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Key Policy Issues Posed by Services JAMES BRIAN QUINN AND THOMAS L. DOORLEY Other chapters in this volume document the scale and importance of ser- vices in the U.S. economy and the role of technology in improving the productivity of, and the value added by, the services sector. Given the dominance of services activities in the U.S. economy, policies supporting technology in services should be an important component of the ongoing debate about the government's proper role in supporting technology for both public and selected private purposes, particularly policies for improving U. S. industrial competitiveness. This chapter focuses on a few themes of particular relevance to the "national competitiveness" debate. Two issues are of special importance: 1. The effectiveness of U.S. services industries and U.S. manufacturing are mutually intertwined. Attempting to strengthen one without strengthening the other would be a misguided policy. Unfortunately, to date there has been a tendency to focus competitiveness policy discussions almost exclusively on manufacturing issues. Effective services activities actually create new markets for manufactured goods, result in lower costs for manufacturers, and are central to increasing the value added by manufactured products. Similarly, manufacturers are important suppliers, customers, and innovators for services activities. Not only are services and manufacturing mutually reinforcing, the same policy approaches that stimulate or retard one sector will generally affect the other in similar ways. However, the impact of policy actions will tend to be proportionally greater on services because of the larger scale of the services industries, which provide 75 percent of all employment and 71 percent of 211

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212 JAMES BRIAN QUINN AND THOMAS L. DOORLEY all U.S. gross national product (GNP). Critical factors affecting both include the high relative cost of U.S. capital (which may benefit from a general leveling of such costs worldwide induced by the global integration of capital markets), the skill and literacy levels of the work force, and the development and application of frontier technologies (particularly those related to com- munications, health care, information handling, and public transport). 2. Technologies in the services sector are restructuring many manufac- tur~ng and services industries as well as the entire U.S. economy and its international trade patterns in ways that make past "industry-focused" approaches to regulation or trade relations even more inappropriate. The dynamics of technology, combined with deregulation, have broken down barriers among industries such as transportation, communications, finance, distribution, education, and health care, and have created a degree of cross- industry interaction and competition that calls for new regulatory philosophies and institutions across a wide spectrum. Later sections of this chapter attempt to coalesce many of the significant policy themes developed by other chapters in this volume and to make specific recommendations concerning these major focal points. BACKGROUND ASSUMPTIONS Services are central to employment, economic growth, and quality of life in an advanced industrial nation such as the United States. However, unlike manufacturing, services have lacked a coordinated advocacy in policy circles. The chapters in this volume strongly suggest the following as essential back- ground assumptions for a balanced U.S. policy discussion: This nation's strong services sector is a natural and desirable outgrowth of a highly productive industrial economy and the sophisticated application of technology to services activities. Services growth has not led to a decline in the overall manufacturing base; rather it has both created new markets for manufactured goods and supported increased manufacturing competitiveness. Despite the serious concerns expressed about declines in specific manufacturing industries in the United States (and in other major developed countries), total employment in U.S. manufacturing has fluctuated around a zero trend line for a long while, and real manufacturing output and value added have continued to grow (see Figures 1-3 in Quinn, this volume). On the other hand, services have been- and will continue to be the nation's driving economic force in both arenas in the near future. A large majority of the most successful new ventures of the last two decades (1960-1980) were in services (see Table 1), and many of the most successful new manufacturing ventures (such as Apple, DEC, and Wang) sold products largely to the services sector (see Roach, this volume). Productivity statistics suggest that there is no inherent reason why large services industries cannot improve their productivity as rapidly and as much as manufacturing. In many services industries, technology can also be effectively leveraged to create competitive advantage and higher margins. In other services industries, productivity and quality improvements must be rapidly passed through to

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KEYPOLICYISSUES POSED BYSER VICES TABLE 1 Examples of Most Successful New Enterprises, 1960s and 1970s 213 Service, 56% Service-Product, 9% Product, 35% H & R Block Mary Kay Cosmetics Intel People Express Computervision Honda Hospital Corp. of America Pizza Hut Sony Microsoft Mrs. Fields' Cookies Apple Hambrecht & Quist Damon Nike LucasFilms, MCI McDonald's DEC Wal-Mart Tandem EDS, Tandy Apollo Federal Express Wang Holiday Inns SOURCE: Compiled from various publications' listings of most successful new companies. customers, adding great complexity to the interpretation of output and productivity mea- sures. Services enterprises, such as banks, communications companies, airlines, and health care providers, are now among the most significant initiators, users, and managers of technological systems. Various chapters in this volume and its companion volume, Man- aging Innovation: Cases from the Services Industries (Guile and Quinn, 1988), illustrate how technologies developed or implemented by such enterprises are revolutionizing long- established economic and trade relationships within and among nations, thus raising profound new policy issues for both business and government. Services are an increasingly important component of international commerce. The fact that countries have begun to recognize the importance of services in economic development (Faulhaber et al., 1986; Shelp, 1986) and the focus on services in the Uruguay round of the General Agreement on Tariffs and Trade (GATT) are indicators of this trend. As Wright and Pauli make clear in their chapter, foreign governments' targeting of specific services for trade development is becoming a high-profile concern, particularly as the services companies of those nations begin to take over attractive U.S. services enterprises and aggressively expand their influence in U.S. and world services markets. Unfortunately, greater understanding of the importance and potentials of the services industries is often obfuscated by mistaken attitudes about ser- vices, limitations in available data, and the misleading measures used for important policy determinations. ~ In particular, difficulties in measuring services productivity (especially the amount and quality of services outputs) and structural problems in utilizing technology within some services activities (particularly personal and profes- sional services) often obscure the importance of technology in services and of services in the economy (Mark, 1982, 19861. Serious funding and administrative support are needed to modernize and upgrade both domestic and international trade data concerning services.

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214 JAMES BRIAN QUINN AND THOMAS L. DOORLEY THE SERVICES-MANUFACTURING INTERFACE The services- and goods-producing sectors are so intertwined that it is counterproductive to think of policy mechanisms for one without carefully considering the impact on the other. The interactions between services and manufacturing cover a broad, and often unrecognized, spectrum of activities and profoundly affect the performance and competitiveness of U.S. manu- factur~ng enterprises (see Figure 11. Although a chapter in the companion to this volume (Guile and Quinn, 1988) makes this point in greater detail, it is important enough to highlight for policy purposes here. Many have noted that U.S. services industries are often dependent on relationships with man- ufactured goods, i.e., their businesses exist largely by providing transpor- tation, finance, advertising, repair, distribution, or communications supporting transfers of manufactured goods. Interestingly, however, many of these ser- vices would still be provided in the United States, regardless of where the product was manufactured. Although some design support functions and supplier interlinkages could move overseas if manufacturing were not per- formed here, even these functions are increasingly being performed remote from manufacturing sites. Because of technological economies of scale and technological innovations, services industries both upstream and down- stream from manufacturing" appear to be actually increasing their leverage versus manufacturing. SERVICES INDUSTRIES E.g., Communications, Transportation, Utilities, Health Care, Banking R&D EXTERNAL SERVICES DIRECTLY EMBODIED IN PRODUCTS I PRODUCT - _ | DESIGN l MANUFACTURING Services Inside the Company - Design, Legal, Accounting, Advertising _ PRIVATE BUSINESS SERVICES Supporting Manufacturing - Accounting, Legal, Consulting, Software, Maintenance =~ l COMMERCIAL SERVICES USER (Self Service) DISTRIBUTION SERVICES Wholesaling __ Retailing Re~ nng I l 1 1 1 SERVICES _ _ I NTERMEDIARY CONSUMER (Self Service) GOVERNMENT SUPPORT SERVICES E.g., Waste Disposal, Road Maintenance, Education, Health Support, Standards, Police and Fire Protection 1 FIGURE 1 Some mutual interactions among manufacturing and services activities. Double-headed arrows indicate that each party benefits from the presence of the other in trade.

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KEY POLICY ISSUES POSED BY SERVICES 215 Less recognized is the dependency of manufacturing on services. Some 70-85 percent of all high-technology (information) products are sold to the services sector. In addition, manufacturing success today often requires more rapid feedback from the marketplace, better customized products, and more accurate delivery in shorter cycle times all of which are dependent on downstream services integration. Proper integration of these technologies throughout manufacturing and distribution could significantly increase the number and range of goods that it pays to produce in the United States, rather than overseas. "Quick response" reordering systems can allow U.S. textile mills significant com- petitive advantages. They make it possible to deliver fabric in one-third the time it takes from Taiwan, and computer-assisted design and manufacturing links between cutters on Seventh Avenue and southeastern mills can halve the time it takes from design to goods delivery (Business Month, 1987~. Well-managed retailers and distributors increasingly know what customers want better than manufacturers possibly can. Many are using their market knowledge and electronic point-of-sale fEPOS) data systems to actively participate in designing products and guiding manufacturers' sales strategy through the improved marketing data they provide. U.S.-based manufacturers able to link flexible production systems directly to their customers' market intelligence networks should have sustainable competitive advantages (both in timing and in transportation costs) over foreign producers. As foreign firs invest in U.S.-based manufacturing ca- pacity to get closer to the country's huge, increasingly customized market- place, this is leading to a substantial "remanufacturing" of the United States. The Japanese automobile companies' recent moves into the United States provide interesting examples of the potential impacts on both producing and supplier industries. In addition, services technologies offer a rich new array of channels through which manufacturers can reach specialized segments of their markets. Elec- tronic home shopping and interactive video terminals located in banks, air- ports, hotels, airplanes, and shopping malls allow manufacturers to make contact with whole new groupings of customers in psychological situations in which they are likely to buy. Manufacturers Becoming Services Providers Increasingly, the profitability of manufacturers depends upon their use of services technologies and their extensions of these technologies as "prod- ucts" for exploitation. The competitive positions of large companies are now largely determined by their capacities to manage information worldwide about suppliers, new technologies, exchange rates, swap potentials, or the changing political or market sensitivities in key countries. For example, with crude oil resources

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216 JAItIES BRIAN QUINN AND THOMAS L. DOORLEY primarily in the hands of sovereign nations, Exxon's profits depend ever more on its ability to find, track, deploy, trade, transport, finance, and distribute energy efficiently. All of these activities are "services" and are technology driven. In addition to such logistics activities (especially in world- wide sourcing), General Motors (through its Acceptance Corporation, GMAC) has found financial services to be an indispensable competitive weapon in the marketplace and a source of over half of its profits in recent years. In many companies such as IBM, services technologies (e.g., software) have always been a key to success, often being "bundled" integrally into product and rental strategies. Now, with the hardware aspects of many elec- tronic products becoming extremely low cost and competitive, these "man- ufacturing companies" are increasingly shifting their focus toward software, networks, and communications linkages (services) as their bases for im- proving value added and profits. Others, such as Caterpillar Company, have found new growth through providing logistics and transportation services (utilizing their own extensive world networks) for other manufacturers in- terested in efficient warehousing or parts delivery worldwide. Lowering Internal Manufacturing Costs Many aspects of a manufacturer's cost competitiveness depend intimately on services activities, either within the firm or purchased from vendors. Greater efficiencies in communications, transportation, financing, distribu- tion, health care, or waste handling (services industries) can markedly affect a manufacturer's direct costs. To the extent that these services are more efficiently provided, they lower living costs for workers and improve the quality of life they can enjoy at any given wage level. In addition to the 75 percent of U.S. employment directly in the services industries, within manufacturing businesses an astonishingly large proportion (estimated to average some 75 percent) of all costsand a much higher percentage of value added are generally due to services activities (Office of the U.S. Trade Representative, 1983; Vollmann, 1986~. Aggressively managing services activities within manufacturing enterprises can provide a major attack point for improving competitiveness in the future. As advanced technologies provide new economies of scale or scope to specialized services providers, manufacturers are increasingly finding that they can substantially improve their costs and effectiveness by "outsourcing" staff services such as accounting, personnel, legal, marketing, and even research and design functions. Services and International Manufacturing Operations One of the areas in which services technologies affect manufacturing most significantly is international operations. Telecommunications, air transport,

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KEYPOLICYISSUES POSED BYSERVICES 217 and surface cargo handling technologies have forced virtually all manufac- turers to consider their supply sources, markets, and competition on a world- wide scale or lose their competitive position. Although the figures do not show up in merchandise trade balance statistics, the greatest impact of U.S. manufacturing technology on world markets is probably through the opera- tions of multinational companies' inside host countries (Sauvant, 1986~. About one-fifth of the total capital invested in U.S. manufacturing firms is in facilities outside the United States, with a similar proportion of output produced there. Some of the largest continuing favorable net balance of trade accounts for the United States have been the profits, royalties, and inter- corporate sales benefits remixed by these multinationals to the United States (see Table 21. Effective coordination of the international operations of large manufac- turing enterprises and of many much smaller companies depends heavily on services technologies and efficiencies. Also, economies of scale in interna- tional operations are very often due to the corporation's services capabilities (i.e., technology transfer, marketing skills, financial services, or logistics) rather than its plant scale economies. A significant component of a multi- national company's competitive edge comes from its capacity to handle cross- border data and services flows. Consequently, maintaining the freedom of these flows is a very sensitive and critical point in maintaining the interna- tional competitiveness of U. S . manufacturing enterprises. International man- ufacturing operations and services technology management are inseparable for producers seeking competitive advantages in today's global marketplace. ManufacturZng's Changing Strategic Environment As has been noted, perhaps the most important structural change in in- ternational manufacturing competition stems from the continuing integration (through electronics) of the world's financial centers into a single world financial marketplace. World financial flows have already become largely disconnected from trade flows (Bell and Kettell, 19831.2 Differences in na- tional economic policies can disturb interest rates only slightly but still call TABLE 2 Manufacturing-Related Trade Balances ($ Billion) Preliminary Category 1970 1975 1982 1985 1987 Royalties and fees, net 2.1 3.8 4.6 5.3 6.8 Direct investments, net 2.6 14.4 18.2 26.6 35.3 Merchandise, neta 2.6 8.9 (36.4) (122.1) (159.2) aExcluding military. SOURCE: Bureau of Economic Analysis, U.S. International Transactions.

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218 JAMES BRIAN QUINN AND THOMAS L. DOORLEY forth huge transfers of assets from one country to another. The U.S. dollar rose 34 percent against the currencies of its major trading partners between 1983 and 1985, then plummeted by 42 percent to recent lows principally because of fiscal and monetary not trade or management decisions (see Figure 2) (The Economist, 19881. Thus, comparative costs for producing or sourcing in particular locations have often become more a function of exchange rates than of productivity or competitive managerial decisions. This argues for new geographical plant- 50 40 30 20 10 - 0 + 10 20 30 40 50 I I 1 1 1 ! 1 1 1 1 :~ ~,,,,,,,,,,,,,,,,,,,,,,,,,,,. ~,,,,,,,,,,,,,,,,,,,,,,/ ~//////i////////////// At: Greece Saudi Arabia Philippines Indonesia Israel Mexico Brazil Switzerland Federal Republic of Germany Japan France Italy United Kingdom Spain Sweden Taiwan Kuwait Singapore Canada Republic of Korea South Africa Australia Hongkong _ /~//////////////////////////3 ~Y////////////////////{ ~ 1 1 0 :////////////// ~ ~7 ////////////////, ~/////~ 1,224 FIGURE 2 Exchange rate fluctuations. Percent change in the dollar (February 26, 1985-October 12, 1987) against national currencies. SOURCE: The Economist (1987a).

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KEYPOLICYISSUES POSED BYSERVICES 219 deployment tactics, market portfolios, and levels of organizational and lo- gistics flexibility not commonly found in past U.S. manufacturing strategies. Recently, the lower cost U.S. dollar has undoubtedly encouraged more man- ufacturing by Japanese firms in the United States. If the European Economic Community integrates in 1992 and maintains internal exchange rate parities, it could become a most attractive location for long-term investment, to the detriment of the United States. The entire power relationship between man- ufacturing and services groups is also changing profoundly in other areas. For example, many manufacturers now find that their medical care or insurance outlays for employees are higher than their own profits. Hence, new strategies creating "coalitions" with providers and insurers have emerged as key elements in cost control.3 Deregulation has created more powerful transportation companies with interrnodal han- dling capabilities that improve shipping efficiencies enormously, but also increase these carriers' bargaining power against manufacturers and other shippers (Cook, 1987~. In addition, large money center banks now offer information, instant capital access, and worldwide connection advantages that few manufacturers can duplicate internally for managing their financial assets. All "services" or "products" are really just means for providing satis- faction to customers. Thus, the boundary between services and manufactures is very fluid and varies widely over time. It is imperative that U.S. domestic economic and international trade policies recognize the extreme fluidity, substitutability, and mutual interrelatedness between manufacturing and ser- v~ces. GOVERNMENT POLICY ISSUES Recognizing these important facts as context, what are the central policy initiatives needed to support the effective use of technology in services? A basic presumption behind sound policy in the United States is that a com- petitive marketplace will allocate resources optimally among producing sec- tors, markets, and technologies. In most instances, market forces are quite sufficient in services. Government intervention would seem justified only in those situations where market imperfections or externalities make it unlikely that private initiatives can meet the challenge. Within this general framework, an attempt has been made to identify a few major points where government interventions would have high leverage. Five basic policy directions would appear to be most productive: 1. macroeconomic and tax policies focused on improved capital formation rates, lower cost of capital, and lengthened time horizons for return on investment; 2. increased and better-targeted national investments in both hard and soft infrastructures supporting services;

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220 JAMES BRIAN QUINN AND THOMAS L. DOORLEY 3. restructured regulatory practices to improve the efficiency and inno- vativeness of the services sector; 4. a refocus on employment and human resources development policies more appropriate to the mobility and intellectual skills required for a services- dominated society; and 5. stronger recognition and exploitation of services-manufacturing inter- face potentials in international trade measurements and in trade negotiations. Macroeconomic and Tax Policies: Capital Formation and Technology Investment . The basic macroeconomic and tax policies to support a strong services sector are quite compatible with those desirable for a healthy manufacturing sector not surprising when one understands the substitutability and inter- relatedness of the two sectors. High among the policies that would be most productive are measures to enhance capital formation and encourage long- term investment in research and technology. In the past, national growth in productivity has tended to correlate highly with national capital formation rates and investments in technology and pro- ducing assets (Bares, 1986; Kendrick, this volume). Because of the high capital intensiveness in services (Quinn, this volume), this should be equally true for larger companies in both services and manufacturing. Capital for- mation is stimulated by policies that selectively encourage savings and in- vestment over consumption. Decreasing taxes on earned interest or the double taxation on dividends would, of course, assist such a reemphasis, as would increasing the relative percentage of government tax revenues from con- sumption taxes as opposed to those based on income production (Landau and Hatsopoulos, 19861. Although the economic benefits and political costs of these measures have been debated extensively, the substantial leverage of the benefits for and from the services sector has rarely been considered. Because of the long time frames they involve, the development and ap- plication of major new technologies are especially sensitive to high capital costs or tax laws that bias decisions toward short-term investments. U.S. capital costs have been estimated to be significantly higher than those in Japan (Hatsopoulos et al., 1988~. A simple calculation will show that a company investing $1 million at the recent U.S. average cost of capital (approximately 15 percent) can only afford to wait 4.7 years to recover an expected income of $500,000, whereas a Japanese company investing at its 6 percent capital cost can wait for 11.9 years. This goes a long way toward explaining the more "patient" Japanese outlook. The cycle for invention, development, and successful implementation of technological innovations in services is quite comparable to that in manufacturing: 3-5 years is a typical time frame for most major innovations to be effectively incorporated in

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KEY POLICY ISSUES POSED BY SERVICES 221 production processes or to breach a new market as a "services" product (Guile and Quinn, 19881. Radical innovations tend to take significantly longer than this. Federal Express's COSMOS II tracking system took 8 years, Citicorp's development of automated teller machine systems spanned more than 10 years, and the cellular mobile telephone waited 11 years from AT&T's public filing to market implementation. Currently, the U.S. tax law is among the industrial world's least attractive for long-te~m investors. Only those of Australia and Britain are worse (see Table 31. Return to a 6-month holding period for capital gains status would be of little benefit in stimulating needed long-term investments, but a minimum holding period of at least 3 years (with a sig- nificantly graduated tax reduction for longer-term gains) could help encourage both start-up enterprises and longer time horizons for corporate shareholders, whose short-term outlook is a constant complaint of corporate managers. Any capital gains tax reduction should, of course, be related to expected rates of inflation. The electronic integration of world capital markets will make a national policy of arbitrarily low capital costs much more difficult to maintain, even for Japan. Nevertheless, selectively lowering capital costs for longer term investments (through something like a 3-year capital gains benefit) could be a viable strategy, especially if combined with less inflationary fiscal policies. Most notable among these would be decreasing national deficits to lower pressures on available capital sources as well as to ameliorate investors' uncertainties and inflationary expectations. Lower and more predictable cap- TABLE 3 Capital Gains Taxes on Share Investments,a 1987 Annual Long-Term Tax-Free Maximum Short- Maximum Long- Qualifying Allowance Term Rate (%) Term Rate (%) Period (dollars) Australia 50.25 50.25 1 year West Germany 56 Exempt 6 months 543 Sweden 45 18 2 years Britain 30 30 10,679 United States 38.50 28 6 months Canada 17.51 17.51 22,650 France 16 16 44,336 Belgium Exempt Exempt Italy Exempt Exempt Japan Exempt Exempt Holland Exempt Exempt aRates exclude local taxes. SOURCE: Arthur Andersen.

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224 JAAIES BRIAN QUINN AND THOMAS L. DOORLEY TABLE 4 Status of Software Protection in Selected Countries: 1986 Trade Secret Country Copyright Unfair Comp. Trademark Patent ~ _ Brazil Unclean Very Limited No France Yesb Unclear Perhaps Federal Republic of Germany Yesb Yes NoC Indonesia No Japan Yesb Limited Sometimes South Korea d Limited Yes Sometimes Taiwan Yesb Pending United Kingdom Yesb Yes Yes Sometimes United States Yesb Yes Yes Sometimes aLegislation proposed. bSpecial legislation passed or decree issued. CPerhaps, if included in process. dLegislation pending. SOURCE: Nusbaumer, 1987b, pp. 216-217. and suggests that international coordination is badly needed. Lack of adequate protection mitigates against innovation and wastes the valuable resources of innovators in seeking tricks to keep others from stealing and exploiting their efforts . Another complex problem is posed by vertical integrations through infor- mation networks that enable retailers, distributors, manufacturers, and sup- pliers to tightly coordinate their efforts. While lowering costs for consumers and increasing U.S. competitiveness, such systems also contain potentials for anticompetitive behavior (Business Month, 1987; Wall Street Journal, 1987a). Developing appropriate competition-inducing guidelines for antitrust and fair practices interpretations will be a significant challenge; yet it could have a high payoff in competitiveness and also, as Kendrick states, in terms of productivity. By encouraging distribution efficiencies through restructur- ing and such technological developments, even Britain's somewhat archaic distribution system has improved to the point where many Japanese-made products can be delivered to U.K. customers at lower prices than those charged in Japanese retail outlets (The Economist, 1987c). A final and very important aspect of regulation in services has to do with financial markets, economic risk, and control. Technological advances in communications and computing have increased the scale and speed of trans- actions and the interdependence of world economies in ways that can have profoundly favorable but also potentially sudden and disastrous conse- quences. The debate is just beginning on how to prevent large-scale inter- national interventions or computer-based trading systems from overwhelming securities markets in the short run. The Presidential Task Force on Market Mechanisms (the Brady Commis-

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KEYPOLICYISSUES POSED BYSERVICES 225 sign), appointed by President Reagan after the market crash of October 19, 1987, suggested oversight of all markets by one competent body, a more unified clearing system, consistent margins requirements for all major play- ers, and expanded emergency techniques to slow or halt trading so that all players have more equitable access to the system (Presidential Task Force on Market Mechanisms, 19881. Other recommendations have focused on institutional corrections, such as changing specialists' roles and rules (The Economist, 1987b). Private groups such as the stock exchanges have often not needed government intervention to implement many of these reforms in their own self-interest, but others may require international coordination through government agreements. The Bank for International Settlements is also setting forth proposals for banks in the Group of Ten industrial countries to have identical, well-defined, minimum standards for both core and secondary reserves. Such standards would mean that banks compete internationally under similar rules and are less likely to drastically stress the world financial system with costly, cas- cading failures (The Economist, 1987d). Yet they could also seriously affect the capacity of less developed countries to obtain needed loans. More atten- tion to the interests of less developed countries and the implications for their international trade balances will be a core policy issue to ensure a more stable and continuously growing world economy. Many maintain that the present complex of insurance mechanisms, hedging instruments, and open markets is sufficient to avert real disasters and that those who invest should bear their own risks (Norton, 19881. Government regulations in anticipation of unknown events always carry with them inef- ficiencies and risks. These must be weighed against potentials of massive losses for the United States or the entire world economy if matters go awry. This probably argues for some combination of increasing the technological capacities of major markets to handle peak trading loads and some carefully constituted mechanisms for limiting the nation's total economic risk, not complete nonregulation, however efficient that might seem in the short run. However, any proposals to selectively regulate U.S. markets should recall that in an integrated world marketplace, any inefficiencies introduced by U.S. regulation will quickly cause customers to seek more efficient solutions in the markets of other nations. Human Resource Policies for a Services-Dominated Economy As in other major policy areas, sound national human resources policies are not substantially affected by the national mix of services and manufac- turing industries. At a specific level, worker adjustment programs are an important ongoing activity in any dynamic economy, and the requirements for good basic skills training for new labor force entrants are high but not

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226 JAMES BRIAN QUINN AND THOMAS L. DOORLEY substantially changed by recent technical advances or growth of services industries. A recent comprehensive review of the impacts of technology on employment (Cyert and Mowery, 1987, p. 169) concludes New technologies by themselves are not likely to change the level of job related skills required for the labor force as a whole. We do not project a uniform upgrading or downgrading of job skill requirements in the U.S. economy as a result of technological change. This does not deny the need, however, for continued investment and improvement in job related skills of the U.S. work force to support the rapid adoption of new tech- nologies that will contribute to U.S. competitiveness. One important concern is a more sophisticated treatment of the issue of services wages in public policy debates. Comparing average wages in man- ufacturing versus those in the services sector is particularly misguided. Be- cause great variations exist among specific job categories and industries, a more relevant focal point would be on the wage levels and opportunities in particular services industries or occupations versus those in individual man- ufacturing categories. Even then certain important adjustments should be made. Today, services not blue-collar jobs provide the most available entry point for new, secondary, or part-time workers, as well as for high school students, females, and retirees entering or reentering the work force (see Table 51. When analyzing the wages in services, one should adjust for these entry conditions, the greater convenience and better working conditions, the lower experience requirements, and the more flexible hours offered by many services jobs. Such jobs are essential for multiple-earner families and for developing the attitudes, skills, and disciplines needed for more permanent job holding (Levy, 19871. The safety net provided by widely distributed services jobs has undoubtedly helped by absorbing displacements from manufacturing into local jobs in the services sector. The economy has benefited if the wage levels in growing services areas and the value added which is presumably necessary to sup- port themare higher than those that displaced blue-collar workers would have had to accept to keep their companies from going overseas. Further, as services company outputs become more substitutable for manufacturing tasks (notably in design, quality assurance, maintenance, accounting, mar- keting, or other support tasks), wages should progressively equilibrate be- tween the two sectors, as data indicate they have begun to over the past five years. Disparaging services wages in policy conversations seems singularly un- productive. Instead, an emphasis on retraining, adapting, and cushioning the personal costs for those displaced because of the loss of certain manufacturing jobs or because of changes in occupational mix would be more appropriate. At the most fundamental level, a more literate and numerate work force will

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KEY POLICYISSUES POSED BYSER VICES TABLE 5 Secondary Workers in the Labor Supply, 1980 Census Data 227 Total Employed Work Less (numbers in than 35 Hours 19 Years Old Industry thousands) per Week (%) and Under (%) Female (%) All manufacturing 21,194 9.1 4.3 31.9 Selected services Food and bakery stores 2,502 38.3 22.8 45.8 Gasoline service stations 627 25.8 22.5 16.7 Apparel and accessory stores 896 40.2 17.7 69.7 Eating and drinking places 4,181 49.8 30.8 59.6 Drug stores 490 39.2 20.2 60.6 Other retail trade 2,217 34.0 10.0 54.6 Private households 701 58.6 9.7 90.9 Hotels and lodging 1,052 29.6 9.7 62.3 Laundry, cleaning, and garment services 399 30.3 7.8 58.9 Entertainment and recreation services 1,007 39.9 16.6 40 4 SOURCE: O'Neill (1987, p.22). be more adaptive to changing economic conditions. Therefore, basic edu- cation remains a high priority, especially if the basic education offered can prepare people for lifetime learning in connection with constantly changing job demands. In his chapter in this volume Kendrick also concludes that it is most important to stress education appropriate for services jobs, especially vocational training and in such programs as the Job Training Partnership Act. Many studies have emphasized that education and human skills develop- ment are the foundations of value-added in many industries and provisions for lifelong education are critical for individuals to obtain and upgrade the skills called for in today's rapidly restructuring economy. Whereas job- specific training by companies is often the most appropriate type of training for economic adjustment, there are situations in which the benefits an em- ployer can capture are significantly less than the social benefits of an enhanced skill base. In those cases public support of training and education is crucial. One particularly important concern is that between 20 and 30 percent of displaced workers with job experience lack basic skills (Cyert and Mowery, 19871. These individuals, with less formal education, are also the least likely to derive benefit from on-thejob training provided by employers and should be a primary target for public training and retraining initiatives. This priority is reinforced by Kutscher's observation (this volume) that job growth in the

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228 JAAlES BRIAN QUINIV AND THOMAS L. DOORLEY near future is likely to be mostly in those jobs currently held by those with higher levels of educational attainment. Finally, at the college and university level, there are a host of initiatives that could strengthen the technology base of the nation with as much benefit to services industries as to manufacturing. The 1985 Report of the President's Commission on Industrial Competitiveness recommended greater funding for engineering education and expansion of the National Science Foundation's engineering research centers. The increasing technological intensity of ser- vices industries argues for sustained support of engineering education as much as does the need to keep U.S. manufacturing technologically dynamic. Sectoral Risks and Diversification Another key policy issue is the extent to which government should attempt to lower the country's economic and political risks by maintaining sectoral diversification between the goods and services sectors. In an increasingly global economy, and one in which the United States is more of an equal participant than an overwhelmingly dominant force, national security con- cerns with the industrial base may require special interventions. Critical issues include whether the growth of services threatens U. S . capabilities to maintain (1) a sufficient presence in international trade, (2) its desired military or defense posture, and (3) its strategic flexibility to obtain vital resources abroad. The latter two points may require special interventions by consciously diversifying national strategic alliances, stockpiling critical materials, or di- rectly subsidizing specialized defense needs. The cost of dealing with these issues through general economic supports for various manufacturing indus- tries would be extraordinarily high; asking consumers to subsidize noncom- petitive industries for the sole purpose of maintaining a production surge capacity for certain defense contingencies is a very inefficient and wasteful way of maintaining our defense industrial base. In the realm of commercial trade, services already account for a high percentage of U.S. and other developed countries' exports (see Figure 41. Yet there is general agreement that these figures are vastly understated. Data concerning services trade measure only a few categories of services activities. Many services are often embodied, but not separately accounted for, in product or technology transfers across borders. However, the most interesting point is generally overlooked: trade figures measure the benefits of products versus services sold in trade in quite different ways. When a product, say a mined raw material, is sold, the selling country registers the wholesale price of the product as its gain or inflow. Yet all the resources embodied in the product are lost to that country for further use. The real net gain on the sale is actually the profit on the sale, perhaps one-tenth of the sale price. On the other hand, when a services company completes a transaction abroad (e.g.,

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KEY POLICY ISSUES POSED BY SERVICES UNITED KINGDOM AUSTRIA BELGIUM/ LUXEMBOURG UNITED STATES SWITZERLAND NETHERLANDS ITALY FEDERAL REPUBLIC OF GERMANY SWEDEN lA"tA~I CANADA ,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,/,= , , 0 ~ 10 15 20 25 30 PERCENT 229 ~3 1976 1 986 35 40 , 1 1 45 50 55 FIGURE 4 Exports of services as percentage of total exports. SOURCE: The Econ- omist (1987b). a banking deal or a bridge design in situ), only the net profit or fee is credited to the selling country. Yet no nonrenewable resources have left the country, and those who handled the transaction (and return to their parent country) may actually have increased value as human assets. Thus, international trade accounting conventions probably overstate the relative net value of products versus services sold in trade by at least an order of magnitude. Some have suggested that it may be impossible for a country to establish meaningful competitive or comparative advantages in services (Deardorff, 19851. Given the capital intensity, economies of scale, and scope of some of the major services industries, some companies and industries can de- monstrably achieve international competitive advantages in cost, quality, or flexibility. The more interesting question is comparative advantage. Because traded services depend so much on costs in the receiving country, do the relative factor endowments of the parent country really determine what is exported? Also, if a country had a factor advantage that favored particular services industries, could that shift trade patterns dangerously (Nusbaumer, 1987a)? Wright and Pauli (this volume) warn that the Japanese may be using such a factor advantage (availability of inexpensive money in Japan) in penetrating U.S. financial services markets. Because exploitation of this advantage will require substantial Japanese investments in their customers' countries (like the United States), there are grounds for negotiating fair access to Japanese services markets in return.

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230 JAMES BRIAN QUINN AND THOMAS L. DOORLEY Despite U.S. strengths in many other services areas, there are significant foreign barriers to trade. Gonen~c, in his chapter, identifies three other factors that may limit the growth of trade in marketed services: (1) the existence of culturally bound services demands, (2) the complexity and cost of interna- tionalization in services businesses, and (3) the lack of incentive to engage in international trade or operations on the part of the many privately held, smaller services establishments. And in fact, the measured world market share of manufactured goods produced by U. S.-based companies has hovered around the 20 percent level since the 1960s, and manufacturing has enjoyed a strong recent export resurgence (Fortune, 19871. Given these and the high degree of interactive support and mutual substitution possible between ser- vices and manufacturing, it seems unlikely that U.S. trade as currently mea- sured will shift dramatically toward services in the near future. However, it is appropriate to focus more attention on the $700 billion international services trade, which is virtually all outside GATT (Shelp, 19871. Because so much of the services sector of most nations is typically government owned or managed, it will take years for a general agreement such as GATT to substantially ameliorate each country's unique constraints. Specific bilateral or limited multilateral negotiations seem the most likely road to progress in the near future. Open access for foreigners to the huge U.S. services markets will normally be a desirable quid pro quo in such negotiations. Federal Express has often been hampered in pursuing Fred Smith's vision of a global just-in-time economy (Smith, this volume) by Japanese government protectionist actions. An effective transportation and logistics system linking U.S. production and distribution units with world- wide sources will demand extensive modification of outdated world air cargo regulations and treaties, but the benefits of less regulation could be great for all parties. The threat of tariff barriers is rarely effective in services trade, but selec- tively being able to deny takeovers of U.S. companies by foreign enterprises whose countries do not offer reciprocal access may be a valuable bargaining tool in obtaining "level-playing-field" conditions with our major competi- tors. The international airlines industry provides an interesting and timely case in point. Successive administrations awarded foreign airlines access to the richest U.S. travel cities, while settling for access to fewer cities abroad and heavy restrictions on U.S. airline operations there (Wall Street Journal, 1987b). Foreign airlines are now asking for cabotage- the right to fly do- mestic U.S. routes and permission to own some U.S. airlines, so a pos- sibility for redress appears to exist. Services trade and merchandise trade are inseparable in many instances. Gonen~c (this volume) points out the way in which Japanese services exports in transportation derive naturally from Japan's large merchandise export activity. Leverage can be brought against countries with strong product trade

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KEY POLICY ISSUES POSED BY SERVICES 231 balances to allow U.S. manufacturing companies to operate under equivalent rules, including provision of U.S. services in support of their product sales in those countnes. To do otherwise is to allow competitor nations to exploit their advantages in manufactunng, while denying the United States the right to benefit from its relative strengths in services. . . Because most of the employment and benefits from providing services in international trade tend to be captured in the receiving country with the exception of some services industries such as water transport or communi- cations there is serious doubt that direct services trade can make up the enormous product trade deficits which the United States has incurred recently. In the near future, services are most likely to help U.S. trade by lowering U.S. infrastructure costs and increasing the value added in exported manu- factures through mechanisms described above. This area, along with ag- gressive efforts to break barriers to services trade and to U.S. services investments abroad, is where much of our strategic focus should be placed. CONCLUSIONS Policy discussions have generally deeded, misunderstood, or underem- phasized the role of services in the U. S . economy. This volume has attempted to systematically address certain important policy areas, by using the most up-to-date data available. These include the issues of productivity, invest- ment, employment, regulation, and trade in services. This chapter attempts to integrate these analyses and set forth some explicit recommendations addressed to those major policy communities that can most dramatically enhance the effective development and use of technology in services. A1- though market forces are generally reasonably efficient in allocating research resources among services-producing sectors, markets, and technologies, a major reordering and refocusing of national priorities and attitudes toward the following could pay high dividends: Developing a strong services sector is an extremely desirable goal for the United States, which will support and enhance U.S. manufacturing competitiveness nationally and internationally. Manufacturing and services effectiveness are so intertwined that any attempt to enhance one at the expense of the other will be actively counterproductive. Macroeconomic and tax policies should focus on improving capital formation rates, lowering capital costs, increasing investments versus current consumption, and length- ening investment time horizons. Crucial, and feasible, elements include fiscal constraints on government expenditures to lower anticipated inflation rates and pressure on capital funds available, institution of a 3-year minimum holding period (and perhaps progressively higher incentives for longer term holdings) to obtain significant capital gains tax advan- tages, and a shift in government expenditures toward infrastructure investments including education and training and other "intangible" investments in social infrastructures. Because services technologies have created a much wider and more complex range of direct and cross-industry competition, new regulatory approaches and institutions are

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232 JAMES BRIAN QUINN AND THOMAS L. DOORLEY needed which intervene at a transactional or functional level, rather than on an industry or institutional basis (i.e., regulating sales transactions or safety functions, rather than banks or airlines as individual industries). Other new modes of intervention may be needed to protect proprietary knowledge and to enforce or enhance competitiveness in the new integrated information environments and cooperative structures permitted by modern services technologies. Human resources policies should be redirected to foster the mobility and intellectual skills required for a services-dominated society. Basic educational, job training, and wage policies should reflect the fact that services, not blue-collar, jobs now provide the primary entry point for new workers, secondary workers, minorities, and other less advantaged people entering or reentering the work force. A particular focus for public initiatives should be continuing education, including on-thejob-training for those with less than average formal education. ~ Further attention to, and leveraging of, the strong U.S. services position in inter- national trade should become a central element in U.S. trade policy. Intense pressures can be brought on selected foreign countries to break down barriers to services trade (and even product trade) by refusing to allow their companies to consummate takeovers of U.S. services enterprises or have access to desirable U.S. services infrastructures such as our major air routes or airports. Pressures should be brought to create level-playing- field access not just for product trade but also especially for the services accompanying that trade, where the United States is likely to have distinct competitive advantages. To do otherwise is to allow other nations to exploit their advantages in manufacturing, while denying the United States the benefit of its relative strengths in services. Although there is no single new "program" or identifiable R&D "agenda" that calls for a special government action on behalf of services, the above recommendations do provide a catalogue of priority shifts that can make an enormous difference in the effective development of this most crucial sector of economic activity. With proper policy support for technology and trade development, services can continue to be the main engine for U.S. growth in jobs, GNP, and value added through the end of the century. Government's main task is to nurture the attitudes, infrastructures, and skills development that will make this possible. ACKNOWLEDGMENTS The authors gratefully acknowledge the important contributions of Dr. Jordan J. Baruch and Penny C. Paquette in developing this chapter, as well as the generosity of Bankers Trust Company, Bell & Howell, The Royal Bank of Canada, Braxton Associates, Bell Atlanticom Co., and American Express in supporting this research. NOTES Unfortunately, national economic data bases (as they are now compiled) are of limited use in understanding the services economy (Quinn, 1987). There are many problems of defi-

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KEY POLICYISSUES POSED BYSERVICES 233 nition. Categories for collecting data still reflect the dominance of manufacturing concerns in an earlier period. Domestic categories do not capture many new services areas (such as software or health spas) until they become more mature industries. Also, data are not refined enough to sort out critical relationships. Step by step, as opportunities present themselves, new categories reflecting services activities should be substituted for the less relevant manufacturing details now collected. Data showing services transactions between industries and in international trade are particularly weak. U.S. input-output tables are not available until 5-10 years after data collection. Various responsible federal groups have formed task forces to improve data and methodologies for analyzing productivity, wage, trade, unemployment, and output data for services. However, they have been hampered both by budgetary constraints and by the cost and difficulty of getting businesses to report in more detail. 2. Bell and Kettell (1983, p. 3) estimate that 95 percent of the daily volume in foreign exchange markets in 1983 was not direct commercial business but trading between the foreign ex- change dealers of the world's international banks. 3. At the national level, the Washington Business Group on Health has been attempting to coordinate provider, payer, and government agency groups that need to cooperate on this issue and has started publishing Business and Health to bring the views of both private and public authorities to the fore. REFERENCES Aschauer, D. A. 1987. Is the public capital stock too low? Federal Reserve Bank of Chicago Bulletin (October). 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. Business Month. 1987. Taking control in the rag trade. (April):48-49. Cook, J. 1987. If it isn't profitable, don't do it. Forbes (November 30):54-56. Cyert, R. M., and D. C. Mowery, eds. 1987. Technology and Employment. Washington, D.C.: National Academy Press. Deardorff, A. 1985. Comparative Advantage and International Trade and Investment in Ser- vices. Philadelphia: Fishman-Davidson Center, The Wharton School, University of Penn- sylvania. The Economist. 1987a. Economic and financial indicators. (October 17):130. The Economist. 1987b. Taking stock. (October 31):14. The Economist. 1987c. Purveyor to all nations. (December 5):16. The Economist; 1987d. Bank regulation: Levelling? (December 12):92. The Economist. 1987e. The wrong kind of squeeze? (December 26):32. The Economist. 1988. Get ready for the phoenix. (January 9):9-10. Faulhaber, G., E. Noam, and R. Tasley, eds. 1986. Services in Transition: The Impact of Information Technology on the Service Sector. Cambridge, Mass.: Ballinger Publishing Co. Fortune. 1987. Crawling out of the trade tunnel. (December 21):43-44. Guile, B. R., and J. B. Quinn. 1988. Managing Innovation: Cases from the Services Industries. Washington, D.C.: National Academy Press. Hatsopoulos, G. N., P. R. Krugman, and L. H. Summers. 1988. U.S. competitiveness: Beyond the trade deficit. Science (July 15):299-307. International Trade Commission.1982. The Relationship of Exports in Selected U.S. Services Industries to U.S. Merchandise Exports. Washington, D.C. (September). Landau, R., and G. N. Hatsopoulos. 1986. Capital formation in the United States and Japan.

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234 JAMES BRIAN QUINN AND THOMAS L. DOORLEY Pp. 583-606 in The Positive-Sum Strategy: Harnessing Technology for Economic Growth, R. Landau and N. Rosenberg, eds. Washington, D.C.: National Academy Press. Levy, F. 1987. Changes in the distribution of American family incomes, 1947-84. 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. National Academy of Engineering. 1983. The long-term impact of technology on employment. National Academy of Engineering Symposium, Washington, D.C. (June 30). Norton, R. 1988. The battle over stock market reform. Fortune (February 1):18-26. Nusbaumer, J. 1987a. The Services Economy: Lever to Growth. Amsterdam: Kluwer Academic Publications. Nusbaumer, J. 1987b. Services in the Global Market. Amsterdam: Kluwer Academic Publi- cations. Office of the U.S. Trade Representative. 1983. U.S. National Study on Trade in Services. Washington, D.C. (December). O'Neill, D. 1987. We're not losing our industrial base. Challenge (September-October):19- 25. Presidential Task Force on Market Mechanisms. 1988. Report of the Presidential Task Force on Market Mechanisms. Washington, D.C.: U.S. Government Printing Office. Quinn, J. B. 1977. National policies for science and technology. Research Management (November): 11 - 18. Quinn, J. B., 1983. Overview of current status of U.S. manufacturing. Pp. 8-52 in U.S. Leadership in Manufacturing. Washington, D.C.: National Academy Press. Quinn, J. B. 1987. The impacts of technology in the services sector. Pp. 119-159 in Technology and Global Industry, B. R. Guile and H. Brooks, eds. Washington, D.C.: National Academy Press. Quinn, J. B., and B. R. Guile. 1988. Managing innovation in services. Pp. 1-8 in Managing Innovation: Cases from the Services Industries. Washington, D.C.: National Academy Press. Sauvant, K. 1986. International Transactions in Services: The Politics of Transborder Data Flows. New York: Westview Press. Shelp, R. 1986. Understanding a new economy. Wall Street Journal (December 23):20. Shelp, R. 1987. The folly of excluding the services from the trade framework. International Management (November): 104. 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. Wall Street Journal. 1987a. Computers as marketing tools. (March 18):1. Wall Street Journal. 1987b. Freeing up the international skies. (December 1):36.