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Technology in Services: Past Myths and Future Challenges JAMES BRIAN QUINN In recent years many have expressed concerns over the decline of U.S. manufacturing. Yet most government statistics show that total employment in manufacturing has decreased only marginally from long-term levels, and both real gross national product (GNP) and real net value added attributable to manufacturing grew steadily until the mid-1980s as shown in Figures 1- 3. Although some recent publications have challenged the assumptions behind these statistics (Mishel, 1988; Office of Technology Assessment, 1988), most projections through the year 2000 show manufacturing output growing at a rate similar to that of the total economy (Personick, 19871. Nevertheless, individual manufacturing industries such as automobiles, basic steel, and consumer electronics have suffered real declines in employment and output over the last 15 years, and in some fields U.S. goods have become uncom- petitive in world markets. Meanwhile, the services sector has grown steadily and now accounts for 71 percent of the country's GNP and 75 percent of its employment (see Table 11. The movement toward services has been a long-term trend not only in the United States but also in all major industrialized countries. It is time to put aside some popular misconceptions about services that may have fit better in an earlier period, but can now seriously impair our capacity to meet future challenges. Those who fail to understand the realities and potentials of ser- vices are very likely to mismanage their own enterprises. They will certainly support some poor national policy choices. 16

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TECHNOLOGY IN SERVICES 80 70 60 50 40 30 20 10 o 17 Services ~ Manufacturing Agric., Min., Constr. ~ I I ~ 1950 1960 1970 1980 1986 Year FIGURE 1 Employment trends by sector. SOURCE: Bureau of Economic Analysis The National Income and Product Accounts of the United States, Bureau of Labor Statistics, Establishment Data Base: Employees on Nonagricultural Payrolls by Major Industry. 1 800 1 600 En 1 400 1200 ~ 1 000 CO 800 600 m 400 200 o ~ Services _ _ _ ~ Manufacturing _ _ Agric., Min., Constr. ) 1950 Year 1970 1980 1986 _ ~ /// FIGURE 2 Real gross national product by sector. SOURCE: Bureau of Economic Analysis, The National Income and Product Accounts of the United States.

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18 JAMES BRIAN QUINN 1 600 1 400 In ce 1 200 o cat 1 000 800 o in 600 o ._ m 400 200 Services ~3 Manufacturing O Agric., Min., Constr. i, _ Hi_ 1950 1960 1970 1980 1986 Year FIGURE 3 Real value added by sector. SOURCE: Bureau of Economic Analysis, The National Income and Product Accounts of the United States. DISPELLING PAST MISCONCEPTIONS ABOUT SERVICES Unfortunately, many executives and policymakers have tended to dismiss services as predominantly "taking in laundry" or "making hamburgers" for each other. Such simplifications belie the complexity, technological sophis- tication, and continuing growth potentials of services in the 1980s and l990s. While there is not a complete consensus on definitions, most authorities consider the services sector to include all economic activities whose output (1) is not a product or construction, (2) is generally consumed at the time it is produced, and (3) provides added value in forms (such as convenience, amusement, timeliness, comfort, or health) that are essentially intangible concerns of its purchaser (Kutscher and Mark, 19831. The Economist has more simply defined services as "anything sold in trade that could not be dropped on your foot." With these definitions in mind, one can readily reassess some of the most misleading myths, held over from the past, about services. The "lower value" misconception perhaps first stated by Adam Smith- regards services as somehow less important on a "human needs scale" than products. Because services are essentially marginal (so the argument goes), they cannot add the same economic value or provide the gro^wth potentials that manufactures can. Perhaps in elemental societies it is true that the first production of food,

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TECHNOLOGY IN SERVICES TABLE 1 U.S. Gross National Product and Employment by Industry, 1986 Employment GNP ($ billion) (millions) TOTAL ECONOMY $4,235 108.0 Goods Agriculture, forestry, fisheries 93 1.7 Mining and construction 293 5.7 Manufacturing 825 19.1 Total Goods $1,211 [29%] 26.5 [25~] Private Services Finance, insurance, real estate 695 6.5 Retail trade 408 18.4 Wholesale trade 295 5.8 Transportation and public utilities 276 4.0 Communications 115 1.3 Other services 700 24.9 Total Private Services $2,489 [59%] 60.8 [56%] Government and government enterprises Total Services Rest of world and statistical discrepancy 19 507 $2,996 [71%] 30 20.6 81.4 [75%] NOTE: The services sector includes some giant industries, larger than the great manufacturing industries such as automobiles or steel. Even the "other private services" category contains such sizable activities as health services ($199 billion), education ($27.0 billion), entertainment ($30.0 billion), design engineering, consulting, legal ($52.0 billion), software, and architecture professions that are sophisticated generators and users of technology. Large government services groups, such as the Department of Defense, the National Aeronautics and Space Administration, the Department of Agriculture, or the Department of Energy, support other huge, advanced technology businesses. SOURCE: Bureau of Economic Analysis, The National Income and Product Accounts of the United States (July 1987, Table 6.1, p. 57; Table 6.6B, p. 60). basic shelter, or clothing may take precedence over other demands. However, as soon as there is even a local self-sufficiency or surplus in a single product, the extra production has little value without further distribution, financing, or storage all "services" activities. In most emerging societies, services such as health care, education, trading, entertainment, religion, banking, law, and the arts quickly become more highly valued (high priced or capable of generating great wealth) than basic production. Such differentials tend to be even more marked in affluent societies. Far from being inferior economic outputs, services are directly inter- changeable with manufactures in a wide variety of situations. Few customers

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20 JAMES BRIAN QUINN care whether a refrigerator manufacturer implements a particular feature through a hardware circuit or by internal software. New computer-aided design and manufacturing software can substitute for added production or design equipment, and improved transportation or handling services can lower a manufacturer's costs as effectively as cutting direct labor or materials inputs. These "services" can improve productivity or add value just like any new investment in physical handling machinery or product features. Even more fundamentally, products themselves are only physical embod- iments of the services they deliver. A diskette delivers a software program or data set. An automobile delivers flexible transportation a service. Elec- tncal appliances deliver entertainment, dishwashing, clothes cleaning or drying, and convenient cooking or food storage all services. In fact, most products merely provide a more convenient or less costly form in which to purchase services. It should be no surprise then to find that, nationally, the total value added in services industries is higher than that in manufacturing (see Figure 31. Although total value added per employee in services is lower nationally than that in manufacturing, in the strategic business units of the larger com- panies sampled by Profit Impact of Market Strategy (PIMS) data, value added per services employee is very comparable to that per manufacturing employee (see Figure 41. This suggests that there are significant economies of scale in the larger services enterprises. 30 25 a) a) o Q _ a) on O O A: ~ a, ~ 10 > ::::::: 5 o Manufacturing All Nonretail Retail Services FIGURE 4 Profit Impact of Market Strategy (PIMS) indices of value added. SOURCE: Figures 4-6 were prepared by Christopher Gagnon from the PIMS 1985 data base of the Strategic Planning Institute, Cambridge, Mass. PIMS data are provided by strategic business units from cooperating companies on a voluntary basis. Most of the cooperating companies are major U.S. corporations.

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TECHNOLOGY IN SERVICES 140 a) a) o Q 100 LL a) 0 ~ 0 cts ~ ~ 60 o o m co in o 120 80 40 20 _ :.:-:.:.:.:.:' :::::: ::::::: 0 ~ Manufacturing All Nonretail Retail Services FIGURE 5 Profit Impact of Market Strategy (PIMS) indices of capital intensity. SOURCE: See Figure 4 legend. 21 The "low capital intensity" perception asserts that services industries are less capital intensive and much less technologically based than manufactur- ing. While this may be so for small scale retailing and domestic services, many services sectors today are very capital and technologically intensive. The prime examples are communications, transportation, pipelines, and elec- tric utilities. However, the banking, entertainment, health care, financial services, auto rental, message delivery, and retailing industries also increas- ingly qualify. In his chapter, Roach calculates that total capital investment and in particular high-technology investment per "information worker" (services activities) has been rising rapidly since the mid-1960s and now exceeds that for workers in basic industrial activities (Roach, 1985, 1988~. Similarly, Kutscher and Mark (1983) show that nearly half of the top 30 most capital- intensive industries (of 145 studied) were services. Furthermore, certain services industries notably railroads, pipelines, broadcasting, communi- cations, public utilities, and air transport were among the most capital intensive of all industries. Surprisingly, few services industries were found in the three lowest capital intensity deciles. Our analyses, based on PIMS data, also show aggregate capital intensity in larger services enterprises com- parable to those in manufacturing (see Figure 51. The "small scale" misconception considers the services sector as too small in scale and too diffuse either to buy major technological systems or to do research on its own. Although complete Hirfendahl indices of concentration

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22 JAMES BRIAN QUINN are not available, PIMS and Fortune 500 data suggest that concentration and scale among larger services units are comparable to those in larger manu- factunng units (see Figure 61. Many companies in the services sector clearly have the financial power to buy technology as it becomes available and needed. Large banks, airlines, utilities, financial services institutions, communi- cations companies, and hospital, hotel, or retail chains not only have the scale needed to purchase technology, but can also contribute to its long-term creation, reduction to practice, and introduction. These and other companies acting in intermediary roles (like distnbutors) often then push technology out into smaller services companies, assisting or forcing its rapid diffusion. Many of these large institutions now support major research programs, creating and guiding new technological developments themselves, as Citicorp did with automated teller machines (ATMs) and Federal Express has done with its COSMOS, DADS, and mass sorting systems. The "services can't produce wealth" viewpoint holds that services are not capable of producing the ever higher levels of real income and personal wealth that have been the hallmarks of the "industrial" era. This argument assumes, in part, that services inherently cannot achieve the productivity increases available through automation in manufactunng. If not, services cannot possibly achieve the inflation-free income growth rates manufacturing can. Productivity in services is notoriously difficult to measure because of the cn ._ [L 70 a) _ I' 60 ~ 50 Q a, I CO a) con o a) Cay a) CL 80 40 30 20 10 o :::::;: ....... :-:-:-:-:-: ...... ...... :-:-:-:-:-: :-:-:-:-:-: :-:-:-::: i-:-:-:-:-:-: :::::: ::::::::: :: :-::: :::::: :-::::-:-:- :-:-:::-:-:- :-:-:-:-:-:- Nh~] Manufacturing All Nonretail Retail Services FIGURE 6 Profit Impact Market Strategy (PIMS) indices of concentration. SOURCE: See Figure 4 legend.

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TECHNOLOGY IN SERVICES 23 many problems, specified in the chapter by Mark, in numerically defining output units and quality differences in services (Mark, 1986, 19881. For example, how does one evaluate medical procedures that may use fewer resources, but substantially increase patients' pain or morbidity levels? Is the number of letters delivered per mail worker a meaningful productivity measure if more letters are late or lost? Of what use are standard economic productivity measures that ignore the output value of public services such as sewage treatment plants or-assume that this output value is only equal to its cost? One should be very cautious in interpreting aggregate productivity data about services. Productivity measures are more valid in competitive arenas where cus- tomers can make direct purchase trade-offs between one class of services and other services or manufactures. Here the sales value of a service can provide a better surrogate for measuring output. In some of these more measurable segments, Bureau of Labor Statistics (BLS) historical data suggest that individual services industries can sustain productivity growth rates as high as those in manufacturing for substantial periods (see Table 21. Although the 1980-1985 aggregates are less encouraging, those for 1985- 1986 have rebounded, and data for more detailed Standard Industrial Clas- sification (SIC) categories show wide variations in productivity growth rates among different segments of both manufacturing and services (see Table 31. Both aggregate and narrower industry-oriented statistics suggest that there is no inherent reason why many services industries cannot keep up with or outperform individual product industries in terms of productivity increases. One key will be the ability and willingness to make new technology invest- ments in each sector. Manufacturing productivity has improved markedly since 1980, based on extensive restructurings and investments. However, new technology invest- ments by services producers have also soared since 1975, with financial services, wholesale trade, and health services among the leaders (Roach, 19871. Interestingly, the information technologies at the heart of services investments often offer multiplying benefits. As workers master the new technologies, they frequently discover or create new or more productive applications not envisioned in the original investment. Both output values and their own skills human capital values not included in productivity measures are enhanced. After a delay for absorption and employment ad- justments, many experts anticipate that these expenditures will boost services productivity substantially, as suggested by Kendrick in his chapter, although the results may not show up as dramatically in aggregates because of the measurement problems cited above. In a similar vein, Barras (1986) in a recent and very thorough study of the British economy showed the services sector productivity growing at 2.9 percent annually (based on the real value of output per employee) from 1960

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24 so i, i_ Cal . ~ ._4 Cal o Cad m Ct C,: O O Ct =_ _ en ~ O US , . O Pa s0 0 ~ _' 00 _ 1 00 _ US 00 _ O 00 ad Ch - 1 of red at _ 1 O _ _ on - ~ ~ ~ ~ O ~ ~ O O ~ ~ ~ 00 _ ~ ~ ~ ~ U~ ~ _ O O O ~ ~ ~ ~ ~ _ ~ _ ~ ~ C~ _ O O O 1 1 1 1 ') C~ _ ~ O ~ _ ~ ~ ~ ~ ~ _ c~] ~ ~ _ ~i ~ ~ _ _ O O O ~ ~ O O ~ ~ O O ~ ~ ~ ~ O . . . . . . . . . . ~ C-l Ir) \= CN ~ ~ O u~ ~ c~ o - - ~ u~ ~ oo - =\ . . . . . . . . . . . . . ~ ~ - ~ ~ ~ ~ ~ ~ - - ~ o ~ - - ~ ~ ~ o o ~ ~ E~ ~ c~ a ; ' ' ~ ~ n ~ ~, ~, ~ D _ ~ i~ oO a~ - C~ C) ._ ._ Ct CQ o Ct ~O 5 C) :- m - o ;: C) E~ Ct ._ . _ o o C) o . . O V,

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TECHNOLOGY IN SERVICES TABLE 3 Productivity Changes by SIC Code Manufactunng Industries Number 25 7 6 9 12 14 15 2 2 88 Compound Annual Rate of Change in Indices of Output per Employee Hour,a 1980-1985 (%) Greater than 6.00 5.00 to 5.99 4.00 to 4.99 3.00 to 3.99 2.00 to 2.99 1.00 to 1.99 o.oo to 0.99 -0.01 to -0.99 - 1.00 to - 1.99 -2.00 to -2.99 - 3.00 or less Totals a 1977 = 100. SOURCE: Bureau of Labor Statistics (October 1, 1987). (Percentages do not total 100 due to rounding. ) Services Industries Number (%) 13.6 4.5 9.1 18.2 9.1 8.0 6.8 10.2 13.6 15.9 17.0 8.0 8.0 8.0 2.3 2.3 100.1 2 4 2 2 o 22 4.5 9.1 13.6 13.6 4.5 0.0 99.8 to 1981, whereas manufacturing productivity grew at less than 1 percent on the same basis. The primary causes of this phenomenon were (1) the continued demand growth in services, which led to (2) both capital deepening (in the sheer quantity or accumulation of capital) in services and improved capital quality (output gain per unit of invested capital) within services. The analyses of Barras (1986), Kendrick (1987), and Kutscher and Mark (1983) all suggest that shifts to services have not been the most important culprit in slowdowns of U.S. or British national productivity growth. What about the longer term prospects for growth based on services? Be- cause the value of all products or services is created solely in the mind (i.e., a jewel, an opera, a Ferrari, a sightseeing tour, or a stylish coat may have little functional value relative to its high price), the growth of a services economy is limited only by the capacity of the human mind to conceive of activities as having high utility. Surely, a safer, healthier, better educated, more stable society can easily be considered "wealthier" than one with more physical goods. Moreover, this wealth can be passed on to future generations. Services, such as better education, art, music, literature, information repos- itories, public health levels, mechanical skills, scientific or design know- how, and institutions of law represent critical investments for the future, yielding higher productivity and living standards both in the present and in the future. In fact, such dimensions have generally been considered both the most important contributions to and measures of a nation's wealth throughout history.

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26 JAAlES BRIAN QUINN HOW TECHNOLOGY AFFECTS COMPETITIVE STRUCTURES Why have services gained such importance in recent years? Steady pro- ductivity increases in agriculture and manufacturing, largely induced by tech- nology, have meant that it took ever fewer hours of work to produce or buy a pound of food, an automobile, a piece of furniture, or a home appliance. Whereas productivity improved, demand for goods was somewhat capped; people consume only so many pounds of food, automobiles, sofas, or washing machines. The relative utility of other possible purchases therefore went up for each individual. Also, in recent years, people have begun to want more services. Thus, to a large extent, the shift to a services economy has been a natural outgrowth of productivity increases induced by technological ad- vances in the product sector. Growth in services sector employment has more than offset declines in the goods-producing sector (gee Figure 11. Simultaneously, new technologies also vastly improved performance in virtually all services sectors. Jet aircraft made long haul passenger and freight handling much more efficient and convenient. New noninvasive imaging devices, drugs, diagnostics, life support systems, and surgical procedures revolutionized medical practice. New containerization, loading, refrigeration, and handling techniques for volatile liquids, by making it possible to transport virtually all goods safely and effectively, vastly extended international trade. Electronics, information, and communications technologies stimulated new innovations in virtually all services areas most notably in retailing and wholesale trade, engineering design, financial services, communications, and entertainment. The restructurings caused by such technologies have been detailed else- where (Quinn, 19871. Major new technologies in services seem to generate certain distinctive and repetitive impact patterns: New economies of scale appear which cause many services activities to centralize into larger institutions, at first concentrating activities into fewer large units, then allowing renewed decentralization as smaller units in more dispersed locations link into networks with larger companies and deliver services to widely dispersed locations. This pattern has recurred in health care, air transport, insurance, ground transport, banking and financial ser- vices, and communications. Midsized services enterprises, unable to afford the new technologies themselves, have often been forced to merge upward in scale, or niche radically, or to go out of business. Strategists refer to this pressure on midsized firms as "being caught in the middle" (Porter, 19851. New economies of scope frequently provide powerful second-order ef- fects. Once properly installed, the same technologies that created new scale economies allow services enterprises to handle a much wider set of data, output functions, or customers without significant cost increases and often

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36 JAMES BRIAN QUII!~:I Corporate managers and public policymakers must also learn to cope with the way global integration has affected national capital markets. As was recently demonstrated, the short-run volatility of securities markets has in- creased enormously because of the capacity of large investor groups to move rapidly into or out of individual securities markets. The stimuli that disrupt a nation's capital markets and relative cost structures can easily come from outside sources. Consequently, it has become increasingly difficult for sov- ereign nations to control their economies in the short run or to fine-tune them through traditional fiscal or monetary interventions. On the other hand, some believe that increased individual access to markets and the greater variety of hedge instruments available, which create a de facto synthetic currency beyond the control of any one country, may actually generate greater long-term financial stability (The Economist, 19881. Much research will be necessary to understand more fully the implications of fi- nancial markets with such rapid responsiveness and high levels of interactive feedback. In the meantime, it will be essential for nations to identify creative new trading rules or regulatory limits that can forestall potentially disastrous upheavals. It is important to note, however, that with freer access to world capital markets everywhere, it is becoming very difficult for a single nation to maintain differentially low capital costs as a policy (as Japan has and the United States once did) in support of aggressive economic development or trading objectives. As capital costs among nations are leveled by globalized financial markets, countries such as the United States and Japan, with high domestic labor and materials costs, will be under ever greater pressures to move manufactures overseas. They will be left with few alternatives for maintaining high incomes and living standards, other than innovating in both technical and structural terms at a rate others cannot match. A key element will be innovation in services and with services enterprises. This will require major social and institutional, as well as business-technological, innovations. Deregulation and Services Innovation An important form of innovation in the United States has been early deregulation of many services, although Euromarkets were a direct conse- quence of the slow response of U. S . financial regulatory practices. If properly exploited by U.S. companies and not by foreign services companies in the United States deregulation can offer significant competitive advantages. For example, The Economist (1985) has argued that America's more timely deregulation of communications may make it impossible for European com- petitors to catch up in this decade. Banking and financial services deregulation has enabled U.S. financial companies to begin offering and managing a broad

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TECHNOLOGY IN SERVICES 37 array of innovative and "denvative" products long before their more pro- tected foreign counterparts could. In addition, transportation deregulation has forced new cost competitiveness, price structures, and innovations in man- agement (such as hub and spoke operations) that could keep U.S. transpor- tation costs below foreign nations' costs for years. These new competitive structures in turn may force a revamping of reg- ulation itself. In many areas, regulation is moving from the institutional level (the economic regulation of banks or airlines) to a functional level (regulating information disclosure, safety practices, environmental standards, commu- nications interfaces, maintenance procedures, etc., across a range of indus- tnes) that could be much more productive. Ultimately this could mean a substantial restructuring (and hopefully elimination) of many regulatory agen- cies. Antitrust law may also be changing because of the realization that mergers that would once have been barred as anticompetitive make sense if (1) the true measure of the company's market share is global rather than national (Kirkland, 1988, p. 48) and (2) increased functional or cross-industry competition is taken into account. In many areas, deregulation and other accompanying innovations have already created a more decentralized, com- petitive, flexible, and lower cost services system for the United States, al- though sometimes at the cost of extensive consumer inconvenience. Although they are not well reflected in current economic measurements, the effects of these and other institutional consolidations that services tech- nologies allow on competitive industry structures can be profound. Some examples follow: -. Disintermediation in a number of areas has generated the same (or a better) level and quality of output with significant cost decreases. Direct access to financial services markets, of course, short-circuited many traditional banker, agent, and broker relationships. Easy direct ticketing by airlines, hotels, tours, and theaters has cut out other intermediaries. Large-scale efficiencies for small-scale operations occur as small local retailers or services units join into sophisticated integrated information and management net- works with large suppliers or wholesalers (e.g., McKesson and Super Valu). The latter offer such services as helping retail customers locate and design their stores, advising them on increased value-added product mixes, managing stocking and dis- plays in key departments, processing medical insurance claims for customers, re- cycling customers wastes through the network provider's own plants, handling customers' accounting and credit functions, and researching new uses for suppliers' products. Linking data bases to downstream services and production has been another structural change. Mead Data Central (with LEXIS, a legal research service, and NEXIS, a newspaper data base) and Lockheed (with Dialog Information Services) have found it natural to connect their electronic technologies to printers and to move downstream into publishing from their extensive data bases. American Airlines makes some $100 million per year by leasing its reservations system to travel agents. It is

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38 JAMES BRIAN QUINN beginning to offer integrated travel reservation services with hotel and car rental chains through its AMRIS division. Citicorp is leasing to its customers access to its own extensive worldwide information network. Manufacturer-services integration for value added or strategic flexibility is in- creasingly common. GM has become the nation's largest private holder of consumer debt and is using the capabilities of its Acceptance Corporation (GMAC) as a key weapon in marketing. Oil companies now run extensive convenience food chains in parallel with their gasoline stations. Further, Sears owns or controls many suppliers for its branded lines and provides after-sale services through its own extensive fi- nancial, credit, and insurance networks. ~ Privatization of government services and direct government competition with private companies have offered a new spectrum of opportunities and threats. On the one hand, state and local governments increasingly purchase services from private suppliers for efficiency. Also, in his chapter in this volume, Goners discusses the trend toward private competition in provision of public utilities and social services- activities which have traditionally been organized as national public monopolies. On the other hand, government institutions with their large capital resources and in-place customer bases are moving strongly into realms which would otherwise be handled by the private sector. Since 1983, Singapore has pressed heavily into electronic banking for which it hopes to become the leading center in Southeast Asia. The British Post Office, Br~tain's largest retail network, is spending $250 million to link itself to Clearing House Automated Payment System (CHAPS) and Society for World Interbank Financial Telecommunications (SWIFT) and to convert 9,000 of its 20,000 outlets into full bank branches and insurance offices. Services technologies are thus breaking down the traditional boundaries of nations, industries, and even government versus private functions. With no element in its value chain (from raw materials to postsale services) immune to structural changes due to services technologies, each producer must con- stantly reassess who its true suppliers, competitors, and customers are and how each could enhance or subvert its competitive posture. International banks already often find that their compatriots may be simultaneously com- petitors, customers, joint venture partners, and suppliers. The same will happen elsewhere. International Trade Implications What are the implications of all these changes for the U.S. position in world trade? Only a few summary observations will be attempted here. First, unlike manufacturing, U. S. trade in services has exhibited a positive balance for years (see Table 61. Whereas the trade balance in merchandise has been negative in 12 of the last 25 years, in over half of these years services (including investment returns often representing technology advantages) have put the U.S. current account into the black. However, since 1981 the net balance of trade in services has become more tenuous (see Table 71. Inter-

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TECHNOLOGY IN SERVICES TABLE 6 U.S. Net Trade Balancesa ($ billion) 39 Net goods and Merchandise Services Date services balance balance balanced Net investment Income 1965 8.3 5.0 0.2 5.3 1970 5.6 2.6 0.2 6.2 1975 22.8 8.9 1.8 12.8 1980 9.0 - 25.5 6.8 30.4 1982 0.3 - 36.4 8.3 128.7 1983 - 36.8 - 67.1 5.7 24.9 1984 - 94.8 - 112.1 1.1 18.5 1985 - 101.1 - 122.1 - 1.0 25.4 1986 - 125.7 - 144.3 1.5 20.8 Preliminary 1987 - 149.6 - 157.5 0.5 8.7 aExcludes military transactions. bCalculated as net services transactions minus net investment income plus net military trans- actions. SOURCE: Bureau of Economic Analysis, U.S. International Transactions (various years and quarters). national Monetary Fund data show the U.S. share of world services exports dropping from 23.8 percent in 1970 to 19.2 percent in 1985. Although trade in services is excruciatingly difficult to measure accu- rately,4 most experts believe that the total volume of services trade has been seriously underestimated. U.S. government trade data track only about 40 services categories, as opposed to some 10,000 items in merchandise trade, and do not capture many important services exports. The Office of Tech- nology Assessment (1986) estimates 1984 U.S. services exports to be $69- 91 billion (as opposed to the official $43.8 billion) and U.S. imports to be $57-74 billion (versus the official $41.5 billion). Data problems are so severe that several groups in Washington are working feverishly to improve the available data for the next (Uruguay) round of General Agreement on Tariffs and Trade (GATT) discussions, where for the first time services will be a major agenda item. One of the peculiarities of services trade is that most of the facilities and jobs created by services exports are in the user country. Unlike manufactures, relatively few services are produced in the parent country and sold for their full product value across borders. Thus, in contrast to manufacturing exports, services trade data frequently recognize only the fees or profit margins that services companies can repatriate a small fraction of their total transactions' value. In part because of such measurement biases, the volume of services trans- actions would have to expand enormously to eliminate current balance of payments deficits due to merchandise trade. Although the United States is

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TECHNOLOGY IN SERVICES 90 to 80 Go 0' 70 CM 60 C5) 50 ~ 40 a' 30 C: a' 20 10 O 41 Total for Goods Total for Services Foreign Direct Investment Direct Investment Abroad F~GuRE 9 Percentage change in foreign direct investment (FDI) versus direct in- vestment abroad (DIA): 1982-1986. SOURCE: Bureau of Economic Analysis, U.S. Direct Investment Abroad: Detail for Position and Balance of Payment Flows; Foreign Direct Investment in the United States: Detail for Position and Balance of Payment Flows. the largest single services exporter, the European Economic Community (EEC) is larger in total volume. Proposed elimination of trade barriers within the EEC by 1992 is already spurring the development of larger and possibly stronger services sector competitors in Europe. The U.S. National Study on Trade in Services (Office of the U.S. Trade Representative, 1983) indicated that at about 1.4 percent, the United States was nowhere near the top in its percentage of gross domestic product exported as services. Expanding its services exports to match France's 5.1 percent or Britain's 6.5 percent of GNP would increase U.S. services exports by some $60-110 billion, enough to offset but not eliminate the 1986 merchandise deficit of $144 billion. Unfortunately, such gains will be hard to achieve. Countries competing with the United States are likely to become more aggressive in their own trade policies as they realize the importance of services in their own trade postures. The overall trade situation is ambiguous. In areas such as public account- ing, law, communications, and international finance, the United States enjoys a very strong position. In others such as international air travel, America's once dominant carriers Pan Am and TWA have fared badly, while competitors such as JAL, Swissair, and Singapore Airlines have thrived. The causes of such shifts are always complicated, but much of the credit for the latter's gains must go to such factors as strong government support, their heavy long-term equipment investments, and their exceptional attention to the qual- ity of customer care on flights.

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42 Total for Services Wholesale Trade Retail Trade Banking Finance, Insurance, Real Estate Other Services Transportation Communications and Public Utilities JAMES BRIAN QUINN :.-.-:.:4 ////////////A _, - ,~ Direct Investment Abroad Foreign Direct Investment ::. :.::... ., I///////////// . . .,~ '///////////~i , ............ ...::::::.::., ............ ////////////] . :---::: -:-: -.-: --:-.-:-:-.~L /////////// ~ ~ ~ ' ~ ~ ,, ,////////////A r7/i77//~///~///////////////////////////////l 0 50 100 150 200 250 Percent Growth, 1982-1986 F~GuRE 10 Percentage growth in direct investment abroad (DIA) versus foreign direct investment (FDI) for various services: 1982-1986. SOURCE: Bureau of Eco- nomic Analysis, U.S. Direct Investment Abroad: Detail for Position and Balance of Payment Flows; Foreign Direct Investment in the United States: Detail for Position and Balance of Payment Flows. Unfortunately, foreign incursions in services are not limited to the inter- national arena. Total foreign direct investment in the United States has grown by 67.9 percent since 1982, while U.S. direct investment abroad has grown by only 25.1 percent (see Figure 91. Foreign direct investment in the U.S. services sector has expanded rapidly (especially in communications, finance, construction, and distribution) over the last five years (see Figure 101. Many well-known U.S. names in services, such as Saks Fifth Avenue, Twentieth Century Fox, Intercontinental Hotels, Allied Stores, A&P, and Marshall Field, now have foreign owners. Technology has made it possible for services companies to grow to a scale where they are attractive acquisitions for foreign competitors, for their even larger acquirers to manage worldwide services networks from their home bases, and for services to become a major target area for countries (such as Janan or Singapore) seeking to expand their world trade positions. WHITHER SERVICES? At present some U.S. services companies enjoy economies of scale and scope that their international competitors cannot equal. The notable excep- tions are banking (Cacace, 1986) and communications, where the Japanese have larger enterprises due to internal structural factors (in banking) and

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TECHNOLOGY IN SERVICES 43 monopoly structures (in communications). Moreover, the deregulated U.S. marketplace provides its own companies a unique stimulus for innovation. If U.S. services companies move aggressively to develop their own pro- prietary technology systems, they can maintain a competitive edge of one to two years in most services areas. Any slowdown or delay in such innovations will be sure to attract competitive incursions in the United States and in world services markets, such as the recent Japanese banking, tourist industry, hotel, and airline expansions and the European acquisitions in U.S. distri- bution and tourist trade activities. As the Wright and Pauli chapter suggests, U.S. companies and policy must move aggressively and avoid the compla- cency, short-term financial orientation, inattention to quality, and emphasis on scale economies (rather than customers' concerns or market responsive- ness) that earlier undercut U.S. manufacturing competitiveness. Even so, there is a nagging and real worry that an economy increasingly dominated by services can irrevocably weaken the United States in world affairs. There is no doubt that loss of manufacturing beyond a certain point can decrease both U.S. flexibilities and U.S. capabilities in defense systems. However, when manufacturing is equated with economic wealth and world power, the fact that the great nations of the past were the trading nations, the educated nations, and the money centers of the world is often forgotten. Their power was often based not on manufacturing capabilities but on superior social disciplines or organizations, raw materials or agricultural capabilities, technological skills or coalition behavior in a hostile world. Has there been a fundamental change in the last 100 years? Given the great expansion, decentralization, and integration of world manufacturing capabilities, perhaps less than many may think. Yet even military power now seems less dependent on basic production capacity than on selected intellectual and research capabilities in a few high- technology areas, supported by specialized manufacturing, transportation, and communications services systems. The commercial airlines, communi- cations, and information industries, for example, now provide much of the basic demand and technical competency that give the United States- both its manufacturing standby and its technological capabilities for defense. Despite the growth of services, it seems unlikely that total manufacturing output capacities will drop drastically lower by the year 2000. Growing services employment and investments should help provide demands for many domestic manufactures. Some innovative manufacturers are learning to compete against low-cost foreign operations. Further, the integration of services and manu- facturing systems should lead to some added manufacturing in the United States. Finally, the government will probably see that specialized manufac- turing capabilities exist for key strategic purposes. Services technologies are crucial to both the future health of manufacturing and the growth and productivity of the entire economy. Many of the greatest

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44 JAMES BRIAN QUINN opportunities for entrepreneurship and applications of technology over the next two decades will- as they have for the past 20 years lie in the services sector. One should not be afraid of, or deride, a services-dominated economy. A greater fear should be that we misunderstand the services sector, under- develop or mismanage it, and overlook its great opportunities while we attempt to shore up certain troubled manufacturing areas at great national and corporate cost. ACKNOWLEDGMENTS The author wishes to acknowledge the very special contributions of Jordan J. Baruch and Penny C. Paquette in the development of this paper, as well as the generous support of Bankers Trust Company, Bell and Howell, The Royal Bank of Canada, Bell Atlanticom Co., Braxton Associates, and Amer- . scan express. NOTES Figures are drawn from Bureau of Labor Statistics, Establishment Data Base: States and Selected Areas (November 1978, pp. 12~133; November 1987, pp. 120-137). 2. The Economist (1987, p. 42) in a survey of the world economy estimated that the 1983 cost of preserving a job in the U.S. auto or steel industry was between $100,000 and $120,000. 3. Bell and Kettell (1983, p.3) estimated that 95 percent of the daily volume of foreign exchange markets in 1983 was not commercial business but trading between the foreign exchange dealers of the world's international banks. 4. For example, if a U.S. bank has a loan officer in its British subsidiary who relies heavily on data or analyses generated in its New York headquarters for a deal consummated in London, is this an export, a return on investment abroad, or just a local sale of services? REFERENCES Barras, R. 1986. A comparison of embodied technical change in services and manufacturing industry. Applied Economics 18(September):941-958. Bell, S., and B. Kettell. 1983. Foreign Exchange Handbook. Westport, Conn.: Quorum Books. Blackwell, R., and W. Talarsyk. 1983. Life style retailing: Competitive strategies for the 1980s. Journal of Retailing 59(4):7-27. Bluestone, B., and B. Harrison. 1986. The Great American Jobs Machine. Washington, D.C.: Joint Economic Committee, U.S. Congress. Bureau of Economic Analysis, International Investment Division, Balance of Payments Di- vision. Foreign Direct Investment in the United States: Detail for Position and Balance of Payment Flows. Series in Survey of Current Business. Washington, D.C.: U.S. Department of Commerce. Bureau of Economic Analysis, International Investment Division, Balance of Payments Di- vision. U.S. Direct Investment Abroad: Detail for Position and Balance of Payment Flows. Series in Survey of Current Business. Washington, D.C.: U.S. Department of Commerce. Bureau of Economic Analysis. The National Income and Product Accounts of the United

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TECHNOLOGY IN SERVICES 45 States. Series in Survey of Current Business. Washington, D.C.: U.S. Department of Com- merce. Bureau of Economic Analysis. U.S. International Transactions. Series in Survey of Current Business. Washington, D.C.: U.S. Department of Commerce. Bureau of Labor Statistics. Current Labor Statistics. Series in Monthly Labor Review. Wash- ington, D. C.: U. S . Department of Labor. Bureau of Labor Statistics. Establishment Data Base: Average Hours and Earnings of Production or Nonsupervisory Workers on Private Nonagricultural Payrolls by Major Industry. Series in Employment and Earnings. Washington, D.C.: U.S. Department of Labor. Bureau of Labor Statistics. Establishment Data Base: Employees on Nonagricultural Payrolls by Major Industry. Series in Employment and Earnings. Washington, D.C.: U.S. Department of Labor. Bureau of Labor Statistics. Establishment Data Base: States and Selected Areas. Series in Employment and Earnings. Washington, D.C.: U.S. Department of Labor. Bureau of Labor Statistics. 1987. Widespread increases in industry productivity in 1986 reported by BLS. Press release (October 1). Washington, D.C.: U.S. Department of Labor. Cacace, L.M. 1986. Japanese banks again winners in top 500 race. American Banker (July 29):1. Chand, R. 1986. Employment during recessions: The boost from services. Canadian Business Review (Summer):37-40. The Economist. 1985a. The other dimension: Technology and the City of London. A survey. 296(July 6):6. The Economist. 1985b. Telecommunications: The world on the line. A survey. 297(November 23):62. The Economist. 1987. The world economy: The limits to co-operation. A survey. 304(September 26):66. The Economist. 1988. Get ready for the phoenix. 306(January 9):9. Kendrick, J. 1987. Service sector productivity. Business Economics (April): 18-24. Kirkland, R., Jr. 1988. Entering a new age of boundless competition. Fortune (March 14):40- 48. Kutscher, R. 1988. Growth of services employment in the United States. In Technology in Services: Policies for Growth, Trade, and Employment, Washington, D.C.: National Acad- emy Press. Kutscher, R., and J. Mark. 1983. The services sector: Some common perceptions reviewed. Monthly Labor Review (April):21-24. Levy, F. 1987. Changes in the distribution of American family incomes, 1947-1984. Science 238(May 22):923-927. Mark, J. 1982. Measuring productivity in the services sector. Monthly Labor Review (June):3- 8. Mark, J. 1986. Problems encountered in measuring single and multifactor productivity. Monthly Labor Review (December):3- 11. Mark, J. 1988. Measuring productivity in service industries: The BLS experience. In Tech- nology in Services: Policies for Growth, Trade, and Employment. Washington, D.C.: Na- tional Academy Press. McMahon, P., and J. Tschetter. 1987. The declining middle class: A further analysis. Monthly Labor Review (December):22-27. Mishel, L. 1988. Manufacturing Numbers: How Inaccurate Statistics Conceal U.S. Industrial Decline. Washington, DC: Economic Policy Institute. Moore, G. 1987. The service industries and the business cycle. Business Economics (April): 12- 17.

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46 JAMES BRIAN QUINN Office of Productivity and Technology, Bureau of Labor Statistics. 1987. Unpublished com- puter data sheets. Washington, D.C.: U.S. Department of Labor. Office of Technology Assessment. 1986. Trade in Services. OTA-ITE-316. Washington, D.C.: U. S. Government Printing Office (September). Office of Technology Assessment. 1988. Technology and the American Economic Transition. Washington, D. C.: U. S. Government Printing Office. Office of the United States Trade Representative. 1983. U.S. National Study on Trade in Services. Washington, D.C. (December). Personick, V. 1987. Industry output and employment through the end of the century. Monthly Labor Review (September):30-45. Porter, M. 1985. Competitive Advantage. New York: Macmillan. Quinn, J.B. 1987. The impacts of technology in the services sector. Pp. 119-159 in Technology and Global Industry, B. Guile and H. Brooks, eds. Washington, D.C.: National Academy Press. Roach, S. 1985. Information economy comes of age. Information Management Review (Jan- uary):9-18. Roach, S. 1987. America's Technology Dilemma: A Profile of the Information Economy. Special Economic Study. New York: Morgan Stanley (April 22). Roach, S. 1988. Technology and the service sector: The hidden competitive challenge. In Technology in Services: Policies for Growth, Trade, and Employment. Washington, D.C.: National Academy Press. Rosenthal, N. 1985. The shrinking middle class: Myth or reality? Monthly Labor Review (March):3- 10. Seth, J. 1983. Emerging trends for the retailing industries. Journal of Retailing 59(3):6-18. Silvestri, G., and J. Lukasiewicz. 1987. A look at occupational employment trends to the end of the century. Monthly Labor Review (September):46-63. Tanaka, M. 1984. Moving beyond merchandise: Japan's trade in services. Journal of Japanese Trade and Industry (4):12-15. Thurow, L. 1987. A surge in inequality. Scientific American 256(May):30-37. UNIPUB. 1984. Measuring Productivity: Trends and Comparisons from the First International Productivity Symposium, Tokyo, Japan, 1983. New York: UNIPUB. Urquart, M. 1981. The services industry: Is it recession proof? Monthly Labor Review (Oc- tober): 12-18. Vollmann, T., 1986. The effect of zero inventories on cost (just in time). Pp. 141-164 in Cost Accounting for the '90s: The Challenge of Technological Change. Montvale, N.J.: National Association of Accountants.