial policy should not attempt to do what it cannot: plan output and/or investment by sector. Exhibit IV Competitive position matrix 1. Promoting innovation Government can promote innovation both by subsidizing R&D costs and by increasing the rewards for successful entrepreneurship. The Japanese give tax credits for increases in R&D, coupled with a limit on the total amount of credit. The French have used a variety of subsidies, some reimbursable if the project is commercially successful. The capital gains tax affects the risk-reward ratio for the scientist or entrepreneur as well as the mobility of risk capital. A high tax reduces the rewards for those who succeed and forces an investor with a large capital gain in one venture to pay a severe penalty for transferring those funds to another venture. The Japanese have no capital gains tax. The Germans, however, tax capital gains as ordinary income. The French are particularly backward; a French inventor who receives stock in a new venture in recognition of the innovation must pay a tax on its nominal value at the time the stock is received rather than when the capital gains are realized. The impact of the capital gains tax rate on the formation of new ventures in the United States has been analyzed in America’s Competitive Edge.4 The authors describe the decline in new ventures and in amounts of venture capital raised following the 1969 increases in the maximum rate on capital gains from 25 % to 40 % . They also note the dramatic increase in venture capital raised once the maximum rate was reduced to 25 % in 1978. Industrial policy can also promote new technologies within existing companies. While U.S. antitrust laws usually preclude joint ventures, the Japanese encourage them within an industry to solve major technical problems or to accelerate the development of prototypes. In numerous cases, the Japanese have made investment subsidies contingent on the formation of the joint venture. The participants are free to use the technological fruits of the venture in competition with one another as well as with foreign companies. 2. Encouraging ‘winners.’ With an adequate portfolio of new ventures and business development in established companies, government can help promote the growth of strong industries through foreign trade and investment policies. Japan, for example, restricted foreign imports and generally limited or prohibited foreign investment in new industries until Japanese entrants were established. While opening up its market in the 1970s, Japan has restricted the roles of foreign companies in those industries targeted for growth in the 1980s and 1990s, such as telecommunications, integrated circuits, and computers. The European Common Market countries do not have this option. There is no European Community policy on restricting foreign investment, and internal trade restrictions are prohibited. The most a member country can do is discourage foreign takeovers and subsidize selected industries or companies. When the French tried to be quite restrictive, investors went to Belgium or Germany and exported to France. The French government uses export subsidies to foster sales of capital equipment and weapons. Aiming to supply 20 % of its energy needs by 1985 (compared with the 3 % to 5 % proportion of its neighbors), it also promotes the development of atomic power. But since the state, through the electricity monopoly, is the only buyer, this is not a model for the competitive sector. In high-technology industries such as computers and space, the French have been less successful. The Plan Calcul was a costly failure, yet the takeover of Honeywell-Bull, plus subsidies for smaller companies, gives France a significant entry in mainframes and minis. Sponsorship by PTT (the French telephone company) of a “program télématique” based on subscriber telephones may give France a strong position, if not the lead, in a sector of telecommunications. Automobiles have been a consistently strong point among French exports, but both state-owned Renault and privately owned Peugeot have operated like private-sector companies. Unless the EC follows the French and Italian lead in imposing quotas on auto imports, France’s auto sector is vulnerable to Japanese competition and also to the French tendency to maintain an overvalued exchange rate. France has a decidedly mixed record in building its new state-sponsored projects into strong, competitive activities. Germany has enjoyed remarkable industrial strength for the past 30 years, but it is concentrated in chemicals, metalworking, and mechanical equipment. Its position is not nearly as strong in electronics, computers, or telecommunications. Indeed, several careful observers point out that Germany not only lags behind the United States, Japan, and France in these growth areas but also has not launched a program to catch up. If Germany permits the renewal of its industrial portfolio to lag, it will have less capacity to carry the costs of its increasingly generous welfare state in the late 1980s and 1990s. The United States has the world’s largest economy and industrial portfolio, mostly the result of natural competitive development. Public policy has focused on the U.S. market and prevention of cooperation among participants in an industry. Until very recently, international competition has been ignored. It is as if our market were so large and our companies so strong that the government need not be concerned with promoting their performance. Neither the regulators nor the courts have given much weight to the impact of regulation on either domestic economic performance or international competition. Recent decisions by the Reagan administration and the Federal Trade Commission to dismiss the antitrust suits against IBM and the cereal manufacturers represent an important and promising policy reversal. And the proposed settlement of the AT&T case should liberate one of the most important sources of U.S. technical strength to compete both internationally and domestically. Industrial Performance—Is There a Problem? How severe are our alleged symptoms? In the last decade, we have become aware that a rising standard of living depends primarily on increasing productivity and secondarily on growth in the labor force. Table A shows productivity trends for selected countries in the 1970s: while all countries grew less rapidly than in the 1960s. U.S. productivity grew the slowest: that of the East Asians, the fastest. Table A Productivity trends in real gross domestic product per person employed Sources: United Nations, Monthly Bulletin of Statistics, March 1981, table 66: International Labour Office, Yearbook of Labour Studies, 1980, table 3 Turning to employment, and particularly to industrial; employment, the Europeans come in last (see Table B). In each major European country, industrial employment peaked around 1970, well before the first oil crisis. The United States, Japan, and Canada have been able to create or maintain jobs in manufacturing. Europe lost manufacturing jobs, and Japan saw employment concentration shift from manufacturing to services—while always maintaining full employment. Table B Comparison of manufacturing or industrial employment in thousands Source: OECD data, courtesy of Data Resources Corporation. In Europe, investment stagnated in the 1970s, in dramatic contrast to the situation in East Asia (Table C). The breakdown of industrial investment in Germany is especially illuminating. By 1976, investment in capacity expansion had almost disappeared, while capital to rationalize operations and so reduce the labor force increased. With a rising exchange rate, companies found investment in Germany less attractive but put in capita to reduce wage costs through labor-saving equipment. Table C Gross domestic investment compound annual growth rate Source: NAE Research Associates, Inc., NAE Research International Perspective, March 1981 Small differences in growth rates make a big difference if they persist. While in 1960 the industrial countries had a higher share of per-capita GNP invested than the East Asians, by 1979 they were outstripped by the Japanese, who were investing more per capita in. absolute terms. A shift in income distribution preceded the stagnation of investment. Between 1965 and 1975 the share of income going to employees went up (see Table D), that to property and entrepreneurship. down. The achievements of full employment in the 1960s increased the power of organized labor, and wage demands far exceeded productivity gains. Eventually corporate balance sheets deteriorated and companies had to trim their rates of investment. By 1973 even the communist leadership in Italy wanted to moderate wage demands in order to reestablish more normal profit margins, new investment, and, finally, new jobs. While data on East Asia are fragmentary, trends of income distribution seem quite different, with only Japan showing a higher share of income for employees. Table D Labor’s share of total domestic factor income Source: Morgan Guaranty Trust Company of New York, World Financial Markets, May 1982, p. 3 Rising labor costs are only part of the problem, of course. The East Asians benefited from trade negotiations that opened the world economy, shipping costs that declined relative to product values, and licensing agreements that made most technologies available on easy terms. Under these circumstances more and more investment has moved offshore, and the East Asians have gained in relative position as the older industrial societies have declined. 3. Limiting investment in low-growth sectors The economic case for limiting investment in low-growth sectors is obvious; countries, like companies, should try to redeploy their resources where the prospects are brighter. In most cases, however, governments do not intervene but rely on market forces. How well the market works depends on the strategy and structure of individual companies. Single-business companies in low-growth industries will continue to invest despite low returns because they know only one product or industry. Diversified companies can invest in higher-growth sectors within the organization.5 Government may implicitly encourage investment in low-growth areas by distorting prices or providing loan guarantees. Trade barriers foster higher prices and profits in protected sectors. Domestic subsidies also lead to overinvestment. For example, the U.S. government protected small banks by fixing prices on savings accounts; at the same time, it provided low-cost mortgage money that increased jobs in the building trades. Coupled with tax deductions for interest on home mortgages and massive spending on freeways, the government subsidized the development of suburbs and drew capital away from industry and into unnecessarily large, single-family dwellings. The negative impact of tariffs and subsidies is well known and the subject of continuing, attention by the public and government. But less well understood is the effect of wage and price controls, which may be worse. By setting uniform criteria for all industries, they implicitly favor the older, slow-growth industries. But controls work against high-growth industries, which generally have the most rapid productivity increases and the opportunity to reduce prices while giving above-average wage increases. In fact, higher wages are necessary to attract enough new employees to sustain productivity. A wage and price control system allows no credit for price cuts by high tech companies and, at the same time, forbids them to use rising wages to bid for new employees. 4. Abandoning losers Political logic in a democracy works against accelerated abandonment of low-growth, low-profit industries. Winning, high-profit companies—and the new jobs they create—seldom get the headlines generated by potential job losses in declining industries. A job lost is more important politically than a job not created, as any government official knows. In most of the North Atlantic countries, government, not business, takes responsibility for unemployment. Government must choose to keep a losing company solvent or pay unemployment compensation and the other costs of a decline or shutdown. The Chrysler saga points up that continued operation, even with losses, may be less costly—at least in the short run. Operating in private and without formal responsibility for job security, companies abandon losing ventures more rapidly than government does. Democratic governments, naturally concerned with jobs and votes, have a long record of retarding rather than facilitating the process. In the same way, private capital markets are more flexible and less politicized than public funding over the long run. When it comes to capital allocation, democratic governments will do worse than the market mechanism and much worse than well-managed diversified companies. If enacted, proposals to revive the Reconstruction Finance Corporation are likely to give government a more adroit mechanism for retarding rather than accelerating disinvestments—or, simply put, a better way of doing the wrong thing. The problem lies not so much with the concept as with the social and political context. On the other hand, large private companies that take little or no responsibility for employment are a major cause of the government’s active involvement in ill-advised rescue attempts. To the extent that senior executives think business leadership is the management of assets that are bought and sold to promote a higher share price for stockholders with little regard for the “investments” made by long-term employees, they abdicate a responsibility they should shoulder. The root of the problem lies in a shortsighted sense of business responsibility backed by equally narrow academic theories of corporate finance that force government to compensate. The recent contract revisions between Ford Motor Company and the United Auto Workers, with their emphasis on employment security and changes in corporate governance, point in a very positive direction. Unfortunately, it is unlikely that the concessions were nearly enough for industry to regain a sound competitive position in the near future. 5. Investment & output planning Several governments have tried to plan investments and output. The most extensive experience was in France, where a process begun in 1945 was much heralded in the 1960s and abandoned in the 1970s—for pragmatic rather than ideological reasons. Bluntly put, it failed. Conceived in a closed economy where the choice was either to make or do without and where it worked well, the plan did not adapt to an open economy with imports, exports, and the critical choices of make or buy. Its focus remained domestic, leading France to overinvest in industries sheltered from foreign competition.6 In the 1950s and 1960s, the Japanese had a similar approach but abandoned it as their economy opened to world trade. At present only the Communist countries, in circumstances reminiscent of the closed economies of the 1950s, attempt to plan output and investments. There is an obvious theoretical attraction to the involvement of government in planning; some economists note that because big business plans, government should do no less. However, they overlook the critical difference: business plans in private, while government—in a democratic society—inevitably plans in a quasi-public setting. Forcing a company to do its planning in public would yield a public relations document, not a plan. In the same way, the French government’s industrial plans were essentially public relations documents by the 1960s and consequently of little value to either business or government. A cautionary note Sound industrial policy could aid the performance of all the industrial countries. But it is not a panacea and does not exist in a vacuum. By itself it cannot overcome the excessive costs and other competitive handicaps imposed by the welfare state, any more than it can offset the impact of a consistently overvalued currency. In fact, much of the current enthusiasm for the notion of industrial policy hinges on the premise that better “portfolio management” by government is both necessary and sufficient to ease the growing industrial malaise.7 This position has obvious attractions for liberal economists with a strong ideological commitment to the welfare state because it allows some of them to dismiss as unimportant the inadequate levels of corporate profitability and investment of recent years. Exaggerated claims for industrial policy could lead to the same kind of unrealistic expectations as did the “fine tuning” of aggregate demand espoused by liberal economists in the 1960s. The claims could blind us to reforms needed to reverse the inadequate corporate profitability found in all the North Atlantic countries. The idea of politicians and bureaucrats guiding business toward a better industrial portfolio is more or less reassuring depending on your view of their values, business savvy, and professional competence. Those who draw inspiration from Japanese experience overlook not only the productivity-oriented nature of the Japanese strategy but also the staffing of key ministries (MITI and Finance] by career civil servants of very high quality. The U.S. bureaucracy, conversely, is characterized by rapid turnover, uneven quality, and—at least historically—little understanding of or concern for the essentials of a productive, competitive industrial sector. These bureaucrats do not have the same capacity or motivation to take a sound, long-term view of business opportunities as do American business executives. And the adversary nature of U.S. business-government relations adds an additional hazard, for it is through this relationship that proposals would eventually be formulated and implemented. Business-Government Relations The four largest market economies have different records in this area. The French and Japanese promote industries most actively; the United States, least. In Germany the government has been less interventionist than in France or Japan, and Chancellor Schmidt’s more activist ministers of science and technology offset free-market advocates in the ministry of economics. Despite their differences, France, Germany, and Japan believe that government is the senior member of the business-government partnership—in short, that it guides without enacting new laws or regulations. When the chips are down, business doesn’t take government to court (as it does in the United States) but rather follows its advice. In fact, we take for granted that business and government are natural adversaries in the United States. But it has not always been so. Alfred Chandler calls the 1890s the turning point for business-government relations here. While businessmen had always been active civic leaders prior to the Civil War, the public—through government—began to attack them before the end of the century. The reason was that big companies, particularly the railroads, came before big government. As Chandler notes, “In 1890 at least a dozen railroads employed over 100,000 workers, [while] the civilian working force in Washington numbered just over 20,000.”8 The railroads enjoyed not only great size but near monopolies in many inland areas, with the power to make or break businesses or even towns by their rates. They also opened the way for national consumer-goods companies, such as the meat-packers or A&P, that displaced many small businesses—nearly 50 % of the wholesalers between 1889 and 1929. Small business, not farmers or consumer groups, mounted the initial attack on big business and helped limit its powers. In Europe and Japan, the national markets were much smaller and big government developed before big business. In addition, consumer-goods producers used wholesalers rather than displacing them through forward integration. Some of the largest companies were manufacturers of industrial goods and interested in export sales. Government was a natural ally; it was more of a senior partner to business than an adversary and sanctioned business federation as a practical mechanism for organized dialogue. In each of these countries, business has developed a “peak federation” that serves not only as a legitimate interlocutor for business with government but also as a way of molding business consensus toward certain general, as opposed to company- or industry-specific, goals. While the United States has an established federation for labor, it has several for business—but not one that enjoys comparable standing to those in other industrial countries. Lack of institutional mechanisms on the business side matches weak institutional links in the US. government. The Commerce Department, as spokesman for business interests, is still organized as a service bureau responsible for the census and weights and measures and not for an important policymaking role. Its voice has been fourth or fifth in economic policymaking, after the Treasury, State, and Justice departments, and the Council of Economic Advisers. Commerce has had very little power; the recent transfer of customs from Treasury to Commerce came not so much from a desire to give the department more power as from congressional frustration and anger that the Treasury could so easily flout legislative intent in the enforcement of antidumping statutes. Adversary business-government relations, coupled with a consumer-oriented economic strategy, produce bizarre policy in the executive branch. For example, the government long considered imports of cheaper manufactured goods beneficial because they reduced costs for the consumer. That some imports might be favorably priced due to dumping—with the potential for destroying an American industry within a few years—concerned only those most directly affected, not the executive branch. Japanese television exports illustrate the problem. While Japanese companies cut prices and raised market share in the United States in the 1970s, their domestic market remained closed. Imports of color televisions into Japan from all foreign sources remained less than 0.5 % . First, the American television industry’s claims of Japanese dumping produced four years of inaction, then a customs investigation that showed that dumping approached 20 % of invoice prices. The Treasury Department attempted to squelch the investigation, but Congress intervened on behalf of the industry. Finally, after most American companies were either forced or bought out, the importers pleaded no contest and paid $ 77 million in fines for dumping and filing fraudulent invoices. Of course, the $ 77 million went to the Treasury Department, not to the injured companies. By settling for no-contest pleas, the executive branch acceded to Japanese requests that there be no public record of the behavior of the exporters, importers, or their respective governments.9 A recently released study of the machine tool industry indicates that the television case is not an isolated example. High officials of the U.S. government describe the process as one where Treasury, State, Justice, and the CEA will take the consumer point of view and support foreign companies against a hopelessly outgunned Commerce Department. Departed officials of the Carter administration not only point to the low priority accorded the role of healthy, productive companies in building the U.S. standard of living but also describe how high officials of the Justice Department threatened other government officials with personal criminal prosecution if efforts to help American companies were viewed as restraint of trade. Our economic strategy is half a strategy, to foster short-term consumer welfare. It is not the strategy that built our industrial base in earlier decades nor is it the one used by the Japanese to overtake us in the last 30 years. Both of those relied on investing in the future to build a rising standard of living through rising productivity. Passing the benefits along to consumers in the form of lower prices was part of the story, but only part. This “half” strategy has also allowed big business to escape responsibility for the economic security of its employees. When Japanese companies shoulder that responsibility, employees have a long-term stake in the company, its products, and their own productivity. Americans have increasingly looked to the federal government for their economic security; product quality and productivity suffer as economic security becomes an entitlement rather than something the employee and the company produce together. Implications for the United States To the extent that damage to our economy is self-inflicted, we can correct it through an appropriate change in economic policy. A good example is the U.S. capital gains tax. Its increase in 1969 resulted in declining investment in new ventures, while its reduction in 1978 quickly brought on a surge of new investment. Recent acceleration of depreciation schedules will pump up cash flows and investment when the U.S. economy recovers. While helpful, the changes do not directly address the critical problem. We cannot achieve long-term economic recovery as long as U.S. policy focuses on short-term consumer welfare and on the entitlements and subsidies of a welfare state. This policy has steadily shifted American economic incentives away from work, saving, and investment. Until the United States rebalances its priorities, its incentives, and its rhetoric, there is little chance we will become competitive with the productivity-oriented societies of East Asia. The Europeans do not pose a similar competitive threat. If anything, they are in a weaker position than the United States because their priorities have become even more lopsided than our own. Recently there has been much discussion of industrial policy and reindustrialization as well as a quickening of interest in improving the business-government relationship. While constructive steps can and should be taken, even the most favorable scenario for change does not nearly address the seriousness of the problem. For example, it is fantasy to hope that government aid in reallocating an inadequate level of saving and investment will turn the economy around.10 In addition, real respect and constructive dialogue in business-government relations will require that both government and business see the need to balance short-term consumer welfare with the imperatives of investing to build long term productivity. The United States has few significant natural advantages to count on, except in agriculture. Our comparative advantage will depend more and more on the goals, policies, and institutions through which the American economy is organized. Over time, the United States and all the other welfare states of the North Atlantic area will be less competitive with the productivity-oriented societies. When we tinker with small issues, we overlook or deny the challenge. To address this fundamental problem, we must recognize that government, in assuming greatly increased responsibility for the economic security of the individual, has relieved the individual and the large business enterprise of that responsibility. The various security programs result in a double cost on business, first by taxing to finance welfare and economic security programs and second by reducing the responsibility, motivation, and mobility of labor. We cannot expect industrial performance to fundamentally improve until we reduce these costs. What It Will Take Industrial performance will improve when employees gain economic security through long-term commitments to productive, profitable companies. In turn, business must recognize this commitment and must adapt its strategies, organization, and personnel policies accordingly. Companies can no longer equate management with manipulation of the balance sheet, where divisions are bought and sold or plants closed and opened with little or no reference to the rights of those who work there. Management must adopt a measure of performance a good deal broader than the highly regarded “impact on the price per share” Unless management defines its role more broadly, government can hardly relinquish its responsibility for employment. If business assumes more responsibility and government less, the two could then work toward a different kind of industrial policy. Achieving a better working relationship requires government to have a more knowledgeable, competent, and credible focal point for its contact with business. Antitrust laws that subject both business and government leaders to the threat of criminal prosecution should be substantially revised. A new federal charter To encourage big companies to accept greater responsibility for the interests of their employees, Congress should enact a new federal charter of incorporation, not to supersede state charters but to serve as an alternative. Incorporation under the new federal statute would require a formal commitment to the interests of both employees and shareholders. Specifically, companies would guarantee employment security for all employees with at least 10 years’ service, subject to safeguards in case of gross negligence or misbehavior. In addition, companies would consult employees through their elected representatives, at various levels, including the shop floor, the plant or product division, and the corporate board of directors. While such a new law would allow companies to tailor their schemes of governance, the law would set certain standards and subject charters to challenge and adjudication in the courts. Charters would last for a finite term (say, 50 years) and would require periodic renewal. As an incentive for management to accept these new responsibilities, a takeover of a federally chartered company would require an affirmative vote by employees as well as stockholders. In addition, the law would exempt the company from the treble-damage provision of the antitrust laws. As an incentive for shareholders, the federal charter would permit creation of a reserve fund for employment stability. Annual payments would be tax deductible, and the fund would finance investments designed to enhance job security. Its use would require approval of employees as well as management. This special reserve for job security would enhance cash flows and strengthen the balance sheets of companies electing to adopt the new charter and thus enhance shareholder interests along with those of employees. A new mission for the Commerce Department The government should make the Commerce Department the focal point for industrial policy, broaden its powers, and change its name. At present, the U.S. government has no such clear focal point. Trade policy, for example, is the mandate of the special trade representative (STR) in the White House. I suggest the merger of STR with the Commerce Department into a new Department of Industry, Trade, and Commerce (ITC). ITC should have primary responsibility for promotion of U.S. exports and the power to authorize joint ventures to promote research or accelerate the development of a new technology, ventures that would be exempt from the antitrust laws. Since the business community is highly fragmented and has no central organization, the ITC should work with business to establish a more legitimate form of dialogue to identify and evaluate industrial problems of general interest to business. The secretary of the ITC should have statutory powers to protect both corporate and government participants in this dialogue from criminal antitrust liability Congress should grant immunity from the sunshine provisions of the Advisory Committee Act, as it has for the committees that now advise the STR. Review of antitrust laws Antitrust laws should reflect the realities of international competition and the need for a less hostile relationship between business and government. Recent decisions, such as the dropping of the case against DBM, are important steps in the right direction. They do not, however, go far enough. It will be difficult for business and government to work toward a more rational economic strategy as long as the Justice Department has the legal basis to threaten either side with criminal prosecution whenever they discuss basic questions of economic strategy. In addition, American business needs some form of relief from the ever-increasing use of antitrust suits as a way to hold companies up for ransom. Such suits, when launched by lawyers working on a contingency-fee basis, have become a new frontier for entrepreneurially oriented lawyers, who know that it is usually cheaper to settle than to fight, even if the allegations are without merit. Provisions of the alternative charter provide one remedy; in its absence another is needed. Industry probably can coexist with the welfare state. The reforms outlined here would enhance its chances of survival in the United States. By themselves they are not enough. Basic reform of the welfare state is also required. Common Cause During the 1930s when the social contract, binding business to society, was being extensively rewritten, the business community resisted innovation and wound up with some unpalatable reforms and a blemished reputation. Now with the social contract again up for revision, new social and environmental problems are generating increasing pressure for further modification and regulation of business. By acting promptly, business can assure itself a voice in deciding the form and content of the new social contract. By taking the initiative, it can contribute technical competence, rational analysis and imaginative innovations to the process of adjusting our system—but it must recognize that some adjustments are inevitable. In certain areas, there may have to be new laws to force consideration of the quality-of-life dimension so that the more socially responsive firms will not suffer a competitive disadvantage at the hands of others who refuse to aid voluntarily… In view of the emerging demands for revision of the social contract, a passive response on the part of the business community could be dangerous. Any adaptation of our system to the changing environment is far more likely to be workable if those who understand the system’s problem share in designing the solutions. So it is up to make common cause with other reformers—whether in government or on the campus wherever—to prevent the unwise adoption of extreme and emotional remedies, but on the contrary to initiate necessary reforms that will make it possible for business continue to function in a new climate as a constructive force in our society References 1. Edwin O. Reischauer. The United States and Japan, 3d ed. (New York: Viking, 1964); (original edition, Cambridge, Mass,: Harvard University Press 1950). 2. Richard G. Hamermesh, “Administrative Issues Posed by Contemporary Approaches to Strategic Planning: The Case of the Dexter Corporation,” Harvard Business School Working Paper (HBS 79–53,1979). 3. Richard J. Rumelt and Robin C. Wemsley, “In Search of the Market Share Effect,” University of California at Los Angles Working Paper (MGL-63; revised May 1, 1981). 4. Richard Bolling and John Bowles, America’s Competitive Edge (New York: McGraw-Hill, 1982) 5. See my article, “The Industrial State: Old Myths and New Realities,” HBR March–April 1973, p. 133. 6. See my article, “How Practical Is National Economic Planning?” HBR March–April 1978, p. 131. 7. See Ira Magaziner and Robert Reich, Minding America’s Business (New York: Harcourt Brace Jovanovich, 1982); and the Boston Consulting Group, A Framework for Swedish Industrial Policy (Uberforlag, Sweden, 1978) for examples of sound analysis of industry coupled with a failure to analyze the impact of the welfare state on the competitive position of industry 8. For a contrary view see Robert B. Reich, “Why the U.S. Needs an Industrial Policy,” HBR January–February 1982, p. 74. 9. Alfred D. Chandler, Jr., “Government versus Business: An American Phenomenon,” Business and Public Policy, ed. John T. Dunlop (Boston: Division of Research, Graduate School of Business Administration, Harvard University, 1980), p. 3. 10. See “Zenith v. U.S.A.,” nos. 4-379-054 and 4-379-067, distributed by HBS Case Services, Soldiers Field, Boston, Mass. 02163; and John J. Nevin, “Can U.S. Business Survive Our Japanese Trade Policy?” HBR September–October 1978, p. 165

Can Industry Survive the Welfare State?

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