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Strategic Implications of European Market Integration for U.S. it&D-Intensive Industry and the Science and Technology Base MR. NILES: I am the ambassador to the U.S. mission to the European Communities in Brussels. I am basically here as the introducer. I will not have separate remarks on the substantive issues since I am not an expert on science and technology. Also, I have been in Brussels for only eight months, and I still have much to learn there. Our first speaker is John McTague, vice president of technical affairs for Ford Motor Company. Born in Jersey City in 1938, Mr. McTague is a graduate of Brown University. He worked with North American Rockwell in Los Angeles from 1964 to 1970, was on the faculty of University of California at Los Angeles, and is a member of the Institute of Geophysics and Planetary Physics. John joined Ford in 1986 and was elected vice president effective the first of March 1990. So John has been on the job now for five days, and we expect him to be a great expert in all things having to do with Ford and automobiles. DR. MCTAGUE: Many of us here are in the business of the future. Certainly our researchers in microelectronics will confidently predict to you that the density of memories will increase by a certain fraction or certain multiple over the next five years and that the speed of devices will go up by an order of magnitude in 2.5 years or 2.3 years or whatever it is, and the cost per unit computation will drop by an order of magnitude in x years. What they say is almost certainly correct. Politicians will predict that the laws of physics and chemistry will allow unknown technology to increase the effectiveness of automotive catalysts from about 96 percent to 99 percent in a few years, and I hope they are correct. If the present laws of physics and chemistry will not do the trick, why, politicians can always amend them. The complex political, economic, and technical environment that we are 103

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104 EUROPE 1992 discussing today I think normally should lead us to a little humility about predicting the future. Probably a year or so ago I would have stated some- thing to that effect. However, some other more monumental things have introduced a new scale of humility. At the beginning of this year, I happened to be away on vacation with my family in a remote area of the world where we did not have access to radio or telephone or television. For the period of 10 days that we were out of contact, there was a revolution in Rumania, Nicolai Ceaucescu literally lost his head, and Manuel Noriega was turned over to the U.S. forces in Panama. Things are changing extremely rapidly. Most recently, of course, there was an election in Nicaragua for which, to my knowledge, only a single expert predicted the proper result, at least in public. We are all watching with absolute amazement what is going on in the eastern part of Europe right now, and I am sure a lot of people in the government in the Soviet Union are wondering what is happening in the elections, particularly in Moscow and Leningrad. What this should tell us is that we should be rather humble about trying to predict the future a few years from now. It also tells us that we cannot look at any one event in isolation. They are all connected. That also goes for the Single Market in the EC. The environment elsewhere in the world the most obvious example being eastern Europe may change any predictions that we might make. It is clear that one thing is true though: Events are changing faster than institutions, in particular large institutions like governments, can anticipate or respond. The institutions are trying to catch up, as opposed to trying to lead. I think that is also true in the case of a European Single Market. That being as it may, however, if you look at the situation of the Single Market, compared to the scale of some of these other things that are happening today, it looks a little more tractable with regard to predicting the future, and the rate of change seems relatively tame all of a sudden. What I am going to talk about today is the experience of large U.S.- based companies. It may not apply universally to smaller companies. Most very large U.S.-based companies certainly have been solid components of Europe for a rather long time. Obvious examples are Ford which has been in Europe since 1903 and is the company I happen to know best, so I will talk a fair amount about it and IBM. What we will be talking about relative to what is going on today and in the near future has to do with the change of pace, not a revolution. It is not primarily motivated by the European structural change that is occurring; rather, from our perspective, both our change and the structural change in Europe are driven by common forces. Let me step back a few years to 1903. Ford was founded in 1903 with 10 people and made its first sale in Europe, actually in Britain, in the same year. Since then it has evolved rather substantially. In 1911 the first

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION 105 assembly plant was opened in Europe, assembling kits of cars whose com- ponents had been put together in the United States and that were U.S.- designed cars, the same cars that were sold here. In 1921 we established our first R&D facility in Europe; it was in Britain. In the late 1920s we had factories not only in Britain but also in Ireland, Germany, and, by the way, Japan. However, they were building U.S.-designed cars. It was not until the late 1920s that Ford made its first design for Europe, but it was designed in Dearborn, specifically for Europe and built in Europe. In the 1930s, however, despite regulations coming from headquarters, a group in Europe bootlegged a design of a European car, and in 1936, I believe it was, the first completely European Ford was manufactured in Europe. In those days, because of the difficulties of transportation of goods and of communication, Ford of Britain and Ford of Germany which had become quite large by then basically operated as stand-alone units, each separate from the other and separate from the United States, designing and building different cars and communicating as little as possible with corporate headquarters. However, as times have changed, as the ease of communication has increased, and as the cost of transportation has dropped to historic lows, there has naturally been an increase in the scale of the coherent unit. In Europe that started for us in 1967, when Henry Ford II decreed that there would no longer be a Ford of Britain, a Ford of Germany, a Ford of France, etc.; instead there would be one Ford of Europe. It would have a common design team, common engineering, and completely integrated manufacturing. That has occurred over time. In fact, now on the design of a vehicle in Europe, the design team, the engineering team might come half from Cologne, half from England; they literally fly back and forth on a day-to-day basis, work together, and then go home at night in their own respective countries. Ford Europe is completely integrated, and it has been a large part of the market for some time. For example, in Britain we are by a substantial amount the largest producer of automobiles. Since that time, of course, communication has increased even more rap- idly, and we are now, have been for about five years, in a completely globalized phase. Engineering teams from around the world work together on common cars; most of the vehicles that will start coming out in the next few years will be globally based in design, although they will be differentiated for local markets. So we are essentially a global company now. We are global not only in the sense of our own situation, but also because the pace of change is so rapid nowadays, and the knowledge and resource base are too much to be self-contained. Even in a company as large as Ford, which is the second largest industrial company in the world, we have had to take other actions, and those include very close associations with people who in fact are our competitors. In Japan we have very close associations with Mazda and Nissan. We

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106 EUROPE 1992 own 25 percent of Mazda, for example, and jointly develop vehicles with them, sometimes them manufacturing them and sometimes us manufacturing them. In Korea we have an association and a partial ownership with Kia; in South America the manufacturing and development operations of Volkswagen and Ford have been completely combined in a joint venture called Auto Latina, which has 56 percent of the Brazilian market. We do joint development and joint production but sell our own vehicles. In Europe for several years we have had a joint venture with Ivecco, which is a Fiat entity, where we jointly design and produce heavy trucks. And we are forming closer associations in Europe with Volkswagen. These integrations are being done, as I said, because the scales have changed: The natural size of the unit to be competitive in this business has changed, and the amount of knowledge and the resource base that one needs have changed, and the ease of moving things around globally has changed. So we are essentially completely integrated. What we see occurring in Europe is a natural evolution. I think you can get an idea of that evolution from Figure 3. If you look at the population of the world on the left side, the population of the United States is rather small; add to it the population of the EC, you get something like 11 percent of the world's population, then the population of Japan, and then there is everybody else. These three entities are rather small in terms of population, but if you look at them in terms of gross national products, or what I call world products, you see a different picture. The GNP of the United States and the GNP of the EC are reasonably simi- lar; the GNP of Japan is smaller. What is more important for most industrial corporations, and indeed for R&D, because civilian R&D is closely tied to it, is manufacturing production. If you look at manufacturing, in fact the world looks like it is naturally divided up into three supercountries, the United States with about a third of the manufacturing, the European Community with almost an identical amount, and Japan with a slightly lesser but rapidly growing amount. It looks like the natural scale for manufacturing has basically resulted in an evolution of the European Community, in order that there be essentially equivalent competition. Now this looks similar, and you might say, well, the European Community is the European Community. However, if you look internally there are some very significant differences. In the United States, for example, about 22.5 percent of GNP is manufacturing and it has been forever. That is also true of almost all the major EC countries, with the exception of Germany, where manufacturing is more than a third of GNP. That means exports; manufacturing exports much more easily than services. Likewise, in Japan, manufacturing is about a third of GNP. So even though an integration of the European market is coming, the different emphases on manufacturing in the various EC countries will probably

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION 100 90 80 60 40 30 20 10 107 o Population World Product EC _ JAPAN ~ OTHER Manufactured Goods FIGURE 3 U.S., EC, and Japanese Share of World Population, World Product, and World Manufactured Goods (in percent). continue. However, from the point of view of a large corporation, the Single Market is just a natural evolution that we have been responding to due to the greatly changed environment relative to communications and the cost of transportation. MR. NILES: The point Mr. McTague made about the Federal Republic of Germany and Japan and the role of manufactured goods in those two

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108 EUROPE 1992 economies is interesting. If you put it in public policy terms, you ask your- self why, then, are the Federal Republic of Germany and Japan, those major industrial exporters, among the least enthusiastic about reforming agricul- tural trade, conducting highly protectionist agricultural policies, and resist- ing pressures to change those policies in the GATT Round. That is something to think about. Our next speaker, Dr. Richard Barker, is a principal in the London office of McKinsey and Company, where he focuses on clients in the pharmaceu- ticals, chemicals, and manufacturing sectors. He is a member of the firm's worldwide core groups in pharmaceuticals and technology management and leads its practice in biotechnology. Before joining McKinsey in 1980, Dr. Barker worked for Esso Petroleum in supply, planning, and operations management. Prior to this he carried out research in biochemistry and biophysics at the universities of Munich and Leeds, having received his bachelor's degree in chemistry and a doctor of philosophy in biochemistry from the University of Oxford. DR. BARKER: Our clients, the companies that we advise, force us from time to time to think the unthinkable, to project the implications of very imponderable trends and events. The emergence of the new Europe is just such a trend and 1992 just such an event. I would like to try to tackle two questions about the new Europe: What is its significance strategically? What are the major challenges that these events will pose to companies in research-intensive industries? We work with many companies in industries in which the long-term competitive position of a company is clearly hinged upon high up-front investments in R&D to maintain this dynamic of innovation. Let me first review the past European realities for such businesses. The pattern is very familiar to most of you: a past that is characterized by national protectionism to some extent, market fragmentation certainly, and a vital erosion, I believe, of global competitiveness of European high-technology companies. The motivations behind this explicit and implicit protectionism are in many ways laudable: the enhancement of national research and innova- tional power, the requirements for national sovereignty or autonomy, pro- tection of employment, prestige, and so forth. Of course, what it led to was the dominance in each European country of a small number of national suppliers, to uncompetitively high prices for some products compared with truly international competitors, and reduced innovation flow. The industries in which this pattern has been most prevalent are a function of how much capability and desire there is to protect them nationally and how much R&D investment there is to protect. The aerospace industry is clearly one that has figured prominently, particularly as it relates to defense. We see it also in telecommunications (e.g., public switches), pharmaceuticals, and so on. The mechanisms for achieving it, consciously or unconsciously, include

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION 109 public procurement policies, legislation, technical standards, and public funding of research. Each in different ways has been used in the industries that we are thinking about here, but we have learned already in this conference of major changes on each of these fronts. The consequence of protectionism, of course, has been the domination of national markets by leading national competitors, in public switches, phar- maceuticals, and clearly also some of the aerospace markets. This, of course, causes those European companies and industries to be technologically uncompetitive only if the critical mass of R&D investment internationally cannot be supported by their national markets. But clearly for even the largest European countries we are well past that stage in aerospace and, increasingly, as we read in the press, we are past that stage in pharmaceutical, as the R&D "competitive mass" increases. Cost competitiveness of those industries is also seriously affected. In telecommunications, for example, if we draw an experience curve (meaning economies of scale) by plotting price per line versus the number of lines produced per year, we see that those operating within only a small national market cannot be as competitive as a Northern Telecom or any supplier that is serving a large international market. It has also led to some lag in the development of innovative products. In PBXs, we see an increasing lag between the major European competitors and their U.S. counterparts in developing new generations of equipment. This clearly cannot be allowed to continue. It results in an uneven set of unnecessarily high prices for some of these products across the European countries. Many of you will have been struck by the variation in price, for example, in leading pharmaceutical products across European markets. So what about the 1992 proposals? I will skip very quickly through this because it is now familiar ground. The technology-intensive industries have been fairly intensive targets for EC regulations and directives. Those mea- sures will tackle the policies on procurement, registration, and technical standards that have given us the pattern of the past. What we will see, as in the particular case of telecommunications equipment, is a phased process that frees up large chunks of the market, which will be available not only for a wider range of European competitors but for people in this room also. There has been much analysis along these lines of the "cost of non- Europe," which some of you will have seen in the very voluminous docu- ments produced at the time of the original 1992 legislation. But in addition to the cost of non-Europe, there will also be a "cost of Europe," because clearly we cannot achieve a more concentrated and consolidated European industry without a certain amount of pain. We already have reached the phase of "work sharing" between national aerospace companies, the forma- tion of consortia in much the same way as in Mr. McTague's references to international alliances in the automobile industry. We will continue to see

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110 EUROPE 1992 the formation of such alliances, and some of those are bound to cross the Atlantic as well as be European based. We will see them most where there is the greatest pressure on contribution margins of the industry and the greatest scope for consolidation. We have already seen quite a flurry of consolida- tion in pharmaceuticals so far in the United States; I believe it will extend into Europe in a much more significant way, as pressures on margins intensify. So one then has to consider how large an industry structure the new Single European Market will support. If we think here of public telecom switches, you can do calculations that persuade you there is only room for three or perhaps four major public switch manufacturers in Europe. As U.S. companies such as yourselves think about your European coun- terparts, obviously you have to consider whether they are going to be future leaders of the global industry, potential partners that could provide you with European infrastructure or specific valuable sources of technology. Overall, there are many hundreds of companies, even in fairly technology-intensive and traditionally profitable industries, that have to worry about their future a great deal. So this is something of the "cost of Europe," to consider alongside the cost of non-Europe. We have spoken so far of "Europe" without defining it. I would assert that you have to distinguish at least three Europes coming into being at different speeds: Europe as a technology source, Europe as a competitive arena, and Europe as a group of customers. It is always a mistake, of course, to think about it as a single place. I believe we will see technology concentrating in certain centers, centers that get funds from the EC, centers that companies themselves set up to be the European focus. We will see consolidated competitors: ABB Asea Brown Boveri is simply the first major European (as opposed to nationally rooted) company. However, we may not see Euro-consumers emerging at anything like the rate that some people imagine. Certainly, companies in industrial markets, because of the economic pressure on them, will soon become less nationalistic in their purchasing policies, but I do not think there is any EC directive that can deal with the psychological barriers that you see between different groups of European consumers. At this point I want to stress that when we think about Europe in the late 1990s, the 1992 event and everything associated with it must be considered alongside the opening of the eastern European frontiers. This second major discontinuity is bound to some extent to distract the German companies to look eastward for markets and partners, and many other European companies will do the same. A major redeployment of defense resources, with its implications for the R&D infrastructure of the defense industry, is bound to take place progressively over the 1990s. We already see people changing

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION 111 their defense procurement policies and funding decisions in a matter of weeks and months following the events we all marveled at last year. The globalization of Far East competitors is another factor. You have to project what the Japanese companies are planning to do; many of them have made some European moves in these industries already. Environmental pressures will also be at least as important for many chemical companies in the 1990s as will 1992, so will health care cost containment for companies based on pharmaceuticals or biotechnology. One could go on; I just want to encourage us all to think about how these trends may interact before launching into a 1992 strategy that simply adds up today's European markets and Eu- ropean competitors and treats them as a measure of the future Single Market. What are the challenges that Europe in the 1990s will represent for companies, and how should they think about responding? Making alliances is one widely canvassed response. Companies that have, for example, only a foothold in Europe and need to extend across it and American companies that want to establish a stronger network there are obvious candidates for such alliances. As Mr. McTague reminded us, neither transatlantic nor transpacific alliances are new. Neither is easy to forge because of the different business psychologies as well as technical specifications that the prospective partners may have. They are certainly difficult to manage, and arguably one has to plan how to exit such an alliance, if it proves unmanageable, just as deliberately and rigorously as how to enter it. A second challenge in responding to the new Europe is designing and phasing in European company structures. It is not going to be possible in a single bound to form a Euro-company structure. In many cases it will take a matter of decades to put this in place. Indeed, more important than formal structures are informal networks networks between technical people, between manufacturing people, between marketing people. Such networks may have no line authority but can be very effective in coordinating policy and action and, of course, in developing Euro-managers. What I want to close on are some of these broad organizational conse- quences of future European companies. This thinking is often uncomfortable for us, since many of us are technologists in background and so would rather think about future technology or the strategy that might follow from this technology. However, because they can constrain technology, strategy, and operations, the organizations of future European companies have to be examined from first principles. You cannot transplant a successful structure, or even an empirical model, of how to run a company from U.S. experience across Europe at least not yet; maybe you never can. You certainly will not be able to over the 1990s, so you have to work on a whole range of different levers and characteristics of the organization in order to make the future European company work. You certainly need to develop Euro-managers, and I believe many American companies will find this to be the most constraining

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2 EUROPE 1992 feature of their moves into Europe developing a cadre of Euro-managers who speak the languages, who know the people, who appreciate both the differences and the similarities, and who can thus operate right across Europe. Today such people are truly rare. In conclusion I want to emphasize that although technology is becoming increasingly global and markets and businesses are converging, developing effective European organization may be the rate-limiting step. As usual, it is the soft stuff that is going to be the hardest to manage. MR. NILES: The point you make about the difficulties of merging across national borders in Europe is an interesting one at least I think that is one you were making. I am reminded of the recent unsuccessful effort to merge a big bank in Belgium with a big bank in the Netherlands. You would think that might not be too difficult, particularly since they fit rather well in financial terms and in terms of the way their operations were struc- tured in each country. But after about six months they abandoned the effort because they could not get together culturally. We have seen quite a few experiences such as that in Europe. One of the things that has struck me in my eight months in Brussels is the fact that the real European companies in Europe are the American com- panies or non-European companies; they could very well be from other parts of the world companies such as the Ford Motor Company. Ford has been in Europe since 1903 and does not think of itself as being a national champion of the United Kingdom, Germany, Spain, or any other market. It has structured its operations with the European market in mind. Other American companies and non-European companies have done the same thing, and I think by and large they are better prepared to deal with the uncertainties and the tremendous changes ahead than many of the national champions in Europe such as the Siemens or the Fiats, which have thought of themselves primarily as German, Italian, or French companies. There is a shakeout ahead in Europe, I think, particularly in the area of manufacturing, that one hopes occurs at a time when the European economies are sufficiently buoyant to absorb the workers who will no longer be making automobiles, for example, and not just because of the penetration of the ~ . Japanese companies. Our next speaker is Mr. Winston Wade, president of U.S. West Advanced Technologies, also a vice president of U.S. West. Mr. Wade was born in Nebraska. He earned a master's degree in business administration and electrical engineering from the University of Nebraska and has worked with the Bell System in Omaha and in other parts of the Midwest. He became president of U.S. West Advanced Technologies in August 1985. MR. WADE: As some of you know, and maybe a lot of you do not know, U.S. West is one of the "Baby Bells." I say baby even though we have revenues of $10 billion. We are very active in Europe and around the

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION ~ 1 1 ^ 1~ ~ to 1 _ _ 1 , ~ 113 worth, ~nougn we nave oeen mere only a couple of years, in contrast to the story you heard about Ford. Our projects include cellular phone service, radio technology, fiber optics, and cable television. Much of the technical consulting and detailed planning work for these projects is provided by one of the organizations I lead, U.S. West Advanced Technologies. The background paper that we all received for this conference really captures the essence of my remarks. The question was raised: Are U.S. government and industry setting appropriate priorities for the country's science and technology base? For my industry, the answer is no. At U.S. West we see ourselves as strategic partners in bringing the benefits of the information age to Europe. By benefits I mean access to the widest possible range of information sources and the freedom to choose from a variety of communi- cation technologies to help manage both the speed of your business life and the quality of your personal time. A few years ago U.S. West had virtually no foreign investments; let me briefly describe to you what we have done in the last couple of years. In the United Kingdom we are involved in cable TV and we are a partner in 10 franchises. You might say, "Why cable?" Well, it is close to our base businesses: telecommunications, switching, transport, and installation. The timing is just right for us there, and the opportunity looks very good. It will also help us learn more about that industry in the United States, so we could potentially, if allowed, be a carrier for the cable companies in the United States. Perhaps even more important, the U.K. cable franchises give us the right to provide telecom facilities in the United Kingdom. Another major U.K. opportunity is in PCNs, personal communication networks. This technology differs from cellular technology a bit: a higher frequency range, more cell sites, and a greater volume of calls. It is really ideal for densely populated areas, using very small portable handsets, we can link a person to the telephone infrastructure. U.S. West is a partner in one of the three PCN licenses in the United Kingdom. We are also involved with cellular technology in Hungary. We have a joint venture with the Hungarian PTT to build and operate nationwide cellular services. There is a huge pent-up demand in Hungary, in all of eastern Europe for telephone service, and of course we can implement cellular services much faster than we can land line services. In the Soviet Union, U.S. West is part of a consortium proposing one of the longest fiber-optic cables in the world, 6,000 miles. It would cross the Soviet Union, linking Europe with the Far East, including Japan. It is not a done deal yet, but we are hoping to get approvals to move forward in this area. In Hong Kong we are a partner in a consortium that is building the largest single cable TV franchise in the world, potentially serving a million and a half customers. We will offer high-speed fiber-optic networks for telecommunications as well as for cable TV.

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION 115 unhampered by U.S. legal restrictions, committing big investments to R&D. Nippon Telephone and British Telephone have very large laboratories, but they do not have the constraints that we have. I read the other day that Nippon Telephone is building a data processing center in New Jersey. We cannot do that; we are prohibited from doing that. Modifying a decree through the existing waiver and petition process is not adequate, and, of course, we are arguing for congressional action and are working very hard to convince Congress of the need. In Europe and around the world, U.S. West has more freedom to pursue R&D and explore new markets than in the United States. We are seriously considering basing researchers in the United Kingdom and may establish a communications laboratory at some point in Hong Kong. If we go ahead, these research efforts would support our investments in cable and telecommunications sys- tems in Europe and Asia and bring our researchers closer to the customers. They would be able to do R&D work on information-age services that should be available to our customers in the United States but are not because of the legal constraints that we now have. I am not talking about designing new customer equipment for manufacturing. We would research the next generation of information services, like broad- cast messaging, which would allow police or fire officials to alert entire neighborhoods of an emergency situation; or advanced electronic mail and fax services, local area networks, and metropolitan area services; or electronic vaulting of critical data for businesses that need to protect themselves against disasters; and inexpensive smart office and home capabilities that use the facilities of the telecommunications network to control temperature and computer systems. We think these ideas are part of the next generation of telecommunications services. We believe they deserve to be researched and developed to the point where market trials will prove their viability and market demand. As I've indicated, this research is difficult for us to do in the United States, not because it represents a major threat to any existing business or unfairly leverages any monopoly we might have, but because of the law. So far the courts have turned a deaf ear to our case. Recently, I told the U.S. House Committee on Telecommunications and Finance that the decree forces us to try and define black-and-white technical boundaries where there are really, as you know, only shifting shades of gray. In the absence of relief from Congress, as I said, we are considering deploying those areas of research and development overseas. The first customers to benefit from this research might be in the European Community and in Hong Kong and potentially even in eastern Europe. Thanks to the modified final judgment, American businesses and consumers could be denied access to the next generation of advanced services. We believe it is critical that Congress act swiftly to modify the decree.

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116 EUROPE 1992 As I said earlier, strength begins at home. It is now easier for American telecommunications companies to deliver the information age to Europe. With more freedom at home, we think we could do a better job serving our customers, contribute more to the growth of the U.S. economy, and potentially help the trade balance. As we look forward to 1992 in Europe and even now, we see great opportunities and, as you heard me say earlier, we are moving on those opportunities. But my bottom-line message is that we really should look at the roadblocks we have here at home that prevent us from taking better advantage of the international opportunities that present themselves. If we don't examine those roadblocks, we could potentially put the United States further behind Europe in the development and exploitation of information-age capabilities. MR. NILES: Mr. Wade raises a very interesting, important question for any company, whether high tech or not, and that is the relationship between domestic antitrust and competition policy and foreign trade. We certainly are aware of cases in the past where well-intended efforts to enhance domestic competition resulted in creating foreign competition for us. One example is the creation of Aluminum of Canada Ltd. out of Alcoa, making the world a little more difficult for U.S. industry in the interest of competition policy. Our last speaker is Professor Richard Cooper of Harvard University, professor of international economics. He has a distinguished career in academia and in government. He served in the Department of State most recently from 1977 to 1981 as under secretary for economic affairs. In that capacity he also worked on the planning and implementation of the economic summits. DR. COOPER: My assignment was to think about the impact of EC 92 on the priorities of U.S. it&D-intensive firms. As I thought about that issue, I concluded with a few exceptions that I will note in a moment- that for the alert, well-managed, forward-looking firm, there should be no impact of EC 92 on its priorities. That is not to say that many changes are not taking Place. but those chances bv and large were taking place independently of EC 92. ~ ~ , - 7 , =7 The European Common Market has existed in a meaningful sense since 1958. Trade is not completely free within Europe, but merchandise trade is largely free. Most firms that have the possibility of trading successfully with Europe, either by exporting from the United States or producing successfully abroad, have already noticed Europe, have seen the opportunities there, and have taken advantage of them. They would be well established already. The EC 92 program is extremely important for certain aspects of internal trade, much more for trade in services than for merchandise trade, but its impact on outsiders, on balance, will be neutral to positive. And as I said, most alert firms would have already seen the opportunities and taken advantage of them. But, of course, most firms are not alert, well managed, and forward

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION 117 looking about all things that are going on all of the time. Like individuals, firms fall into patterns of behavior. They develop formulas and rules of thumb that have been successful, and they tend to discard those formulas or rules of thumb reluctantly. In this sense, EC 92 plays an extremely impor- tant role, but it is a psychological rather than a tangible one. It serves to remind firms that Europe exists, that there is a huge market there, that it has been open. But after 1992, assuming the Europeans succeed and every indication is that they will succeed with at least 90 percent of their program- the market will be even easier to deal with than in the past. So the great value of the EC 92 program for outsiders is to disrupt our habitual patterns of thought, our rules of thumb, to force us to think again, as we should have been doing all along, about the opportunities there. Decisions that were made five or 10 or even 15 years ago may no longer be optimal today and should be rethought and reexamined, not because of a program called EC 92 but because of all the other developments that have taken place since previous decisions were made but that we have not yet integrated into our thinking in a systematic way. Certainly, that is what is happening in Europe. It is odd to recall today that as recently as five years ago the general theme on both sides of the Atlantic was one of Euro-pessimism, Euro-sclerosis, and Euro-stagnation. The Brookings Institution, one of better public policy research institutions in the United States, undertook a study in the mid-1980s, with European encouragement, called Barriers to European Growth. It is characteristic of the scholarly and publication lags that the book came out in 1987, just as Europe was beginning to recover from nearly a decade of stagnation. But in the last few years Europe has become a much more vibrant economy, and it has become vibrant not least because EC 92 has induced European firms to shed their habitual patterns of thought and to think about new possibilities. One manifestation of that change is the accelerating number of mergers and acquisitions in Europe since the 1985 White Paper, Completing the Internal Market. European firms are taking EC 92 seriously. Shrewd American and other third-country firms will also take seriously the new possibilities in Europe, not just because of the EC 92 program but also because of the many other changes. One of the consequences of the developments within Europe is that at least some European firms will become more formidable competitors on the world market, as a result of the consolidations and rationalizations that are taking place within European industry. Extensive economic studies were done on the consequences of completing the European internal market, and it was concluded that there would be substantial cost-cutting advantages arising from economies of scale and perhaps more importantly from the increased pressures of competition, which would be more acute after completion

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118 EUROPE 1992 of the Common Market. The Emerson Commission estimated that on aver- age costs would drop about 6 percent compared with what they would oth- erwise be. One can argue about the magnitude of the drop, but the pressures are clearly there, and that will have consequences outside Europe as well as inside Europe for American, Canadian, Japanese, and other firms that are in competition with European firms. I said there were a few exceptions to my generalization that EC 92 narrowly considered should not have any implications for the priorities of the alert and well-managed firm. The first concerns standards, to which a session has been devoted, so I can be brief about it. The first point to note is that the harmonization of standards in Europe should offer tremendous opportunity to American firms. American firms above all others are accustomed to producing for a large market to a common standard. One of the problems in Europe for any firm, European or non-European, has been producing for moderate-sized markets that do not operate to a common standard. That will change. The change might not be completed by the end of 1992, although that is the target date for common standards or sometimes only common minimum standards for the whole range of industrial products and services throughout Europe. Americans have learned how to take advantage of large scale in marketing, and common standards will provide new opportunities In Europe. In setting the standards where third countries other than the EFTA countries are not actually present in the process, there is some danger that outsiders operating to different standards may be put at some disadvantage. That risk is certainly present. It has already materialized in a few cases. The response to it is vigilance and constant awareness of what is happening in the standards- setting process. Brussels is as leaky as Washington when it comes to policymaking, so it should not be difficult to find out where the arguments are, where the disagreements are, and where the consensus is tending. If those tendencies look as though they are going to be disadvantageous from the point of view of American firms, the proper response is to make representations before the standards are set definitively. These should take place first at the level at which the standards are being set. If that approach does not seem to be working, you can always complain to Ambassador Niles, whose job it is, among other things, as our chief delegate to the European Community, to represent the interests of Americans there. But this activity is not something that American business should sit back and wait for the U.S. government to take care of. With a few possible exceptions, the U.S. government does not have the technical knowledge to be able to identify when the evolution of a particular standard was going to be disad- vantageous or not. That is the responsibility of those who have the knowl- edge. The U.S. government can come in at a later stage and make represen- tations as necessary. But on balance in the area of standards the opportunities

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION 119 outweigh the risks and the risks are manageable with proper vigilance to the standards-setting process. The second area where my opening proposition is incorrect concerns those sectors of the European economies where government procurement has played an important role. Unlike most merchandise trade, Europe has not had a common market in government procurement. It is not just that outsiders have been excluded; other Europeans have been defined for these purposes as outsiders. The Commission estimate is that only 2 percent of total government procurement within Europe has been across European boundaries. Government procurement has been overwhelmingly national in its orientation. That, the Europeans are agreed in principle, must cease if Europe is to complete the Common Market. A major effort is now afoot to generalize government procurement. There is a lengthy list, including power generation and pharmaceutical where na- tional health authorities are involved, but telecommunications is perhaps the most significant area. In these areas the market will change dramatically after 1992, and the open question is how it will change. There will be tremendous resistance to this change because some firms' survival today depends on having a cozy relationship with government purchasers; those firms may be in serious jeopardy. So there will be tremendous resistance. The open question is whether government procurement will be opened up just for other Europeansthat is to say, will this be a Common Market- wide procurement alone or whether it will be opened up for third parties as well? That is to say, will Americans, Canadians, Japanese, and others be able to participate in what inevitably will become a more transparent process of government procurement? That issue has not been settled. European officials in Brussels say the right thing, which is that it should be opened up in general. One of the economic purposes of EC 92 is to get more competition into these industries, and that competition can come from outside Europe as well as from within. Whether that view is sufficiently attractive to overcome the political resistance to its execution is still open. In this area the U.S. government can play an important role. A code that covers some government procurement dates from 1979, negotiated in the Tokyo Round of GATT, under which Ameri- cans should exercise their rights. The current Uruguay Round of trade negotiations provides an opportunity to broaden the coverage of government procurement open to international competition. It is already on the agenda. To nudge the Europeans in the direction of allowing third countries to participate in their opening, the United States, Japan, and others should reduce the barriers to foreign bidders in their own procurement. So in selected industries there are potentially important new rlevelanme.nt~ e.~neri~llv they'd He Arrow ~~ + . . . A.. IS slgnl~lcant. A ~ ~ _ _ A ~ ~ ~ J ~ A A ~ V _ V ~ A A ~ A ~ ~ V v ~ ~ 1 11 1 1~1 1 ~ ~1 v ~ U 1 ~ 1 1 1 ~1 1 L

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120 EUROPE 1992 The final issue I would like to address, since it is on the list of questions circulated to all of us for this session, has to do with export controls by the United States. It will be difficult, and in the end impossible, to sustain the current U.S. government position on export controls of high-technology products to eastern European countries, which one by one are developing democratic forms of government. We are in transition at the present time. The Hungarian election is later this month, and non-Communists are expected to win handily. The Poles have locked themselves temporarily into a particular government that involves a coalition between Communists and Solidarity, but that will change over time. Czechoslovakia now has a democratic government, but it presides over an apparatus that has been there for over 20 years. Nonetheless, the possibility of sustaining a high degree of control on exports of dual-use but militarily significant exports to countries such as Poland, Hungary, and Czechoslovakia, not to mention an East Germany that is integrated with West Germany, becomes nil. even if the U.S. government were to stick by its historical position in this regard, because the Europeans will not agree to it, and the United States no longer has even a near monopoly on high technology. It will be impossible to separate East Germany from West Germany for trade control purposes once Germany is reunified, for example, and the logic of relaxing controls to countries such as Czechoslovakia, Hungary, and Poland is too compelling. At the same time, one has to recognize that strong ties have developed between those countries and the Soviet Union, not only institutionally but also, and more importantly, between individuals. We must assume that high-technology exports to those countries, or the technological content of them, will occasionally find their way to the Soviet Union. Take the case of East Germany. Many individuals, whether or not they are personally upset by the reunification of Germany under a capitalist regime, have personal ties with Russian officials, and no doubt many will go into private enterprise as spies, basically, for the Soviet Union after reunification of Germany. A new set of issues arises for managing the control of militarily signifi- cant technology to the Soviet Union. At a minimum, however, the situation implies that the United States must back off from the position that it has taken in practice so far, that anything that is militarily useful not militarily significant but militarily useful should be denied to the Soviet Union and its east European allies, and we should establish an apparatus that attempts, however imperfectly, to accomplish that end. given the recent developments in eastern Europe. It becomes unsustainable that position is untenable I would hope therefore that the U.S. government shows more flexibility and more suppleness than it normally does in adapting its policies to rapidly changing circumstances in this area. It has an important bearing, I do not have to remind this audience, on the practical possibilities for U.S. exports.

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION 121 MR. NILES: I would like to make a few comments. As Dick pointed out, I am your representative in Brussels to the extent that you run into problems or have questions involving activities by the European Community. While we have talked a little bit about EC 92, basically there are lots of other things going on in Europe today as well. Some of them have potentially greater implications for us than the Single Market program, which, as Dick Cooper points out, is something that has been under way in one form or another since 1958. Economic and monetary union is on the agenda, and I think European political union is very much on the agenda, too. The relationship between the European Community and the countries of eastern Europe is on the agenda and will be discussed at a summit on April 28; I think there will be some important decisions taken there. The European Community and the EFTA countries are moving into a relationship that will be something more than association and less than membership, difficult to define; whether they will actually find something that works for both sides remains to be seen. It may well be that some of the EFTA members, particularly as neutrality in Europe becomes less significant, will continue to opt for membership, as Austria says it will. You could see other members of EFTA applying for membership in the European Community. The psychological changes in Europe, to my way of thinking, are almost more important than the negotiations that are under way and the changes within the European Community as far as regulations, unification of rules, etc. There is a sense of optimism, There is a certain sense of unease right now because of what is going on in eastern Europe, particularly in Germany, but there is a very optimistic, dynamic spirit. These developments represent a response, as Dick Cooper suggested, in part to fear, as a result of the period of stagnation of Europe from 1975 to 1985, of falling behind the United States, and, to an even greater extent, a fear of Japan, which is as present in Europe as it is in the United States. This has led to much more emphasis in Europe on cooperation across European boundaries, and this is where I think the questions of future U.S.-EC scientific technical cooperation are particularly raised. There is today in Europe, in the private sector as well as in the public sector and the two, of course, work very closely together a sense of preference for the European solution, a preference to work together in Europe, between European companies, perhaps excluding U.S. companies. The same thing is true to a degree on the part of European governments, which look in the first instance to these programs under the EUREKA program (which was, in a sense, the scientific/technical counterpart of the 1985 White Pa- per, Completing the Internal Market, that led to the Single Market exercise), and the strictly EC scientific programs such as ESPRIT, BRITE, RACE, and so forth. There is a preference for doing things within Europe, and that is not something

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22 EUROPE 1992 I think we should be overly alarmed about, provided we manage our side of the relationship wisely. However, we have contributed to this European attitude in part by the mistakes we made in the past. The image of the United States, in the eyes of many Europeans, particularly in the area of scientific-technical cooperation, is of a country that is incoherent, inconsistent, and arbitrary, a country that changes its direction frequently, adopts programs, as Professor Bromley mentioned this morning, and then tries to sell them to other countries and is surprised sometimes when other people are not prepared to jump on board with great enthusiasm. Then after having signed everybody up, we decide, well we won't do it quite that way, we will do it this way, and we will let you know about it when we have decided how we want to do it. This will not work anymore. There needs to be a cultural change in the United States in the way we look at western Europe and the rest of the world for that matter. It involves a sense of the proportionality between the United States and western Europe, and in no area, I think, is it more important that we do this than in the area of scientific-technical cooperation. Dick Cooper talked about the need for a partnership between government and the private sector. I think it is a very good point. We feel, in the U.S. mission to the Community, that we have to work very closely with the private sector if we are going to do our job properly. We want to hear from you, from the private sector, about problems. Dick mentioned standards. That is certainly an area where we need to work closely together, and I think the previous panel made clear that a lot of progress has been made in that area. Government procurement is something that we have very much on the agenda between now and the end of the year, parallel with the Uruguay Round talks, the talks on extending the government procurement code to these four famous excluded sectors: telecommunications, water supply, transportation, and power generation. The European Community has now made an offer, in a sense, by adopting a directive that unifies the European market in these areas. We think we have the possibility at least for a deal in the procurement code negotiations. Finally, we will be adding, in April 1990, a scientific counselor at the mission to the European CommunitiesBud Rock, who currently works in the Oceans, Environment, and Science Bureau of the Department of State. MR. LEIGHT: Walter Leight, NIST. We heard Dr. Contzen applaud the partnership in prenormative research. We heard Dr. Dunstan say that Americans or other third parties could make comments on draft CEN-CENELEC stan- dards. We heard that we can participate in ISO after the standards are forwarded to ISO. In response to a question, we heard Dr. Dunstan say that those American companies or non-European companies with European sub- sidiaries could participate in the development of CEN-CENELEC standards, and now we have heard Professor Cooper suggest that Ambassador Niles can raise protests with the European Commission if something goes wrong.

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION 123 The simple question is, would it not help short-circuit the whole process if we could participate directly in the development of European standards in the first place, in exactly the same sense as most of the major standards- developing organizations in this country are completely open to participation by anybody from any part of the world. DR. COOPER: The answer to your question is yes. We put it to the Europeans and they rejected it. Tom Niles probably knows the story. He can perhaps elaborate. MR. NILES: I would not say we put it to them in quite that way, but the answer to your question is yes, it would be simpler. Is that possible today? The answer, realistically, is no. What we have done, I think, is to construct a network of contacts that to a large degree make up for the fact that we are not at the table in CEN or CENELEC or ETSI unless, of course, we go back to the question raised by the Eastman Kodak representative. U.S. companies in Europe have every opportunity through the national standards organizations to participate in the establishment of CEN-CENELEC-ETSI standards. The key for the United States is to get more actively engaged in the international standards process through IEC and ISO. I really believe that. The United States is missing a great opportunity here, it seems to me, by not being more engaged than it has been traditionally in the international standards-setting operation because, as was made clear earlier by the panelists in the previous session, to the extent there is an international standard, CEN, CENELEC, and ETSI adopt it. I must look into this case about ETSI perhaps departing from some international standards. I had not heard about that, but we want to protect our interest in the international standards area, not just in the case of Europe. The key is through ANSI into ISO and IEC. DR. DUBY: Jean-Jacques Duby, IBM Europe. I have one question for Professor Cooper. You said that you do not see any impact of the European programs on the American companies' research and development strategy, and I am perfectly willing to believe you on this point. My question is, do you see the same zero impact on American companies' research and devel- opment localization on the one hand and R&D alliances strategy on the other hand? DR. COOPER: The question is a general one, and both industrial activ- ity and R&D activity are series of specific cases. I guess I would not want to answer the general question in the negative, but my basic view that I tried to suggest is that Europe has been there for some time. It has been a great opportunity for some time, and most of the firms that have opportunities there, apart from those areas where government procurement has confined the market very sharply, should already have been doing the things that they now might think of doing as a result of EC 92. I am not sure that is responsive to your question. It is not that changes are not taking place; it is

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24 EUROPE 1992 that I do not see EC 92 per se, apart from the areas that I mentioned, as generating those changes. If there are reasons to promote the EC 92 program, they are generated because really interesting work is going on in Europe, and, in order to tap into it, you have to locate your research facilities there. That by and large would have been true without EC 92. MR. KALIL: Tom Kalil, Labor-Industry Coalition for International Trade. It seems to me that part of the message of the European Community is that if you want to participate in Europe's market you at least ought to have the decency to make your stuff in Europe. They have been very effective at using antidumping duties and anticircumvention orders and rules of origin to encourage U.S. and Japanese manufacturers to increase their manufacturing presence in the Community, particularly in areas like consumer electronics. My question for the panel is whether the Community is not shooting itself in the foot by creating overcapacity in certain sectors. MR. NILES: I will try to respond to that, at least for me; I do not know whether I can respond for the panel. The problem that we have encountered, and to which you allude, is a rather restricted one. It involves antidumping cases arising from Japanese market success in Europe, and anticircumvention arrangements designed to ensure that so-called screwdriver plants set up by the Japanese elsewhere in one case the Ricoh Company moving into Cali- forniado not have the effect of getting around the antidumping requirements. So they established a requirement that in order to avoid the dumping duties at least 40 percent of the product has to be from a country other than the country of the dumping company. The Japanese company must acquire at least 40 percent of the value of the product somewhere else. Where does that 40 percent come from? There were some indications the Europeans had said to the Japanese companies in a couple of cases that they would be a lot better off if they acquired that 40 percent in Europe. That would of course encourage the Japanese to buy European and would encourage United States companies, in order to sell to the Japanese, to invest in Europe when they would not otherwise have invested there. We have now secured from the Commission an explanation that indeed that is not the policy, that if the Japanese company wishes to buy that 40 percent from other parts of the world, that is fine and it does not have to be acquired in Europe. A problem remains on the matter of defining the origin of a printed circuit board, which is an important part of many consumer and industrial electronics items. It is a mind-numbing problem if you have ever tried to get into it. I will not even try to describe the complexity of it, but that is the one very limited case where we have an ongoing discussion with the European Commission. The problem has been narrowed down to the point where we are discussing what sort of a rule to use in determining the origin of a printed circuit board.

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STRATEGIC IMPLICATIONS OF EUROPEAN MARKET INTEGRATION 125 Whether this could result in the creation of excess capacity, the answer to your question is yes, if rules of origin were misused in order to force investment in Europe. We believe the Commission has made clear to companies that this is not its intention, that it is not trying to force investment in Europe. To the extent that companies are investing in Europe, they welcome it, but this is not a result of manipulation of the rules of origin. DR. BARKER: It seems to me that, picking up Dick's view about progressive thinking, global manufacturers should be beyond some of this already. This may be an idealistic point of view, but the optimum location of your manufacturing facilities globally should be regarded as very much an open question. There are European countries such as my own that have pretty low labor costs and pretty high skill levels. You see the same elsewhere; you see the Japanese companies, for example, setting up many of their manufacturing facilities offshore in Singapore, Malaysia, and so on. I would have thought it was worth our while thinking beyond whether we can export U.S. manufactured goods to asking where in the world does it make economic sense to carry out research, development, manufacturing, and so forth.