How Competitiveness Can Be Achieved: Fostering Economic Growth and Productivity

Ralph Landau

We hear much about the lack of competitiveness of the United States, but seldom is this concept defined, except in terms of international trade balances and market share.1 It is obvious that this country could improve its trade balance if we reduced the wages and living standards of the American working population to those in Mexico, China, or Brazil, but this would not make America more competitive. What we should mean by competitiveness, and thus the principal goal of our economic policy, is the ability to sustain, in a global economy, a socially acceptable rate of growth in the real standard of living of the population with a politically acceptable fair distribution, while efficiently providing employment for those who can and wish to work, and doing so without reducing the growth potential in the standard of living of future generations. This last condition constrains borrowing from abroad, or incurring excessive future tax or spending obligations, to pay for the present generation's higher living standard. As discussed below, such criteria for competitiveness have historically been best realized in industrialized countries by a healthy annual increase in labor force productivity in which the United States has been the leader for most of the past century, and still is in absolute level.

If the U.S. economy could be isolated so that international trade balances were not significant and domestic capital needs were met by domestic savings, these growth criteria for the economy would still apply, but policy could be adjusted more easily to reflect domestic political preferences, such as in targeting interest and inflation rates. Now, with trade in goods and services constituting almost 20 percent of gross national product (GNP), that is, the sum of exports



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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering How Competitiveness Can Be Achieved: Fostering Economic Growth and Productivity Ralph Landau We hear much about the lack of competitiveness of the United States, but seldom is this concept defined, except in terms of international trade balances and market share.1 It is obvious that this country could improve its trade balance if we reduced the wages and living standards of the American working population to those in Mexico, China, or Brazil, but this would not make America more competitive. What we should mean by competitiveness, and thus the principal goal of our economic policy, is the ability to sustain, in a global economy, a socially acceptable rate of growth in the real standard of living of the population with a politically acceptable fair distribution, while efficiently providing employment for those who can and wish to work, and doing so without reducing the growth potential in the standard of living of future generations. This last condition constrains borrowing from abroad, or incurring excessive future tax or spending obligations, to pay for the present generation's higher living standard. As discussed below, such criteria for competitiveness have historically been best realized in industrialized countries by a healthy annual increase in labor force productivity in which the United States has been the leader for most of the past century, and still is in absolute level. If the U.S. economy could be isolated so that international trade balances were not significant and domestic capital needs were met by domestic savings, these growth criteria for the economy would still apply, but policy could be adjusted more easily to reflect domestic political preferences, such as in targeting interest and inflation rates. Now, with trade in goods and services constituting almost 20 percent of gross national product (GNP), that is, the sum of exports

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering and imports, and the country importing approximately $110 billion of capital in 1989,2 the previous freedom to set policy is no longer possible. The country must be able to pay for its essential imports (of goods, services, and capital) by exports, and thus international competitiveness and growth in domestic living standards cannot be separated from each other. It is important to examine briefly the changes in the international economy since the Second World War, to understand both this growing economic interdependence among nations and the resulting changes in economists' views of appropriate policy options. During the first 20-25 years after the war, the United States enjoyed an essentially unlimited economic horizon. Propelled by the head start this situation permitted, real U.S. gross domestic product— GDP—(which differs slightly from GNP by omitting net factor incomes from abroad), tripled since 1950 and income per capita almost doubled; meanwhile real GDP of the world, aided by the United States to recover from the war, quadrupled. The United States relied on domestic savings to meet its domestic capital needs, exported capital to the recovering countries, and used macroeconomic policy to adjust demand to cyclical changes. Supply could—and did—take care of itself through the vigorous activities of the private sector. World trade in this period grew sevenfold and enhanced this remarkable economic growth. Indeed, systematic empirical research indicates that a closed economy is ultimately a low growth economy (Grossman and Helpman, 1990). There are compensating advantages to greater participation in the world economy, such as the opportunity for nations to specialize in areas particularly advantageous to them, even though other nations have caught up and become strong competitors. Trade permits achievement of economies of scale in strong industries, and raises the level of consumer welfare by providing a greater diversity of goods and services of higher quality. Trade provides greater opportunities for exploiting research successes made in one country in other countries, first by trade and then by local manufacture. These advantages can likely become even larger as the rest of the world becomes more prosperous and provides additional markets for our goods, services, and investments. Nevertheless, it is clear that the arena of U.S. firms and entrepreneurs has irrevocably changed. International capital and technology flows have become global and in many cases virtually instantaneous. Therefore, domestic freedom to control national destinies, formerly taken for granted, is increasingly constrained by the disciplines of the international capital markets, as well as by the trade in goods and services. On the other hand, fiscal and monetary policies, as well as

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering those dealing with trade, legal, tax, financial, and other matters, vary widely among countries. At the same time, the world continues to develop extraordinary new technologies that promise to substantially raise global living standards. The age of the computer has just started, but it has already penetrated widely (Figure 1). Telecommunications via satellite and fiber optics are binding the world together at an ever-increasing rate. Robotics provide the means to eliminate hazardous and boringly repetitious tasks. The biotechnology revolution has hardly begun, but already its potential to affect human health and improve productivity in farm and factory is immense. Superconductivity is certain to play a major role in the twenty-first century; new materials are penetrating realms as diverse as medicine and aerospace; new catalysts and pharmaceuticals are improving the efficiency of industry and the human body. Many of these developments are American. To be a scientist or technologist today is to be at the frontier of human explorations FIGURE 1 The impact of technology on economic development: new processes, products, and services. Source: The Technological Dimensions of International Competitiveness. Prepared by the Committee on Technology Issues that Impact International Competiveness, National Academy of Engineering, Washington, D.C., 1988, p. 14.

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering and aspirations, but we must be cognizant of the economic and social limitations on such exciting prospects. What in this should or does make us worry? From 1870 to 1984, the country's average real growth rate in GDP, was about 3.4 percent per year; from 1948 until recently it exceeded this level. This growth was accomplished mainly by a growth rate of about 2 percent per year in real income per person in the United States and the rest by average growth rate in population. Standards of living nearly doubled between generations. The United States surpassed the United Kingdom, the one-time leading industrial power, whose per capita real income grew at only 1 percent per year. Today, the United Kingdom is not even the leading member of the Common Market. On the other hand, starting with the Meiji restoration of 1868, Japan has recently exceeded even the high American growth rate. With an annual real GDP growth rate of more than 6.9 percent from 1952 to 1987, it has become the second largest economy in the world. Such dramatic reversals underscore the power of compounding over long periods of time. Differences of a few tenths of a percentage point, which may not appear very significant in the short term, are an enormous economic and social achievement when viewed in the long run. For example, an increase of only 2.5 percent in the annual growth rate (which means raising the growth rate of GDP by less than 0.1 percentage point per year) will double the standard of living per capita in less than 30 years (a generation) with a constant population. Thus, it is of concern that since 1979 the U.S. real annual GDP growth rate has averaged only about 2.75 percent, with substantial year-to-year fluctuations, and with an almost static per capita real income, despite a more than seven-year economic recovery. Will the United States follow the fate of the United Kingdom, while Japan and the Far East, or post-1992 Europe (aided by the appearance of new markets in Eastern Europe) eventually outdistance it? Or can it maintain a prominent stance of economic, and strategic leadership, which its unique position of being both an economic and a military superpower demands of it? The answer to this question is not at all clear, and this alone is a reason for worrying. Both economic evidence and historical experience suggest that sustained economic growth does not come from only doing more of what we already do, although in a global economy we must capitalize on existing technologies more fully and more rapidly than ever. For 100 years, our economy grew because we made the capital investments necessary to exploit great discoveries such as machine tools, the electric motor, petroleum exploration and refining, and semiconductors, to

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering name but a few. Our poorer recent growth performance cannot be attributed to a dearth of new investment opportunities now. To achieve more rapid economic growth, the promise of the new technologies must also be realized, but it cannot be accomplished without taking into account the historical realities under which new technology is applied. THE ROLE OF TECHNOLOGICAL CHANGE IN GROWTH The United States could have achieved its growth in per capita real income (1) by using more resources, or (2) by getting more output from each unit of resources (increasing the productivity). How much of the long-term rise in per capita incomes is attributable to each? The surprising answers emerging in the 1950s indicated that long-term economic growth (since the Civil War) had not come from simply using more and more resources, that is, capital and labor, but rather, overwhelmingly (85 percent) from using resources more efficiently. Many attached the label ''technical change'' to that entire residual portion of the growth in output which cannot be attributed to the measured, weighted growth in inputs and thus equated it to the growth in productivity. Certainly, however, many social, educational, and organizational factors, as well as economies of scale and resource allocation, also affect productivity. Stanford's Moses Abramovitz (1956), who published some early studies of this nature, called it "a measure of our ignorance." Out of this work came the detailed growth accounting studies of the 1960s and 1970s, based on the neoclassical growth theory of Robert Solow (1957) at the Massachusetts Institute of Technology. This theory holds that in a perfectly competitive economy, in the long-run steady state, the rate of growth is independent of the saving (or equivalently the investment) rate; in other words, growth is independent of the proportion of output that is reinvested. These studies, led by Edward Denison of the Brookings Institution, Zvi Griliches and Dale Jorgenson of Harvard University, and John Kendrick of George Washington University, sought to reduce the residual by identifying some of its components and measuring the inputs more accurately. In all these studies, the strangest aspect was that the actual sizable growth rates in the industrial countries constituted a remarkable economic phenomenon: a tribute to the dynamic performance of capitalist economies, especially significant in view of the collapse of the socialist economies in the 1980s and the reevaluation of Soviet growth rates to an essentially stagnant or declining level. And yet, because the technology, the residual, was assumed in this theory as exogenous,

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering not a product of traditional economic activity, it appeared that a large part of this remarkable accomplishment was unknowable, generated somewhere outside of the economy! Economists responded to this challenge by studying the American economy from various perspectives. Some of the group mentioned above tried to relate technological change to economic forces, and thus sought in effect by various approximations to endogenize or integrate the measured phenomena into the rest of the economy. The residual was thus a summary, at the aggregate or macroeconomic level, of forces occurring at the micro level of firms and individuals, and was therefore really a part of the economy. However, the unexplained part remained disturbingly large and variable, and there were many assumptions and intuitive elements involved. Another version of this approach addressed the measurement issues, on the assumption that if the economic variables such as scale economies and the quality and quantity of inputs were properly measured, the residual could be greatly shrunk. Obviously, as better data and methodologies became available in more recent years, this work, described in the recent book by Jorgenson and Landau, Technology and Capital Formation (1989), did shrink the residual, but it did not go away. Some of this may have been due to still unrecorded measurements such as the acquisition of human capital, to various social and political factors, and also, as we have shown in our detailed study of the chemical process industries (Landau, 1989a, 1990b; Rosenberg and Landau, 1989), to less-than-capacity utilization at times, which has had a very negative influence on productivity. Certainly no methodology of this kind is free of assumptions either, although there are fewer of them. Nevertheless, by either approach, a significant residual remains and has difficult-to-explain large fluctuations at intervals. Furthermore, the extrapolation by these methods from the infinite variety of microeconomic activities of firms to the macro economy over time was either a rather bold leap of faith, or else the models developed were too simplistic to reveal the functioning of the "black box" of technical change at the firm level, and so left obscure just what could or should be done to increase growth rates, which, after all, is the point. In fact, a major assumption of present-day neoclassical macroeconomists about the microeconomic world, is the textbook assertion that business firms are homogeneous maximizing agents, whose history, internal structure, and characteristics are not examined, or at least are not central to the analysis. Such a static view holds that eliminating inefficiencies and gaining economies of scale are the keys to success.

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering This treatment is a requirement for their growth analysis at the macroeconomic level but, in so doing, they virtually throw away the essential elements of the problem of technology commercialization. They also disregard how firms can be managed for greater competitiveness in the international marketplace—a far more powerful growth mechanism than the static efficiency model, because it continually introduces new products, processes, and services to disrupt any supposed steady state. If the economics textbooks are right, why is the business and general literature so full of accounts and advice of how different firms and industries are succeeding or failing in the international and domestic markets? And, with all their imperfections, the capital markets recognize their varying results. This is the puzzle that conventional growth theory cannot solve. Within the past few years, new international phenomena have begun to draw the attention of economists as a means of widening their understanding of the growth process. In the past two decades, some fascinating divergences in growth rates have occurred outside the socialist bloc, such as the swift rise of the Asian "dragons," the economic decline of some South American and African countries, and, above all, the extraordinary recovery of Japan from wartime devastation. In addition, there was an almost universal slowdown in growth in the 1970s, with some recovery in the 1980s. Meanwhile, advances in economic theory were taking place. Kenneth Arrow of Stanford as early as 1962 had already pointed the way toward a better understanding of this issue. If the predicament of exogenous technical change was to be escaped, and the possibility of sustained and fluctuating growth per capita (as actually occurred) was to be retained, there has to be some form of nonconvexity in the production process, aided by endogenous technical change. From such international observations, development economics and growth theory seemed to begin to merge. This line of work has recently been led by Robert Lucas (1988) and Paul Romer (1986; 1987a,b; 1989a,b; 1990) of the University of Chicago, but it has received varying amounts of support in papers and statements delivered at Robert Solow's sixty-fifth birthday symposium in April 1989 at the Massachusetts Institute of Technology. This support came from Joseph Stiglitz and Robert Hall of Stanford University, Frank Hahn of Cambridge University, and Avinash Dixit of Princeton University. In addition, Richard Nelson (1981, 1982) of Columbia University has produced a new evolutionary theory of growth that has many similarities to the new work of Lucas and Romer. Gene Grossman and Elhanan Helpman (1990) of Tel Aviv are also supportive of these new directions in growth and trade theory. This new work in growth theory reignited interest in increasing returns to scale as

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering one of the forces driving growth, especially for less developed economies, and introduced complex general equilibrium models into growth research. But economies of scale are also important for industrial countries, particularly for industries in which American firms are strong, such as aircraft, chemicals, machinery, and motor vehicles (Lipsey, 1990). The residual disappears but is replaced by the postulate of externalities, or spillovers—that is, the influence of investments of all kinds on one another. These models also include imperfect competition as the only form that can allow a role for patents and privately financed R&D, as actually occurs. This work brings back into growth theory some of the key concepts first disclosed by Evsey Domar of the Massachusetts Institute of Technology and Roy Harrod of Oxford University (Eatwell et al., 1987) even before Solow's publications, although of course in a far more sophisticated manner. Our practical observations of the economy would support such a concept. In our studies of the petroleum and chemical industries, we describe how the invention of the assembly line by Henry Ford led to the development of modern petroleum refining aided by the rise of the chemical engineering discipline, which in turn led to the great expansion of the chemical and petrochemical industries, first in the United States, and then abroad. The penetration of the computer has had comparable if not even greater effects. Jeffrey Bernstein of Carleton University and M. Ishaq Nadiri of New York University measured such spillover effects for the high-tech industries and found them to be substantial in almost every case for R&D capital (Bernstein and Nadiri, 1988). They also measured rates of return on both physical and R&D capital, and showed that the latter are higher. However, it is very hard to incorporate the detailed micro view into these models, and much remains to be done. From the recent work in growth theory, we therefore perceive two important modifications in Solow's neoclassical growth theory, which affect both economic research and its policy implications: (1) it applies to long-run steady-state equilibrium of the economy and not necessarily for the more immediate challenges in periods of less than perhaps 25 or 50 years because the economy in such periods is in a dynamic transition disequilibrium stage; and (2) technology in a mature economy like the United States is largely endogenous. Other deficiencies of the neoclassical theory, in our view, lie in the omission of public, environmental, and R&D capital stocks, the growing openness of the economy and trade, premature technological obsolescence from external shocks, the different vintages of capital stock, which are not perfectly substitutable for one another, and the not necessarily constant returns to scale in production. Markets are not

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering always perfectly competitive as the neoclassical theory postulates; rather the competition is more often Schumpeterian (innovative, entrepreneurial), and this is a much more powerful force for growth than standard classical price competition. Firms have found, particularly in an era of international competition, that price wars are unattractive, and seek to focus, where possible, on those forms of competition for which there are greater potential profits, that is, the development of new products and processes. There are, of course, many commodity markets that are price-competitive. However, particularly in those manufacturing industries shown in Table 1, managerial energies seek to differentiate themselves by product distinctions, better and lower-cost technologies and operating procedures for their production, and more successful financing strategies. These are research-intensive industries that collectively perform 95 percent of all the industrial R&D in the United States, industries in which there is continual introduction of new products and rapid technological change. Robert Hall of Stanford University, in a timely National Bureau of Economic Research reprint (1092) has studied pricing versus marginal cost in a number of American industries. He shows that American firms often sell at prices well TABLE 1 The Major R&D Investment Industries, 1989 Estimates (More than $1 Billion)   R&D Expenditures (in billion $)   Industry Total Privately Financed Percentage Privately Financed 1. Aerospace 19.16 3.45 18 2. Electrical Machinery & Communications 18.55 10.57 57 3. Machinery 12.13 10.43 86 4. Chemicals 11.52 11.17 97 5. Autos, Trucks Transportation 11.41 9.47 83 6. Professional & Scientific Instruments 6.52 5.54 85 7. Petroleum Products 2.09 2.07 99 8. Rubber Products 1.24 0.93 75 9. Food & Beverages 1.17 1.17 100 TOTAL 83.79 54.80   NOTE: T U.S. R&D estimated at $129.2 billion, of which all industrial R&D is $92.7 billion (67% comes from companies and the rest from government so that the above are the bulk of the investors in R&D). Source: Battelle Memorial Institute.

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering above marginal cost, and this fact requires interpretation in terms of theories of oligopoly and product differentiation. He concludes by saying that the evidence against pure competition is reasonably convincing. Our recent detailed study of the American chemical process industry bears out Hall's conclusion and illustrates the richness of these motivations, and the highly successful resulting growth on a world scale, which have given this industry a consistent postwar positive balance of payments. It is one of two such major manufacturing industries (the other being aerospace). Not all industries have been equally successful, as our research shows, and this exemplifies the problem of dealing with growth at the aggregate or macro level only. Because of such theoretical limitations, comprehension of changing trends in growth from decade to decade requires comparative empirical studies among nations over shorter periods of time, as a guide to national policies. GROWTH IN THE UNITED STATES VERSUS JAPAN First, let us examine the relative performance of the United States and Japan, where the contrasts are the most revealing. Since the mid-1960s, productivity growth in the United States has greatly diminished from previous levels. For the period 1964-1973, the labor productivity growth of the U.S. economy was 1.6 percent per year; but from 1973 to 1978, it fell to-0.2 percent, and in 1979-1986 revived to only 0.6 percent. The Japanese labor productivity growth rates for the same periods were 8.4, 2.9, and 2.8 percent per year, respectively. In much of the later part of this period, the growth of total output in the United States was brought about almost entirely by increases in supply of capital and labor, especially (in the 1970s) the latter, as the baby boom peaked. Although explanations for the collapse in American productivity vary, it seems clear from our recent studies that one of the major reasons is that the comparative performance of the U.S. and Japanese labor productivity growth rates over this period has been heavily influenced by the much higher (often twice as high) rate of Japanese capital investment in a number of their industrial sectors, made possible by the very high Japanese savings rates. This is a significant departure from the neoclassical growth model which, as stated above, treats growth as independent of the investment rate. As a result of the low interest rates available in Japan, the discount rate for research and development and other technology-intensive efforts was also low, encouraging long time horizons, as further described below. This helped fuel the rapid adoption by most Japanese industries of

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering the latest available technologies from abroad. Many U.S. industries were not incorporating new technology with the same urgency. Other reasons uncovered by our work include the two oil shocks of the 1970s (which had a worldwide negative impact on growth rates); the sharp inflation of the 1970s, which gave false signals to managements about market opportunities; the entrance of the baby boomers and other new and less skilled workers; the excess capacity in many industries; and so on. Because this flood of labor market entrants was comparatively cheap, managements favored labor over capital. The ratio of capital to labor in the United States had grown by 3 percent between 1948 and 1973, but then it slowed to less than 2 percent. Growth in Japan's ratio was higher. The post-1973 decline in growth was not limited to the United States and Japan, but was widespread and variable among many other countries. Now, despite the lower energy costs, most countries have not recovered all the way from the pre-1973 conditions, for a variety of individual reasons, including the time lags needed to adjust to the seismic economic changes of the last two decades, as we discuss later. In studying these many events, we have found that physical capital formation has contributed far more significantly to longer-term economic growth than earlier estimates had suggested. And the residual of technological change, while not wholly explicable by our methodology, constitutes less than 30 percent, rather than the earlier estimates of 85 percent. Of course, like others in the past, we assumed the major inputs to be independent of one another; as we shall see, this assumption needs modification. There are still many measurement issues and methodologies to be resolved, but the direction now seems well supported. The important point of these findings is not their exact magnitude, but that there are several primary identifiable ways to improve growth rates over the medium term of 20 to 30 years: physical capital investment, improvement in labor quality, and R&D and technology. THE JORGENSON ANALYSIS OF THE SOURCES OF ECONOMIC GROWTH In the accompanying table (Table 2) we present an analysis of the sources of U.S. economic growth, still employing the neoclassical framework, but improving the methodology for measurement and allocation of inputs. The output of the U.S. economy at the aggregate level is defined in terms of value added for the domestic economy. The growth of output is decomposed into the contributions of capital and labor inputs and growth in productivity. Growth rates for the

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering stantial number of really novel technologies now available and the effects of continuing R&D and design efforts, the need for totally new facilities and closing down of obsolete units is becoming much greater—a version of "catchup" for the United States, particularly in some of its industries. CONCLUSION There seems to be little remaining doubt among economists that to improve American living standards and maintain American influence in international affairs, increased investment in all kinds of capital per worker will be necessary, especially considering the growing environmental concerns. The cost of funds (the mix of debt and equity) is a fundamental driving force in the private sector decisions that lead to such accumulation. However, the basic consideration for physical capital investment is the cost of capital, which is the pretax return required to pay all taxes and depreciation on plant and equipment. Public investments in infrastructure are also important, and are certainly sensitive to the savings rates. With declining demographic increases in the work force, enhanced productivity improvement obtained in this way need not be at the expense of job creation. As Table 3 demonstrates, the policies of the United States in the past two decades have had a very beneficial effect on job formation (unemployment is now 5.3 percent) compared with Europe and Japan, where productivity and capital formation were higher, but so was unemployment (over 8 percent in Europe). A large measure of this accomplishment TABLE 3 Employment-Civilian Millions Year EEC USA Japan 1955 101.4E 62.2 41.9 1965 104.8E 71.1 47.3 1975 105.5 85.8 52.2 1985 106.7 107.2 58.1 1986 107.5 109.6 58.5 1987 108.3 112.4 59.1 1988 110.8 115.0 60.1 Net Increase 9.4 52.8 18.2 NOTE: EEC = The Ten; E = estimate. SOURCE: OECD, EEC, Bank of Japan, IFO. Courtesy of The Economist.

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering comes from the American entrepreneurial ability to generate many new small and medium sized companies. The price we paid, as shown in Figure 4, was a rise in long term real interest rates, and an inevitably weak capital formation (Figure 6). Figure 7 shows the growth rates per employed worker to emphasize this divergence in national results. Business investment, of course, is cyclical. The low (often negative) real interest rates of the 1970s led to a capital spending boom and the overcapacity in some industries cited above, with low productivity gains. The rise in rates in the 1980s has shortened the horizon of investors. Nevertheless, it must be reiterated that interest rates are only one component of the cost of capital to firms, which depend in varying degree on mixes of debt and equity. The United States must get its cost of capital down to the level of its international competitors by, among other structural measures, removing the tax biases against productive investment and savings, so that it is no longer necessary to pay a high premium to import foreign capital. As Durlauf says, growth is a function of how each economy is managed, despite the internationalization of capital markets. This paper is not the place to enlarge on this theme, but it will clearly necessitate all of the goals described above. Such an altered policy is not now in place. Because, in a scarce savings economy (and domestic savings and investment are still linked in an open economy, although less tightly), returns to financial assets in the 1980s exceeded returns to many physical assets in the real sector, the economy had to adjust by rationalizing the use of capital so that it could compete with the returns available on its paper image. This adjustment is in the form of a lower investment pattern and entailed mammoth equity retirements, mergers and acquisitions, leveraged buyouts, privatization, and "junk" bonds. Restructuring responds to the need to make physical capital productive enough to withstand the high real interest rates required by the financial markets. However, the cost may well be greater vulnerability because of the greater indebtedness, and the erosion of the critical but capital-intensive manufacturing base. The net interest payments of nonfinancial corporations rose from 8.6 percent of cash flow in late 1959 to 24.2 percent by the late 1970s; in 1989 year this figure reached almost 26 percent (and exceeded after-tax profits by $40 billion). Bankruptcies have been increasing. The savings and loan crisis is a glaring example. In significant and sobering contrast is the current performance of the Japanese economy. As the Wall Street Journal has recently reported (Ono, 1989), Japanese capital spending has been growing at double digit rates. Many industries, from autos to computer chips to shipbuilding

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering FIGURE: 6 Weak capital formation in the 1980s. SOURCE: Datastream International/ Worldview. FIGURE: 7 International comparison of average annual rates of economic growth. Average  annual percent change in real gross domestic product per employed person. SOURCE: U.S. Department of Labor.

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering are modernizing, expanding capacity, and developing new products. In the 12 months ending 31 March 1989, Japan's capital outlays exceeded those of the United States (measured at prevailing exchange rates), $521.4 billion compared with $494.8 billion, despite the fact that Japan's GNP is less than two-thirds that of the United States. It was probably well over $600 billion for Japan in all of 1989 compared with somewhat more than $500 billion for the United States. Figure 6 shows the divergence between the two countries. Much of this investment boom is in the high-tech industries that already threaten the viability of many American firms. It seems increasingly clear that the United States now has a new economic rival, as the Soviet Union retreats, and one far more formidable because it is so difficult to develop a "crisis" mentality to spur Americans to change their habits. This Japanese investment boom is fueled by an enormous capital market that channels the large Japanese private savings into productive enterprises. Debt capital is available at interest rates still below those of the United States. Equity issues are far larger than in the United States. Whereas in 1986, American companies raised a record $67.9 billion from the sale of stock and similar securities, by the first eight months of 1989, Japanese corporations raised more than $110 billion, compared with $20 billion by American companies. Can anyone doubt that in a relatively few more years, Japanese productivity advances will greatly exceed ours, and new plants will be able to supply world markets with even more and better products? A recent visit to Japan confirms that there are many other favorable factors to fuel rising Japanese competitiveness: a homogeneous disciplined population; an excellent secondary educational system; a manipulated financial system; a tax system favoring saving over consumption; a strong governing party (even if somewhat weakened); a strong and competent bureaucracy that favors its industry in domestic and foreign markets; a relatively mild antitrust stance; and fierce competitiveness between firms, among many special characteristics. Perhaps Japan has even improved upon the capitalist system that we invented along with the British! But it has not achieved perfection. The recent fall in the Japanese stock market and rising inflation bring to an end the speculative bubble in stock and land prices, raise somewhat the cost of Japanese equity, and herald a reduction in the flood of capital flowing overseas, especially to the United States. We may, therefore, see continuing high real interest rates and slow growth here, unless our national savings rate improves, as it has recently begun to do. The adaptable Japanese system, however, continues to hold many advantages, and Japan should continue to grow over the longer term at a higher rate than other industrialized countries.

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering There is a massive job ahead to change the direction of our economy. The American people need to understand the choices they must address. These must link the three types of capital (physical, human, and intangible) to the current economic situation. Our argument for more capital investment is grounded in the economic and technical opportunities facing the United States now. The current importance of the great (and as yet only very partially realized) information technologies revolution means that technical progress is embodied in physical capital to an unprecedented extent. The same is true for the new materials and biotechnology. This embodiment links investment in new knowledge for growth with investment in new physical capital. Similarly, opportunities for technical advance are linked with investment in R&D and human capital. These new technologies require a different skill mix in the work force, especially at the high skill end, where the American higher education system offers a source of substantial comparative advantage to the United States, if exploited with new investment in physical and intangible capital. This is also an imperative because the major Japanese exports to the United States are both research intensive and capital intensive, and to compete, firms need all three legs of the stool of growth. Yet, current policies disfavor investment in general, and indeed have tended to encourage investment in the less productive forms of capital. How can these choices be made constructively in the face of profound skepticism about the efficiency and scandals of government? As Michael Porter (1990a,b) of the Harvard Business School says, direct intervention by the Japanese government has been abandoned, and this is appropriate at Japan's advanced stage of competitive development. America should not be pushed into adopting policies that do not work in an advanced economy, and instead should concentrate on getting the overall climate right. Nevertheless, many attempts are being made by various interests and scholars to justify managed trade, and by some technologists and businessmen who feel unable to compete against foreign-managed trade and buyouts of critical technologies and urge government counter efforts. A more reasoned approach lies in the question of where government can intervene effectively in the microeconomy. In March 1990 President Bush committed his administration to fostering critical precompetitive generic technologies that ''support both our economic competitiveness and our national security.'' Robert M. White (1990), president of the National Academy of Engineering, in a speech in April 1990 developed this theme further in a thoughtful way, but there is as yet no national consensus on where generic technology

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering lies between basic research and applied industrial development, and to what extent and by what means it should be addressed. However, the President's reference to national security reminds us that there are many who feel that certain industries (particularly semiconductors) are essential to national economic security, and that both America's inadequate macroeconomic policies and the failings of American firms and industry structures are going to hand control of critical technologies and companies to foreign-based companies, especially the Japanese. They are encouraged by the recent growth and trade theory developments (referred to earlier) that suggest some protection in early stage technology may be positive for economic growth. It is not clear, nevertheless, whether U.S.-owned companies behave differently than foreign-owned businesses in the United States, or whether control of technology is associated with national ownership. Companies are increasingly becoming not just multinational but global—perhaps slipping beyond the control of any national government. So far, however, this has been less true of the Japanese, and this gives rise to strong protectionist feelings on the one hand, and surrender of hope for American firms' ability to compete on the other, and hence a desire to see more aggressive firms from abroad locate in the United States, even at the expense of American-owned firms. Considering these contentious forces, the desire for greater national controls and strategy versus the spread of superanatural global companies based in many countries, it is no wonder that there is a growing concern among many economists that the United States will therefore be increasingly pushed toward protectionism of various kinds. Their concern is over costly intervention in the private sector, such as the proposal by a National Advisory Commission on Semiconductors for government funding of a venture capital corporation at a multibilliondollar level to resurrect the defunct American consumer electronics industry, despite the well-established inability of such policies to ensure success. In the absence of the necessary industrial structure, reviving a whole industry would have ramifications throughout many other sectors of the economy and incur huge costs. Considering how hard such intervention can be, the best that any government can do in its four-year term is probably to focus primarily on getting the macroeconomic policies right as its highest priority. When one couples this fundamental problem with the growing and frequently legitimate pressures of the environmental advocates, and the deteriorating infrastructure, which also requires large investment (and which is conducive to productivity gains in the whole economy [Munnell, 1990]), there must arise a gnawing fear that America's

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering position in the world may slip before too many years into a second-class role, and that growth in living standards will be inadequate to address the many social problems and inequities that exist today. The proper remedy, as pointed out in this paper, is becoming quite clear, but it will require patience, determination, and leadership, a change in fundamental perceptions of national priorities, and abandonment of obsolete economic theories and perspectives. NOTES 1.   In this article, the use of "we" implies references not only to my work, but to other work (or experience) done (or had) at Stanford and Harvard universities. I am particularly indebted to the directors of the programs on technology and growth, Nathan Rosenberg and Lawrence Lau (Stanford) and Dale Jorgenson (Harvard), with whom I serve as codirector of both programs. Thanks are also due to Paul Romer of Chicago and Timothy Bresnahan, Steven Durlauf and John Shoven of Stanford. However all errors are my sole responsibility. 2.   As a consequence of the current account deficit; in addition, central bank transactions may have resulted in perhaps another $50 billion inflow. 3.   See Denison (1957, 1962, 1967, 1972, 1979, 1985). 4.   See Griliches (1979, 1988), Griliches and Jorgenson (1967, 1972a, 1972b). 5.   See Jorgenson, Gollop, and Fraumeni (1987); Jorgenson, Kuroda, and Nishimizu (1986); and Jorgenson (1988). 6.   See Kendrick (1961, 1973, 1976, 1983) and Kendrick and Grossman (1980). REFERENCES Aaron, H., B. Bosworth, and G. Burtless. 1988. Can America Afford to Grow Old? Washington D.C.: The Brookings Institution. Abramovitz, M. 1956. American Economic Review 46(May):5-23. Arrow, K. 1962. The economic implications of learning by doing. Review of Economic Studies 29(June):155-173. Baumol, W. J., S. A. Baley Blackman, and E. N. Wolff. 1989. Productivity and American Leadership: The Long View. Cambridge, Mass.: MIT Press. Bernstein, J. I., and M. I. Nadiri. 1988. Interindustry spillovers, rates of return, and production in high tech industries. American Economic Review (May): 429-434. Boskin, Michael J. 1986. Macroeconomics, technology, and economic growth: An introduction to some important issues. Pp. 33-56 in The Positive Sum Strategy: Harnessing Technology for Economic Growth, R. Landau and N. Rosenberg, eds. Washington, D.C.: National Academy Press. Boskin, M. J. 1988. Tax policy and economic growth: Lessons from the 1980s, Journal of Economic Perspectives 2(4)(Fall):87 Boskin, M., and L. Lau. 1989. Capital Formation and Productivity Growth: An International Comparison. Paper presented at Conference on Economic Growth and the Commercialization of New Technologies, Center for Economic Policy Research, Stanford University, September. Boskin, M. J., and L. J. Lau. 1990. Post-War Economic Growth in the Group-of-Five Countries: A New Analysis. Working paper. Department of Economics, Stanford University, July.

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering Bosworth, B. Testimony before the Committee on Ways and Means, House of Representatives. United States Congress April 19, 1989. Christensen, L. R., and D. W. Jorgenson. 1969. The measurement of real capital input, 1929-1967. Review of Income and Wealth 15(4)(December):293-320. Christensen, L. R., and D. W. Jorgenson. 1970. U.S. real product and real factor input, 1929-1967. Review of Income and Wealth. 16(1)(March):19-50. Christensen, L. R., and D. W. Jorgenson. 1973. Measuring the performance of the private sector of the U.S. economy, 1929-1969. Pp. 233-351 in Measuring Economic and Social Performance, M. Moss, ed. New York: Columbia University Press. David, P. A. 1990. The dynamo and the computer: An historical perspective on the modem productivity paradox. American Economic Review. 80(2)(May):355-361. Denison, E. F. 1957. Theoretical aspects of quality change, capital consumption, and net capital formation. In Conference on Research in Income and Wealth, Problems of Capital Formation. Princeton, N.J.: Princeton University Press. Denison, E. F. 1962. Sources of Economic Growth in the United States and the Alternatives Before Us. New York: Committee for Economic Development. Denison, E. F. 1967. Why Growth Rates Differ. Washington, D.C.: The Brookings Institution. Denison, E. F. 1972. Final Comments, Survey of Current Business, Part II. 52(5):95-110. Denison, E. F. 1974. Accounting for United States Economic Growth, 1929-1969. Washington, D.C.: The Brookings Institution. Denison, E. F. 1979. Accounting for Slower Economic Growth, Washington, D.C.: The Brookings Institution. Denison, E. F. 1985. Trends in American Economic Growth, 1929-1982. Washington, D.C.: The Brookings Institution. Dertouzos, M. L., R. K. Lester, R. M. Solow, and the MIT Commission on Industrial Productivity. 1989. Made in America: Regaining the Productive Edge. Cambridge, Mass.: MIT Press. Durlauf, S. 1989. International Differences in Economic Fluctuations. Paper presented at Conference on Economic Growth and the Commercialization of New Technologies, Center for Economic Policy Research, Stanford University, September. Eatwell, J., M. Milgate, and P. Newman, eds., 1987. New Palgrave. New York: MacMillan. The Economist. September 23, 1989. Editorial pp. 13-14, 81. Gomory, R. 1989. The Technology-Product Relationship: Early and Late Stages. Conference on Economic Growth and the Commercialization of New Technologies, Center for Economic Policy Research, Stanford University, (September). Gomory, R. 1990. Of ladders, cycles and economic growth. Scientific American (June):140. Greenwald, B. G., M. A. Salinger, and J. E. Stiglitz. 1990. Imperfect capital markets and productivity growth. National Bureau of Economic Research conference paper, April. Griliches, Z. 1972a. Issues in Growth Accounting, A Reply to Edward F. Denison. Survey of Current Business 52(4) Part II, (May):65-94. Griliches, Z. 1972b. Issues in Growth Accounting, Final Reply. Survey of Current Business 52(5) Part II, (May):111. Griliches, Z. 1979. Issues in assessing the contribution of research and development to productivity growth. The Bell Journal of Economics 10(Spring):92-116. Griliches, Z. 1988. Technology, Education and Productivity: Early Papers with Notes to Subsequent Literature. London: Basil Blackwell. Griliches, Z., and D. W. Jorgenson. 1967. The explanation of productivity change. Review of Economic Studies 34(2)(99)(July): 249-280. Grossman, G. M., and E. Helpman. 1990. Trade, innovation and growth. American Economic Review 80(2):86-91.

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering Hatsopoulos, G. N., P. R. Krugman and L. H. Summers. 1988. U.S. competitiveness: Beyond the trade deficit. Science 241(July):299-307. Helliwell, J. F., and A. Chung. 1990. Aggregate productivity and growth in an international comparative setting. In International Productivity and Competitiveness, B. G. Hickman, ed. New York: Oxford University Press. Huber, P. 1989. Liability and insurance problems in the Commercialization of new products. Paper presented at Conference on Economic Growth and the Commercialization of New Technologies, Center for Economic Policy Research, Stanford University, September. Hulten, C. R., and F. C. Wykoff. 1981. The measurement of economic depreciation. In Depreciation, Inflation and the Taxation of Income from Capital, C. R. Hulten, ed. Washington, D.C.: Urban Institute Press. Hulten, C. R., J. W. Robertson, and F. C. Wykoff. 1989. Energy, obsolescence, and the productivity slowdown. Pp. 225-258 in Technology and Capital Formation , D. Jorgenson and R. Landau, eds., Cambridge, Mass.: MIT Press. Imai, K. 1989. The Japanese Pattern of Innovation and its Commercialization Process. Paper presented at Conference on Economic Growth and the Commercialization of New Technologies, Center for Economic Policy Research, Stanford University, September. Jorgenson, D. W. 1988. Productivity and postwar U.S. economic growth. Journal Economic Perspectives 2(4)(Fall):23-41. Jorgenson, D. W., and B. M. Fraumeni. 1990. Investment in education and U.S. economic growth. In The U.S. Savings Challenge, C. E. Walker, M. A. Bloomfield, and M. Thorning, eds. Boulder, Colo.: Westview Press. Jorgenson, D. W., and R. Landau. 1989. Technology and Capital Formation. Cambridge, Mass.: MIT Press. Jorgenson, D. W., M. Kuroda, and M. Nishimizu. 1986. Japan-U.S. industry-level productivity comparisons, 1960-1979. In productivity in the U.S. and Japan, C. R. Hulten and J. R. Norsworthy, eds. Chicago: University of Chicago Press, Jorgenson, D. W., F. Gollop, and B. Fraumeni. 1987. Productivity and U.S. Economic Growth. Cambridge, Mass.: Harvard University Press. Kendrick, J. W. 1961. Productivity Trends in the United States. Princeton, N.J.: Princeton University Press. Kendrick, J. W. 1973. Postwar Productivity Trends in the United States, 1948-1969. New York: National Bureau of Economic Research. Kendrick, J. W. 1976. The National Wealth of the United States. New York: Conference Board. Kendrick, J. W. 1983. Interindustry Differences in Productivity Growth. Washington, D.C.: American Enterprise Institute. Kendrick, J. W., and W. S. Grossman 1980. Productivity in the United States, Trends and Cycles. Baltimore, Md.: Johns Hopkins University Press. Landau, R. 1988. U.S. economic growth. Scientific American 258(6)(June):44-52. Landau, R. 1989a. The chemical engineer and the CPI: Reading the future from the past. Chemical Engineering Progress (September):25-39. Landau, R. 1989b. Technology and capital formation. Pp. 485-505 in Technology and Capital Formation, D. Jorgenson and R. Landau, eds., Cambridge, Mass.: MIT Press. Landau, R. 1990a. Capital investment, key to competitiveness and growth. Brookings Review (Summer). Landau, R. 1990b. Chemical Engineering: Key to the Growth of the Chemical Process Industries. AIChE Symposium Series 86(274):9-39. Lindbeck, A. 1983. Econ. Journal 93(March):13-34.

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering Lipsey, R. 1990. NBER Working paper No. 3293. Lucas, R. E., Jr. 1988. On the mechanics of economic development. Journal of Monetary Economics 22:3-42. Maddison, A. 1987. Growth and slowdown in advanced capitalist economies: Techniques of quantitative assessment. Journal of Economic Literature. 25(June):649-698. Mansfield, E. 1986. Microeconomics of technological innovation. Pp. 307-325 in The Positive Sum Strategy, R. Landau and N. Rosenberg, eds., Washington, D.C.: National Academy Press. McCauley, R. N., and S. A. Zimmer. 1989. Explaining international differences in the cost of capital. Federal Reserve Bank of New York Quarterly Review 14(2)(Summer). McKinnon, R., and D. Robinson. 1989. Dollar devaluation, interest rate volatility, and the duration of investment. Paper presented at Conference on Economic Growth and the Commercialization of New Technologies, Center for Economic Policy Research, Stanford University, September. Munnell, A. H. 1989. Social Security Surpluses: How Will They Be Used? Paper presented at American Council for Capital Formation conference "Saving—The Challenge for the U.S. Economy," Washington, D.C., October. Munnell, A. H. 1990. Why has productivity growth declined? Productivity and Public Investment. New England Economic Review (Jan./Feb.):3-22. Nelson, R. R. 1981. Research on productivity growth and productivity differences: Dead ends and new departures. Journal of Economic Literature. 19(September): 1029-1064. Nelson, R. R., and S. G. Winter. 1982. An Evolutionary Theory of Economic Change. Cambridge, Mass.: Harvard University Press. Ono, U. October 26, 1990. Capital Spending. Wall Street Journal. Porter, M. 1990. Harvard Business Review, (May-June):190-192. Porter, M. 1990. The Competitive Advantage of Nations, New York: The Free Press. Romer, P.M. 1986. Increasing returns and long-run growth. Journal of Political Economy 94(October):1002-1037. Romer, P.M. 1987a. Crazy explanations for the productivity slowdown. NBER Macroeconomics Annual. Stanley Fischer, ed., Cambridge, Mass.: MIT Press. Romer, P.M. 1987b. Growth based on increasing returns due to specialization. American Economic Review 77(May):56-62. Romer, P.M. 1989a. Capital Accumulation in the Theory of Long-run Growth, in Modem Business Cycle Theory, R. Barro, ed., Cambridge, Mass.: Harvard University Press. Romer, P.M. 1989b. Measurement Error in Cross Country Data, Manuscript. Romer, P.M. 1990. Endogenous technological change. Journal of Political Economy. Rosenberg, N., and R. Landau. 1989. Successful Commercialization in the Chemical Process Industries. Paper presented at Conference on Economic Growth and the Commercialization of New Technologies, Center for Economic Policy Research, Stanford, University, September. Shoven, J., and D. Bernheim. 1989. Comparison of the Cost of Capital in the U.S. and Japan: The Roles of Risk and Taxes, Paper presented at Conference on Economic Growth and the Commercialization of New Technologies, Center for Economic Policy Research, Stanford University, September. Solow, R. 1956. Quarterly Econ. 70:65-94. Solow, R. 1957. Review of Economics and Statitistics. 39:312-20. Solow, R. 1987. Nobel Lecture. Summers, L. 1989. What Is the Social Return of Capital Investment? Paper presented at Robert Solow's 65th birthday symposium, MIT, April.

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Technology & Economics: Papers Commemorating Ralph Landau's Service to the National Academy of Engineering Turner, P. 1988. Saving and investment, exchange rates, and international imbalances! A comparison of the U.S., Japan, and Germany. J. Japanese Int. Econ. 2(3)(September):259-265. White, R. M. 1990. Technology policy in an interdependent world. Paper presented at American Association for the Advancement of Science, Washington, D.C., April 13, 1990. Wykoff, F. C. 1989. Economic depreciation and the user cost of business-leased automobiles. Pp. 259-292 in Technology and Capital Formation, D. Jorgenson and R. Landau, eds. Cambridge, Mass: MIT Press.