Policy Implications of Japan's Growing Technological Capabilities: Framing the Issues

RICHARD R. NELSON

My aim here is to provide a frame for discussion of the policy issues associated with the rise of Japan as a major technological power. I do so by flagging five matters. First, there has been significant convergence of the technological capabilities of the major industrialized nations, and this was inevitable and will not be reversed. Second, since the early 1970s the U.S. economy has seen very slow growth of productivity and incomes, compared with growth rates during the earlier postwar era; this phenomenon often is associated with and indeed blamed on convergence, but likely has little to do with it. Third, while in the early postwar era the United States had special advantages in what have come to be called "strategic" industries, in recent years this has been less and less the case; however, whether this significantly disadvantages the United States is an open question. Fourth, the national institutions and policies supporting the development of technology are complex and varied, involving much more than simply "private enterprise" and "markets," and this is true in the United States as well as Japan; the question of what is appropriate and fair government involvement in technological advance and what is not does not have an easy answer. Fifth, the relationship between national policies and national technological capabilities has become even more complex in recent years as a result of the increasing internationalization of business. I want to briefly develop each of these themes.



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Japan's Growing Technological Capability: Implications for the U.S. Economy Policy Implications of Japan's Growing Technological Capabilities: Framing the Issues RICHARD R. NELSON My aim here is to provide a frame for discussion of the policy issues associated with the rise of Japan as a major technological power. I do so by flagging five matters. First, there has been significant convergence of the technological capabilities of the major industrialized nations, and this was inevitable and will not be reversed. Second, since the early 1970s the U.S. economy has seen very slow growth of productivity and incomes, compared with growth rates during the earlier postwar era; this phenomenon often is associated with and indeed blamed on convergence, but likely has little to do with it. Third, while in the early postwar era the United States had special advantages in what have come to be called "strategic" industries, in recent years this has been less and less the case; however, whether this significantly disadvantages the United States is an open question. Fourth, the national institutions and policies supporting the development of technology are complex and varied, involving much more than simply "private enterprise" and "markets," and this is true in the United States as well as Japan; the question of what is appropriate and fair government involvement in technological advance and what is not does not have an easy answer. Fifth, the relationship between national policies and national technological capabilities has become even more complex in recent years as a result of the increasing internationalization of business. I want to briefly develop each of these themes.

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Japan's Growing Technological Capability: Implications for the U.S. Economy CONVERGENCE During the quarter century after World War II the United States led the other countries of the world in productivity, income levels, and command of technologies across a very wide front. I believe it is useful to distinguish two components to the U.S. technological lead. One component was in mass production industries like automobiles, steel, and meat packing, and this was of long standing. It reflected the fact that, as long ago as the close of the nineteeth century, the United States was the world's largest, richest common market, and international trade in manufactured goods was limited. The other component, the commanding U.S. lead in ''high tech" industries, was new. Before World War II the United States was scarcely a slouch in high tech, but Europeans felt no sense of inferiority here. What led to the American lead here was the massive investment in education in science and engineering, and in research and development, that the Americans made after World War II. The investments made by other industrial nations were much, much lower. Over the last five years or so there has grown up a significant economic literature on "convergence." For the most part, that literature treats the American postwar lead as something of a "sport," having to do largely with the fact that our major industrial rivals had been badly hurt by World War II, and therefore as something that naturally would dissolve as they recovered. My argument above is that the U.S. lead was not a sport and had something but not very much to do with the wartime devastation of our industrial rivals. And there was nothing "automatic" about the convergence process that did occur after they recovered. There were two major factors behind convergence. First, largely as a result of U.S.-pressed policies, the world increasingly became a common market in manufactured goods. With easy access to foreign markets, the size of one's home market mattered much less. And so the United States lost its long-standing advantages in mass production industries. The second major factor was that other advanced industrial nations came to match the large investments in science and engineering education, and in research and development, that the United States had been making. In the early stages of this catch-up, firms in foreign countries became more sophisticated and more rapid imitators of technologies first introduced in the United States. But by the late 1970s in many areas foreign firms were close to where U.S. firms were. These two developments interacted strongly. Internationalization of trade and business, combined with the catching up of other countries to U.S. levels in science and engineering education, and in research and development, to make technologies international rather than national. How is all this germane to the topic at hand? It is germane because

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Japan's Growing Technological Capability: Implications for the U.S. Economy much of the rise of Japan as a technological as well as an economic power reflects exactly the processes of convergence I have discussed above. Japan did it through massive investments in education, and in research and development. But she couldn't have done it without the internationalization of trade. The other side of this coin is that, in my view at least, one will not see in the foreseeable future the opening up of big gaps in technological capabilities, among the major industrial nations of the sort that one saw after World War II. It is extremely unlikely that the United States possibly could redeem those kinds of leads. On the other hand, I doubt seriously that Japan will be able to establish and hold them. The major industrial nations of the world are tied together economically and technologically as never before. SLOW GROWTH IN THE UNITED STATES In my view, convergence would have occurred rapidly over the last quarter century whether economic growth in the United States had been fast or slow. However, the rate of productivity and income growth in the American economy slowed down significantly in the early 1970s from what it had been earlier. Perhaps that has hastened convergence. But its more important effect has been to thwart the expectations of Americans regarding what their economic future holds. Convergence has been associated with "bad times" here, as contrasted with good times. Economists have gone over a long list of explanations for the productivity and income growth slowdown. During the middle 1970s, it was energy price shocks. During the middle and late 1980s, low savings rates have become the culprit fingered by many. Problems with American education constitute another popular culprit. However, I think that it is fair to say that economists simply don't understand very well the reason for the growth slowdown. I doubt seriously that the rising technological and economic competencies of other nations would have bothered Americans so much had these not been accompanied by the slowdown in the United States of productivity and income growth. More, there clearly is a tendency of some to see stagnation in the United States as a consequence of rising competencies abroad, particularly as these have been manifest in a surge of U.S. imports and a decline of U.S. industries in fields where, during the heyday of the 1960s, we used to dominate. However, in my view at least, it is highly unlikely that the rising strengths of other nations, particularly Japan, have been an important factor behind the weak performance of the United States. Strong performance abroad and the consequent sharp increase in imports in many fields certainly have been a cause of the erosion of employment and output in a number of industries

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Japan's Growing Technological Capability: Implications for the U.S. Economy that used to pay high wages and to be relatively profitable. A good case can be made that the result has been a transfer of real income among Americans between those who used to be fortunate enough to be employed by those industries, and the rest of us who now are getting better products at lower prices. But this is not an argument that if foreign economies had not advanced so rapidly, or if the United States had insulated itself from their growing prowess by blockading imports, the real productivity and income of Americans would have grown faster. Indeed, I think this highly unlikely. There is a somewhat different argument that I find more plausible. It is that the increasing openness of the United States to imports, and the internationalization of financial markets, diminished the ability of the United States to operate its economy with demand pressing hard on capacity and with low levels of unemployed, and that this has fed back to diminish our growth rate. But this is not a story linked particularly to the growing technological sophistication of Japan. THE ''STRATEGIC" INDUSTRY CONCEPT There are two somewhat different concepts of a "strategic" industry that have some currency within economics. One is a relatively new one, associated with the rise of what has been called the "new" trade theory. It is based on the argument that, in industries that are inherently oligopolistic, because of large economies of scale in production, or large up-front R&D costs, or strong learning curve effects, the countries where these industries reside may be advantaged economically because their equilibrium profits and wages are higher than in the run-of-the-mill more structurally competitive industries. A different argument is that a nation may be advantaged if it possesses industries that generate a considerable amount of "externalities'' and that these externalities tend to remain within national borders. This latter argument sometimes is seen as connecting with an older one, associated with Schumpeter, to the effect that at any time there tend to be a small group of industries that are strategic in the sense that the technological advances they create have very widespread impact, being the basis for technological advance across a wide spectrum of other industries. In recent years, microelectronics and new materials have been argued to have this characteristic. It has been argued that, while the United States used to have these industries, it is precisely these strategic industries that we now are losing to Japan. More, the reason Japan is gaining ascendancy in these industries has a lot to do with the policies of the Japanese government specifically aimed to help these industries. According to this argument, if the United States does not match these policies, or otherwise protect these industries, the result will be highly detrimental to the American economy. This argument

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Japan's Growing Technological Capability: Implications for the U.S. Economy clearly lies behind the beliefs of many who posit that the Japanese technological and economic successes of the 1970s and 1980s are the cause of the poor performance of the American economy over this period. Current arguments to this effect lie behind the political thrust toward protection and toward more active U.S. policy in support of "strategic" industries. I do not want to argue against the point that, in certain circumstances, industries where firms have considerable market power are able to pay higher wages and reap higher profits than more competitive ones, or against the argument that technological advance in certain industries yields widespread externalities. However, I proposed earlier that the erosion of market power in the American steel and automobile industries, because of import competition, probably is better regarded as having caused a redistribution of real income among Americans than having caused a transfer of real income from Americans to Japanese and other foreigners. International competition in these "natural oligopolies" is fierce, and it is not at all clear that the surviving companies in these industries are all that profitable. Also, while I believe strongly that technological advance in microelectronics, and in materials, yields widespread benefits, they are not captured by the companies introducing the new products; it is not at all clear to me that these benefits are largely captured by firms, and citizens, who reside within the country housing the innovating firms. What is striking about these industries is the web of transnational intercorporate technology trading arrangements that have developed over recent years. I come back to a point I made at the outset. National borders seem to mean far less economically, and technologically, than they used to. THE INDUSTRIAL POLICY DISPUTE Americans over the years have put in place a large variety of policies aimed at enhancing the technological capabilities of "our" firms. For example, we long have had significant funding of agricultural research. Our publicly funded biomedical research program is by far the world's largest. U.S. government agencies routinely target research monies at technologies of interest to them. SEMATECH is one of the largest public programs supporting research in semiconductor technology. Nonetheless, many of us have the perception that we do very little of that; that foreign governments, particularly Japan, do much more; and that this is "unfair." It is not quite clear what the basis of that claim is—what divides "fair" from "unfair'' policies. Sometimes fair seems to mean what we do, or claim we do, but this position clearly is not acceptable internationally, even if we could agree on what we actually do. A better position might be Kantian, with unfair policies being those that, if everyone engaged in them, would make everyone worse off, but if

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Japan's Growing Technological Capability: Implications for the U.S. Economy some do and some don't the former are advantaged and the latter disadvantaged. In the economists' jargon, government support or protection or coordination ought to be defendable on the basis of persuasive arguments about "market failure." If it can be argued that, while positive public action may give advantage to a particular national industry, such support can be argued to increase economic efficiency, the program is not on its face "unfair." But the problem with this line of argument is that "market failure" is ubiquitous in the activities associated with industrial innovation, and thus subsidy or protection or guidance could be efficiency enhancing, and hence the game of active industrial policy need not be negative sum. What has come to be called "the new trade theory" recognizes some of this, nervously. If there are large "up-front" R&D costs, or significant learning through doing or using, or major externalities in certain activities like research and training, the simple arguments that free trade is "Pareto Optimal" (in the parlance of economists) falls apart. Of course "market failure" is greater in certain activities than in others. Also, government competence and incentives are more likely to lead to productive programs in certain arenas than in others. Further, it is apparent that competitive protection and subsidy among nations can go beyond any level conceivably justified on grounds of "efficiency." It is in the interest of all nations to reign in such tendencies. Nor is it likely that simple rules—for example, that government support of R&D on public sector needs and for "basic" research is efficient and fair, while direct support of industrial R&D aimed to develop products for a civilian market is both inefficient and unfair—will carry the discussion very far. This argument certainly can be used to attack European government subsidies to Airbus. But Europeans rejoin that government help was needed to overcome the huge head start American companies had won in large part as a spillover from military R&D, and can be justified economically both on infant industry grounds and as a policy to avoid the development of a one-company world monopoly. And what of government support for telecommunications R&D where telecommunications is a government service? Americans are prone to argue that telecommunications should be privatized, but there surely is limited agreement on that. And what to one eye is blockage to competition in public procurement, to another is a valuable close relationship between customer and supplier. Nor are there clean lines separating "basic research" from applied. No one seems to object to government support for research on the causes of cancer (although a breakthrough here may give the firms with close contact with the research a major advantage in coming up with a proprietary product). But what about research to advance agricultural productivity? To improve crops growing in a particular national climate? Research on super-conductivity, or on surface phenomena in semiconductors, conducted in

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Japan's Growing Technological Capability: Implications for the U.S. Economy universities? Conducted in an industry cooperative research organization? In a particular firm? Presently, different countries are trying various of these approaches to enhancing technological competencies. In my view, we should welcome the diversity, not label it "unfair," because we have a lot to learn about what kinds of policies are effective and what kinds are not. INTERNATIONALIZATION OF BUSINESS AND TECHNOLOGY I want to conclude by returning to my opening point. A central irreversible development of the past quarter century has been the internationalization of trade, business, and technology. An important consequence is that national policies aimed at enhancing the technical capabilities of "national" firms increasingly are at odds with the structure of business. National firms, particularly in "strategic industries," now often have a set of technological agreements and relationships with "foreign" firms. In the United States and Europe (less so in Japan) many of the establishments within national borders have their central headquarters in other nations. As Robert Reich has asked, "who is us?" However, I would like to put the matter another way. While this conference is focused on the consequences for the United States of Japan's growing technological capabilities, perhaps that question is too narrow and slanted to orient the discussion in a useful way. Let me propose that the real question is how the United States can learn to cope better with a world where technology is international, where the advanced industrial nations are basically on a par with each other in terms of access to technology, as are the firms that happen to be headquartered in different nations. We must understand that, today, national borders and citizenship, including our own, mean much less economically than they used to mean.