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The Dynamics of Long-Term Growth: Gaining and Losing Advantage in the Chemical Industry1 RALPH LANDAU Stanford University ASHISH ARORA Carnegie Mellon University What factors support the long-term growth of industrial societies? This chap- ter examines the innovative and competitive performance of the chemicals indus- try over the past 150 years. It draws on a recent book analyzing factors that contribute to the flourishing or failure of companies in the industry in the United States, the United Kingdom, Germany, and Japan the four countries with the most extensive available data and case histories (Arora et al., 1998~. It links this history with the external factors, the "climate" in which these companies oper- ated during different periods and probes the interrelationship. By focusing on the "long run," we hope to bring out some of the underlying factors, such as change in the institutional landscape, that influence industrial and economic performance but that are not easily captured in analyses covering shorter time periods. This analysis of the long-run factors supporting industrial growth and competitiveness complements the discussion of short-term trends in performance in the other chap- ters of this volume. The chapter relies on an analytical framework developed elsewhere, a frame- work that highlights the multiple sources of comparative advantage (Landau et al., 1996) (Figure 1~. As Krugman (1996) notes, countries do not compete, firms do. Nonetheless, countries can establish a more or less favorable climate for their firms to compete, helping them to gain comparative advantage for their industry and producing benefits for their home country. iThe authors are grateful for the invaluable assistance of Johann Peter Murmann and for continuing advice from Nathan Rosenberg and Paul Romer. 17
8 U.S. INDUSTRYIN2000 FIGURE 1 Levels of sources of comparative advantage. We conclude that a well-functioning and growing economy depends on . a complex mix of institutions and policies that extend beyond the legal system and fiscal and monetary authorities to include entities such as national systems of higher education, industry-specific and economy-wide regulation, and trade policy; · market-based policies that support the interaction of social institutions and policies to generate higher economic growth within a relatively stable macro- economic environment but avoid unwarranted intervention; and · the size of the market, the historical development, and the political and social environment of the country in question. Our long-term view highlights the central importance of technological inno- vation for the growth of the chemical industry and for industrial societies as a whole. But like other chapters in this collection, we stress that a narrow defini- tion of "technological innovation" is inadequate for this analysis. Instead, tech- nological innovation must be defined to include the broader constellation of risk- taking activities that commercialize the technology and underlying science. These activities are influenced by social institutions and policies.
THE DYNAMICS OF LONG-TERM GROWTH SOME PERSPECTIVES ON GROWTH 19 The conventional neoclassical views of the causes of growth neglect other aspects of economic structure, policy, and society that affect the growth or de- cline in comparative advantage. Most neoclassical models of economic growth assumed a world of perfect competition, in which the only institutions needed to achieve good economic performance are a legal system, a specification of property rights, and an antitrust authority that can prevent the emergence of mo- nopoly power. Experience has taught economists to add to this list government institutions that seek to ensure a stable monetary policy and avoid macroeco- nomic disruption. "Growth accounting" studies inspired by neoclassical models have consis- tently found a significant unexplained residual, labeled "technology" or, more accurately, multifactor productivity. The factors contributing to this residual en- compass a substantially broader and more diverse list than those included in nar- row definitions of technological change indeed, they encompass many of the factors included in Figure 1. Moses Abramovitz (1956) coined the words "social capability" to describe the complex of institutions and policies embedded in these levels. The factors influencing economic growth in this conceptual framework are more numerous and complex than the parsimonious list associated with the neoclassical model and its applications in growth accounting.2 Newer work on endogenous growth theory has introduced concepts to mod- els of economic growth that fit reality more closely (Romer, 1994, for example). This theory recognizes that the underlying assumptions of neoclassical econo- mists, such as perfect competition, emphasized the central role of new technolo- gies and simultaneously denied the possibility that economic analysis could have anything to say about the processes that affect their creation, improvement, or adoption. These neoclassical models allowed little scope or significance for in- vention or innovation, learning by doing, technology transfer from abroad, or systematic research and development, all of which can produce new and improved products, processes, and services and greatly enhance the growth process. A1- though endogenous growth theory has recognized many of these important fac- tors, neither it nor its neoclassical predecessor takes into account historical ef- fects, such as path dependence (Arora et al., 1998~. A richer model of long-term economic growth requires examination of how commercialization of technology actually takes place at the firm level and an understanding of the forces external to the firm that influence that commercial- ization. Internal factors that are well known from the business literature include management recruiting, research and development, and manufacturing and mar- keting and need no further detailing here. But external factors also influence the evolution of management strategies, and the nature and channels of this influence 2See, for example, Lau (1996).
20 U.S. INDUSTRYIN2000 remain poorly understood. The technology of a firm depends in part on the per- formance of institutions of learning, as well as scientific and engineering research conducted by various public and private institutions. A firm's investment strate- gies depend on the cost and availability of capital, the division of profits between the owners of the company and the other stakeholders, and the efficient function- ing of the labor market. Capital supply in turn depends on the functioning of the external, and now largely international, capital markets, the intermediating insti- tutions such as banks that allocate capital from savers to investors, and the com- petition for capital by other firms and governments. Government policy is essential in several areas. Government tax policies affect the net returns to investors for the employment of their capital, which in turn guides future investment. Government budgetary and monetary policies af- fect national welfare and aggregate domestic demand as well as domestic savings and the cost of capital. Governments set trade policies. Governments must main- tain a legal order so that firms know what they and their competitors can and cannot do. Governments provide for much of the education of the labor force and promulgate a variety of regulations to control many aspects of the economy. These factors are individually complex, and their interrelationships and in- teractions, intended and otherwise, are even more so. We cannot hope to provide a definitive description of these individual factors, let alone their interaction, for such a lengthy period in four large industrial economies. The historical and ana- lytic discussion that follows instead should alert economic theorists, policy- makers, and managers to the complexity of the factors and forces that support long-term growth. This discussion also should give pause to those who proclaim the arrival of a "new paradigm" or the onset of an indefinite period of U.S. eco- nomic dominance in chemicals or other industries. An exclusive focus on the near term in such analyses will result in myopic conclusions and prescriptions. THE CHEMICAL INDUSTRY The history of the chemical industry offers clear illustrations of the interde- pendence between the strategies of individual firms and the environment of eco- nomic policy and institutions that their home-economy governments create. Three characteristics illustrate the economic and technological significance of the chemical industry as well as its long history. First, chemicals was the first science-based, high-technology industry. More- over, with the exception of this century's two world wars, this industry's research and development has been financed almost entirely by private investment. Fig- ure 2 gives the most recent data available in this form. An estimation of 1997 expenditures is given in Figure 3, which also shows federal funding of R&D by industry for 1996. It is evident that R&D in the chemicals industry, which, along with transportation equipment, is one of the two largest R&D performers in the U.S. economy, is virtually all privately financed.
THE DYNAMICS OF LONG-TERM GROWTH 21 1. Aerospace 2. Electrical Machinery & Communications 3. Machinery 4. Chemicals 5. Autos, Trucks, Transportation 6. Professional & Scientific Instruments 7. Computer Software & Services 8. Petroleum TOTAL 16.63 16.12 13.42 13.55 14.78 15.14 14.65 16.71 10.80 10.37 8.71 9.65 5.77 6.66 2.50 2.34 87.26 90.54 6.25 9.69 14.07 16.42 9.48 7.43 3.89 2.33 69.56 39% 72% 93% 98% 91% 77% 58% 99% Note: Total R&D in 1992 was $154.5 billion, of which R&D performed by industry was $107.6 billion so that the above are the bulk of R&D performers. Battelle estimates these figures for 1995 at $182 billion and $130.6 billion. Source: National Science Foundation, Division of Science Resources Studies, "Selected Data on Re- search and Development in Industry: 1992" and "National Paterns of R&D Resources." FIGURE 2 The Major R&D Industries, 1991 & 1992 R&D Expenditures (billions of current dollars) 1. Chemicals and Pharmaceuticals 2. Transportation 3. Telecommunications 4. Computers 5. Electronics 6. Software 7. Semiconductors TOTAL 31.4 30.4 29.0 22.5 15.2 9.9 6.8 145.2 Note: Total R&D for 1997 is estimated by Battelle at $192 billion, of which 62.8 percent ($120.6 billion) will be financed by industry, 32.4 percent ($62.2 billion) by government, and 4.9 per- cent ($9.4 billion) by others (such as non-profits, universities, research institutions). Numbers have been rounded and may not add to 100. Source: "1997 R&D Funding Forecast" by Battelle. Transportation Equipment 52% Professional & Scientific Instruments 17% Electric Equipment 9% Non-manufacturers 15% Other Manufacturers 7% 100% Source: National Science Foundation. FIGURE 3 The Major R&D Industries for 1997 (top) (billions of current dollars) and Federal Funding of R&D by Industry for 1996 (bottom).
22 U.S. INDUSTRYIN2000 Second, the chemicals industry has generated technological innovations for other industries, such as automobiles, rubber, textiles, consumer products, agri- culture, petroleum refining, pulp and paper, health services, construction, pub- lishing, entertainment, and metals. In this regard, the chemical industry illustrates the general tendency for the benefits of internationally competitive industries to spill over to other industries. Third, the chemicals industry is a U.S. success story. The chemicals industry is one of only two major high-technology industries (aerospace being the other) in which the United States has maintained its competitive lead in international trade. Its growth rate has exceeded that of the overall U.S. economy since World War II. The output of the modern chemicals industry conveys some sense of the diversity of activity. It includes paints and coatings, pharmaceuticals, soaps and detergents, perfumes and cosmetics, fertilizers, pesticides, herbicides and other agricultural chemicals, solvents, packaging materials, composites, plastics, syn- thetic fibers and rubbers, dyestuffs, inks, photographic supplies, explosives, anti- freeze, and many other kinds of chemicals more than 70,000 products. It is the leading U.S. export industry, with a long-term favorable balance of trade. Very few industries have the complexity of the chemical industry. The enormous size of this industry in 1996 is shown in Tables 1 and 2 (Figures 4, 5, and 6 contain other comparative data on the U.S. chemicals industry and other U.S. high-tech- nology industries). In Europe, it is second only to the food, drink, and tobacco industries in size and value added and has a consistently positive balance of trade. TABLE 1 GDP by Industry (1996) U.S. Manufacturing Sector (17.4% of total GDP) $1332 billion $7636 billion Chemicals and allied products Industrial machines and equipment Electronic and electric equipment Food and kindred products Fabricated metal products Printing and publishing Motor vehicles and parts Paper products Instruments Other transportation Petroleum and coal Other Total $157.8 150.2 143.8 122.6 98.2 90.4 85.1 57.1 52.3 49.7 30.1 294.9 $1332.2 Source: U.S. Bureau of Economic Analysis, Survey of Current Business, November 1997.
THE DYNAMICS OF LONG-TERM GROWTH TABLE 2 The World Chemical Industry in 1996 23 Sales volume $ billion % of total United States Japan All others Western Europe (includes EFTA) 445a EFTA = (36) 372 216 533 28 (2) 24 14 34 Total 1566 100 a of which German sales value is about $117 billion and the U.K. is $56 billion. The most important class of chemicals is the organic compounds, which are much more varied and pervasive than the inorganic compounds (e.g., derived from salt and minerals). Organic inputs like oil and natural gas contain hydro- carbons, which form the backbone of final organic chemical outputs. In the first stage of processing, chemicals such as chlorine and oxygen are added to the hydrocarbon backbones to give the compounds certain desired charactenstics. The final output may be nylon or polyester fiber, plastic, a pharmaceutical prod- uct, or other products that are rarely considered to be chemical industry outputs. Trade Balance (in billions of $) 40 20 o -20 -40 -60 . ~ 1992 1993 1994 1995 1989 1990 1991 | ~ AEROSPACE ~ CHEMICALS ~ ~ ~A ·c t~Y ~ ~ B'~ M~ Ms ~ SCIENTIFIC APPARATUS ~ ADPIOFFICE EQUIPMENT `3 AUTOMOTIVE ~ PETROLEUM FIGURE 4 U.S. Industries with heavy R&D. Source: U.S. Bureau of Census.
24 U.S. INDUSTRY IN 2000 Return on assets and profit margin, % Operating rate, % 12 0 8 4 2 At, `N Aft ~ ~ -~- ~ ~ ''a ,-,, ^/ / ~ ~'%.Q ~ -\\~ ~.,y /' _ .,- I'm. NET INCOME/SALES NET INCOME/ASSETS OPERATING RATE 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 I ,.~ '69 '71 '73 '75 '77 '79 181 '83 '85 '87 '89 '91 '93 '95 '70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 FIGURE 5 Return on assets and profit margin (%) and operating rate (my. Source: Chemical Manufacturers Association. A BRIEF HISTORY OF DYNAMIC COMPARATIVE ADVANTAGE IN THE CHEMICAL INDUSTRY 100 80 60 40 20 o To understand the development of comparative advantage in the chemical industry it is useful to summarize the essential historical facts before offering a ~ . ~ ~ . ~ ~ ~ . ~ ~ ~ ~ ~ ~ . ~ . . ~ . ~ ~ more detailed analysis. England already dominated inorganic chemicals when William Henry Perkin discovered the first synthetic dye (mauve) in 1856 and launched the modern organic chemical industry. England in the mid-1800s was wealthy; it had the know-how, the largest customer base (textiles), and the largest supply of raw material (coal). But the chemical industry let its advantages slip away, and by the end of the 1880s the Germans dominated the organic chemical industry. By 1913 German companies produced 140,000 tons of dyes, Switzer- land produced 10,000 tons, and Britain produced only 4,400 tons. The American industry depended mainly on German dyestuff and other chemical imports, al- though it was a large producer of basic inorganic chemicals. World War I brought a change in the relative position of the four countries. The United States built its own organic chemical industry, and the German indus- try fell on hard times. With the tacit support of the German government, their competitive difficulties contributed to the merger of the leading German chemi- cal companies to form the I.G. Farben company. Britain and the United States took advantage of the military defeat of Germany, refusing to give back prewar patents to German firms. Further, by sanctioning the merger that created Impe
THE DYNAMICS OF LONG-TERM GROWTH US o US CO CO Cal S)EIIOp 10 SU°!II!O 25 US o US o Cal ·_. Cal ·_. Cal Cal o = .~ o ;~. ¢ Cal ~ ·0 Cal _ ~ .e ~ . ~ a= ~ V . . o V,
26 U.S. INDUSTRYIN2000 rial Chemical Industries (ICI) in 1926, Britain avoided falling further behind Ger- many. At the same time, the United States was gaining strength through the development of a large petroleum refining industry and was creating new skills in the design of large-scale continuous processing plants through the use of chemi- cal engineering. These skills, largely in the hands of specialized engineering firms, were readily transferable to the burgeoning petrochemical industry, which was based on the cheap petroleum and natural gas feed stocks with which the United States was abundantly endowed. The European chemical industry contin- ued to use coal, rather than petroleum, as its main feedstock through the 1940s. World War II resulted in the physical destruction of a significant portion of the German chemical industry. During the postwar period, the U.S. industry developed uses for petrochemicals in the production of fibers, plastics, and many other products, while dyestuffs shrank in importance. America's chemical indus- try grew enormously and dominated the market at least until the 1970s. As world prosperity returned, however, so did a successful chemical industry in Germany and in Europe more generally. Petrochemical industries were soon well-estab- lished in Asia, in the oil-exporting countries, and elsewhere. No longer did one country dominate; the industry's growth had made it a truly global industry. Com- petitive advantage at the firm level came to the fore, with different companies in different countries excelling at what they did best. Japan was the one exception. Although the Japanese chemical industry grew to become the second largest in the world, it never became a major player in international markets for products or technology. TRACING THE DEVELOPMENT OF COMPARATIVE ADVANTAGE THROUGH THE MATRIX We now discuss briefly how each level of the matrix in Figure 1 has affected comparative advantage and growth in the chemical industry over the last 150 years. National Governance and Socio-Political Climate How do factors related to national political and social factors help to explain the shift in comparative advantage from Britain to Germany after the 1 870s until 1914? To begin with, the national governmental structures were very different in the two countries. Britain had a parliamentary system of government; Germany was a collection of 39 political entities that had a customs union but otherwise differed widely in their governmental structures and policies. The competition among the various states contributed to the rise of many German dyestuff compa- nies. Germany's political unification in 1871, under Chancellor Otto von Bis- marck, a Prussian, not only created a common market and an investment boom
THE DYNAMICS OF LONG-TERM GROWTH 27 but also produced a foundation for a unified patent system that proved to be very important. Much has been written about the reluctance of British investors to undertake the higher-risk organic chemical investments that their counterparts in Germany did. Britain had many opportunities for low-risk investments throughout its own empire, the United States, and South America. Germany in contrast had no em- pire and, even with the creation of a larger domestic market, had a limited market. German senior industrial managers, supported by their investors who were re- ceiving rich dividends, accordingly took bigger risks, including investments in scientific and technological developments of the second (electrical and chemical) industrial revolution. Political and social factors also influenced the relative positions of the Japa- nese and U.S. chemical companies, particularly during and after the two world wars. In Japan, the feudal regime was replaced in 1868 by the Meiji restoration, yielding a somewhat more democratic society. But the Japanese military' s politi- cal influence expanded in the early twentieth century, partly as a result of victo- ries in wars with Korea and Russia, and the military assumed control of Japan's government by 1931 with the invasion of Manchuria. The two world wars led to major governmental changes in Germany and Japan and influenced the subsequent direction of their chemical industries. The war also led to changes in the U.S. chemical industry. The two world wars, however, drained Britain of much of its economic strength and, as the history of ICI, its largest firm shows, had an influence on its chemical industry. The rise of consumerism and the substitution of natural materials as a result of the depriva- tions of the war in the West led to the creation of new products and an enlarged demand for the newly developed plastics and other synthetic materials, some of which had been discovered in the interwar years. These developments allowed the chemical industry to grow for many decades much faster than gross domestic product. Macroeconomic Factors: Monetary and Fiscal Policies Prevailing government and sociopolitical conditions profoundly influence macroeconmic policies, which have affected the growth pattern of our four na- tional chemical industries in important ways. Macroeconomic policies during the period before the World War I favored British capital exports. Most major indus- trialized countries sooner or later adhered to the gold standard before World War I. Britain had control of much of the world's gold supply and therefore was able to maintain clear leadership in the international flow of capital. British investors preferred low-risk foreign investment opportunities to the riskier domestic in- vestment options offered by the nascent chemical industry. German investment overseas was constrained by these British policies, and so Germany was forced to export goods instead of capital.
28 U.S. INDUSTRYIN2000 In the nineteenth century, Britain imposed the first modern income tax, which, while low, nevertheless provided a flexible source of government rev- enues to sustain the costs of its empire. Thus, the average British taxpayer sup- ported the very low-risk investments in the empire, an advantage not available to the Germans.3 After its defeat in World War I, Germany faced serious economic problems resulting from the reparations imposed by the Versailles Treaty and a postwar recession. To cope with the effects of the war reparations payments, the German government printed large quantities of money, which produced runaway infla- tion. The resulting economic turbulence discouraged new investment and con- tributed to massive unemployment, the political crises that led to Hitler's Nazi government, and eventually war. Macroeconomic policies in all of these nations changed after World War II. In Germany, Ludwig Erhard' s free-market economic policies created the "Wirt- schaftswunder'' (economic miracle), characterized by minimal government inter- ference with the private sector. By contrast, Great Britain after losing its empire pursued the creation of a welfare state that led to price controls, inflationary poli- cies, frequent labor unrest, and recurrent currency crises. Productivity growth in Britain lagged behind that of Germany during most of the post-1945 period, re- ducing demand growth for chemicals. The Japanese government systematically established its chemical industry through a series of government plans and decrees, developing a petrochemical industry that grew rapidly from the mid- 1950s onward. Another area of difference in national macroeconomic policies was the man- agement of exchange rates in the postwar era.4 Undervaluation of the yen and the mark during the 1950s and 1960s helped Japanese and German exports and the recovery of both nations from wartime destruction. The "hard dollar" in the early 1980s had a significant and unfavorable effect on U.S. exports; the hard yen of the later 1980s had a similar effect on Japanese exports. In both Japan and the United States, however, overvalued exchange rates intensified competitive pres- sures on domestic exporters to improve their innovative performance and effi- ciency. Macroeconomic Factors: Trade Policies Between 1879 and 1882 Germany imposed higher tariffs on heavy chemi- cals, which hurt the British soda exporters and helped to enhance the competitive position of the German soda industry. The German organic chemical industry, 3A much fuller discussion of more recent developments in tax policy and their effects on industrial investment may be found in Jorgenson and Landau (1993). 4A discussion of the exchange-rate policies of leading governments during the interwar period, along with some consideration of the effects of these policies on the chemicals industries of the United States, Japan, Great Britain, and Germany, may be found in Arora et al. (1998).
THE DYNAMICS OF LONG-TERM GROWTH 29 however, succeeded in keeping dyes tariff free, reflecting the dominant position of German firms in the global dyestuffs trade. Throughout Britain adhered to a free trade policy. The American inorganic chemical industry flourished during this period but only after the government raised tariff barriers, which further dam- aged British exports of these products. In response to the World War I, the United States and Great Britain enacted strong tariff protection for their infant organic chemical industries. Subsequent increases in tariffs throughout the world dramatically reduced Germany's world market share in this industry. Japan was essentially a closed economy and de- voted an increasing share of national investment to military preparations after the military seized power in the 1930s. As the dominant political and economic power in the West after 1945, the United States was able to reverse the trend of the trade barriers and cartels of the interwar years. A number of trade agreements were launched under the leader- ship of the United States including the formation of the General Agreement on Tariffs and Trade, the Kennedy Round, the Uruguay Round, and finally the World Trade Organization. Step by step other barriers have been lowered in the postwar years, and trade as a whole has stimulated the growth of many economies and industries, including the chemical industry. Worldwide trade in the postwar era has grown about sevenfold, outstripping a quadrupling of overall gross domestic product within the global economy during this period. Institutional Setting: Legal Institutions A profound difference arose at the end of the nineteenth century between the legal systems of the United States and the European countries. Whereas the United States passed the Sherman Antitrust Act of 1890 and the Clayton Antitrust Act of 1914 to discourage trust formation, Germany in 1897 declared cartels to be legal, making it possible for German firms to eliminate competition among them- selves in many branches of the chemical industry. Germany and Britain partici- pated in a large number of international cartels that led to fixed prices and market shares in the most important segments of the world chemical industry during the interwar period. The cartelization of the interwar German chemicals industry in I.G. Farben, which was dominated in many aspects by BASE, contributed to the ultimately unsuccessful policy of developing high-pressure synthetic fuels tech- nologies. In the United States, by contrast, brisk competition among domestic chemicals and petroleum firms led to the development of the petrochemical in- dustry and to the rapid growth of a number of companies that in 1920 were still quite small, such as Dow.5 Some U.S. firms entered into technical exchange 5Still another important legal influence on corporate innovation and performance, especially in the postwar U.S. chemicals industry, is product liability. High levels of liability litigation and costly court judgments may have discouraged the introduction of some new products by U.S. chemicals firms, especially pharmaceutical products.
30 U.S. INDUSTRYIN2000 agreements with European firms. Japan had no antitrust policy until after World War II. Germany had no national patent system until 1877. In a certain sense the newly rising entrepreneurial chemical firms, the most prominent being BASE, Bayer, and Hoechst, were lucky because the absence of a unified patent system allowed them to copy with impunity the technologies developed abroad. Follow- ing political unification, when chemical science and the German chemical indus- try had advanced sufficiently to make R&D investment lucrative if its results were protected by patents, German chemical companies joined in the lobbying campaign for the creation of a unified domestic patent system. Although Britain had a unified patent system, the excessive breadth of patents and the limited sci- entific understanding of the field of organic dyestuffs weakened British organic chemicals firms, which endured long-lasting patent conflicts. The United States also had a patent system, but by the late 1 800s its inorganic chemical industry had reached a level of maturity where patents were not nearly so important. The patent system became important in the American chemical industry only after the or- ganic chemical industry began to develop around the time of World War I. As mentioned earlier, German chemical firms lost their patents in Britain and the United States as a result of both wars, which put them at a significant disad- vantage in these two important markets. Access to these German patents eventu- ally enabled British and American firms to enter markets that German firms pre- viously had dominated. Patents are still very important in pharmaceuticals and the newer field of biotechnology. Institutional Settings: Financial Institutions One difference across the four countries that was already apparent before World War I concerns the relationship of chemical companies to their domestic financial systems. Britain at that time had the most advanced financial services industry in the world, located in London, but young firms in the chemical indus- try had great trouble raising money because the British bank system largely took a hands-off attitude toward its clients' welfare. Firms had to prove profitability before they could qualify for loans, which was always difficult in a risky science- based industry. The Germans, however, had a strong investment bank system and very soon developed a relationship banking system whereby the principal banks took a direct interest in assisting companies to which they lent money. Banks not only helped companies manage their affairs but frequently took owner- ship interest in them. In this sense, the German industrial banks resembled the American venture capitalists of the present day. Indeed, the largest of the nine- teenth century German chemical companies, BASE, from the beginning had its investment bankers from Ladenburg & Sons on its board and listed among its shareholders. Rapid expansion of the German chemical companies required large
THE DYNAMICS OF LONG-TERM GROWTH 31 amounts of finance, even though the companies rapidly became very profitable, and their relationships with large banks were indispensable. The American financial system was dominated by firms such as J.P. Morgan, with extensive experience in railroad financing; but Morgan's investment bank- ing efforts were centered on the big basic industries such as oil and steel. The Mellon group in Pittsburgh likewise helped finance many growing companies, such as U.S. Steel, Pittsburgh Plate Glass, the Koppers Company, and Alcoa, but devoted little attention to the nascent chemicals sector. Other U.S. banks fol- lowed much the same policy as the British financial institutions. In Japan after the Meji restoration of 1868, large industrial holding compa- nies (zaibutsu) appeared around large banks. Their attentions, however, were focused primarily on military requirements as Japan entered into a series of wars including the conquest of Korea and the Russo-Japanese War early in the twenti- eth century. Chemicals, with some exceptions such as fertilizers and explosives, were not an important part of this development. During the interwar period, the financial markets in Germany remained much the same as they had before World War I, with close bank-industry relationships. The American companies had much greater difficulty in growing rapidly because of the hands-off banking style, reinforced by the passage of the Glass-Steagall Act; but the size and flexibility of the American financial system as a whole produced a greater reliance by U.S. chemicals firms on equity finance than was true of their counterparts in Western Europe or Japan for much of the postwar period. After World War II Japan's zaibatsu were converted to keiretsu, but the banking relationships persisted and cross stockholding among the groups continued. Institutional Setting: Corporate Governance Issues of corporate governance did not arise in any of these countries, al- though the U.S. capital markets put greater pressure on American firms to pay out profits. Gottfried Plumpe (1990) shows that the large American firms achieved consistently higher returns on investment than did the British and German firms during the transwar period. Since World War II, their relationship banking sys- tem has essentially insulated German firms from shareholder pressure. In the 1990s, however, corporate governance has become an important issue within German management and in the financial industry, as globalization of German industry has proceeded rapidly and capital markets have become international- ized. We return to this issue later. Structural and Supportive Policies: Environmental Regulation The chemicals industry raised environmental concerns in Germany, the United States, and Great Britain at an early stage. Nevertheless, until relatively recently industry and jobs were so important that environmental concerns had
32 U.S. INDUSTRYIN2000 little effect on the operation of these firms. Regulatory and environmental con- siderations became much more important after World War II, even though the problem had been perceived a hundred years earlier. The publication of Rachel Carson' s Silent Spring in 1962 galvanized a rapidly growing environmental move- ment throughout the free world, which spurred adoption of accompanying regula- tion. These regulations have imposed substantial costs on the manufacturers of chemicals in many industrial countries, especially Germany, which enforces its regulatory laws vigorously. Many European chemicals firms devote as much as 15 percent of average annual capital spending to environmental remediation, a cost that has led some firms to move operations out of the industrialized countries of Europe into some of the newly industrializing countries of Asia, where regula- tory policies are less stringent. Structural and Supportive Policies: Labor The Communist movement that ignited in 1848 produced tense labor rela- tions in Germany and Britain. The Bismarck government passed strict laws to control the labor unions, which kept an adequate labor peace. But the government also pioneered in creating a social safety net for workers, and many German chemical companies erected company housing and provided other benefits to their work force. The Communist movement in Britain touched off a long history of adversarial labor relations. Management and owners largely controlled the House of Commons and were able to politically subordinate labor until well into the twentieth century. Owners and managers also dominated U.S. labor policy during this period, and the American Federation of Labor did not wield much power until after World War I. During the interwar period, regulatory and environmental policies were subordinated to the greater needs of a faltering economy in the four countries of our study, and the urgency of job formation also modulated the demands of labor. Only in the late 1930s were strong unions formed in the United States. Following World War II, Germany established a domestic "social contract" among employers, the government, and unions that led the country along a high investment, low labor conflict path; Germany had labor peace and high taxes. In Britain, despite the arrival of the "fair shares for all" economics, labor conflicts and more general adversarial relations between management and unions hurt the introduction of efficient production methods until the Thatcher period in the 1980s. In the United States strikes and other labor problems were relatively mi- nor during the postwar era; as the power of labor unions diminished, their politi- cal strength weakened. The same is true in Japan where labor negotiations were almost pro forma and were dictated primarily by industry. After a very short period of violent labor strife, management and labor in Japan developed life-time employment in the large companies as an effective peace-agreement that has
THE DYNAMICS OF LONG-TERM GROWTH 33 lasted to the present day, despite growing problems brought about by the reces- sion of the 1990s. Structural and Supportive Policies: Education, Science, and Technology The rise of the German chemical industry in the nineteenth century was sup- ported by the most advanced research capability in organic chemistry at its lead- ing universities. Justus von Liebig established the first academic research insti- tute for chemicals at the university in Giessen in the late 1 820s. Liebig's approach closely associated systematic research with teaching. Both before and after po- litical unification, the governments of the various German states invested heavily in universities to increase their intellectual capital. The young German chemical companies maintained close contacts between their own chemical researchers and the universities, which enabled the German firms to develop the new tech- nologies faster and more fully than did their British and American counterparts. The American research university followed much later and did not materially affect American innovation until virtually the end of the nineteenth century. Ja- pan had no important institutions of science and learning during this period. Both the German state and its firms and the U.S. private foundations and firms supported science and technology research earlier and to a much greater degree than did Britain. Few English universities focused on chemistry and tech- nology. The tradition in Britain was set by the Oxford-Cambridge model of edu- cation, which emphasized the classics and prepared students for careers in the church, the diplomatic service, the armed forces, and the government. In the United States, in contrast, the rise of the research university in science and engineering gave a strong boost to the American chemical industry. Many chemistry teachers in the United States had undertaken their graduate studies in Germany, and they helped build advanced research and training capabilities in many American universities in the early part of the twentieth century. Unlike either Germany or Britain, an American tradition of engineering also arose that proved beneficial because of the large, homogeneous domestic market of the United States, which favored the extensive application of large-scale mass pro- duction technologies. The United States was the first nation to develop a system of manufactures by utilizing standardized parts. As early as 1851 in the London Crystal Palace Exhibition, American exhibitors displayed firearms made by these methods that were much lower in cost than those shown by other countries. In 1862 the United States passed the Morrill Act, which created the land grant colleges for training students in agricultural, engineering, and other mechanic arts. The Massachusetts Institute of Technology (M.I.T.), the first technologically based land grant col- lege, was established in 1865. It remained entirely an undergraduate engineering school until the beginning of the twentieth century, a pattern that was typical
34 U.S. INDUSTRYIN2000 elsewhere in the United States. Britain had some engineering curricula but lacked one specifically adapted to the chemical industry. In nineteenth century Ger- many, engineers were treated like second-class citizens. Engineering was taught not in universities but in technical institutes (technische hochschulen), which were not allowed to grant advanced degrees until the early part of the twentieth century. Consequently, German chemists dominated the German chemical com- panies in this period and used engineers, primarily mechanical engineers, to help them design plants, relying on fairly direct scale-up from laboratory apparatus. This U.S. engineering tradition in the early part of this century led directly to the development of the chemical engineering profession, which came to fruition in 1920 when M.I.T. established the first independent department of chemical engineering and developed a new engineering model called unit operations (Walker et al., 1923~. At about the same time, as a consequence of their close inspection of the German chemical industry after World War I, American univer- sities became much more concerned with improving chemistry education. Brit- ain, Germany, and Japan were much later in developing the chemical engineering profession, and so the United States was able to gain an important lead in design- ing and operating large, continuous process chemical plants. Another important factor in the rise of chemical engineering in the United States was the growth in consumer demand for low-cost gasoline to fuel the auto- mobiles that more and more people were buying. U.S. chemicals and petroleum firms were compelled to develop new techniques for refining unprecedented quan- tities of petroleum. The oil companies had anticipated the growth in automobiles. The first major petroleum industry R&D organization, Esso Research and Engi- neering, was established by Standard Oil of New Jersey in 1919. ESSO worked closely with M.I.T. faculty to establish chemical engineering as a genuine intel- lectual field at the university level, and many institutions adopted it. The pio- neers in the creation of petrochemicals were two oil companies, Standard Oil of New Jersey (now Exxon) and Shell, and two chemical companies, Union Carbide and Dow (Spitz, 1988~. At the same time the German universities, even technical universities, began to withdraw from close contact with industry. Although BASE had developed the Haber-Bosch process to produce synthetic ammonia in 1913, a remarkable feat of chemical engineering, this accomplishment was never shared with the educa- tional institutions, and as a result no chemical engineering discipline arose in Germany before World War II. The absence of a strong engineering tradition in Germany contributed to a lag when the new petrochemical era dawned after the war. Japan's first chemical engineering department was established in 1940; but it had little influence for several years and remains less advanced than Japanese electrical engineering, materials science, and other fields. A major post-war change in university and government relationships took place in the United States, following the publication of Vannevar Bush's Science: The Endless Frontier in 1945. For the first time the federal government became
THE DYNAMICS OF LONG-TERM GROWTH 35 the main source of undergraduate scholarships through the GI Bill and granted fellowships and research grants to faculty in the sciences. Compared with the United States and Britain, German spending on universities has declined since the war, particularly in the last quarter century. The German states support higher education, but the relationship between universities and industry has cooled. A1- though German chemical firms appear to get all the chemists they need in Ger- many, many of the brightest students now go to the United States to receive their postdoctoral training, and German universities have lost their leading position in chemistry to American universities. The Industry and Firms As noted earlier, Britain dominated inorganic chemicals by the mid-1800s. The British industry, with many firms competing intensely, was efficient and able to hold down prices. The incumbent firms, however, failed to make investments in the newer alkali technologies, such as the Solvay process, because of thin profit margins and their reluctance to scrap investments in older processes. The rapidly growing U.S. domestic market gave American firms the incentive to build large and efficient inorganic chemical plants, eliminating the competitive advan- tage of foreign firms in this segment. The German firms also had more efficient technologies than did the British and also freed themselves from British imports in the late nineteenth century. The organic chemical industry, however, showed a completely different pattern, as German dyestuff companies proved to be extraor- dinarily innovative and very profitable and soon dominated world markets. In the late 1880s the Germans drew on their dyestuff technology to enter the pharma- ceuticals industry and became strong players in this area well before the United States and Great Britain. Japan had no strength in chemicals in this period. Three major firms BASE, Bayer, and Hoechst soon dominated the Ger- man industry. Companies like BASE, which was the largest in the world in the last part of the nineteenth century, were enormously profitable, encouraging even further growth. These German firms maintained close relationships with univer- sities and proceeded in developing a new corporate function the R&D labora- tory. After the passage of the unified patent law in 1877, German firms further cemented their lead in organic chemicals by organizing systematic, large-scale efforts to create new chemical products. In contrast to British firms, German chemical firms developed strong marketing capabilities, which aided their pen- etration of export markets. Neither Britain nor the United States replicated this industrialization of innovation until after World War I, giving German firms a strong comparative advantage. Britain's slower growth rate in the chemical in- dustry was to a large extent the result of its inability to compete against the con- stantly innovating German firms. The economic difficulties of the interwar years, such as protectionism and macroeconomic turbulence, triggered a wave of mergers that created large chemi
36 U.S. INDUSTRYIN2000 cat firms in Germany (I.G. Farben) and Britain (ICI) and several large firms in the United States. The American chemical firms had made large profits during World War I, which enabled them to diversify and invest in R&D and acquisitions. Du Font, for example, purchased a 25 percent interest in General Motors that subse- quently gave the chemical company substantial profits both from dividends and the ultimate sale of that stock under an antitrust decree after World War II. Union Carbide was formed by such mergers, as was the Allied Chemical Company. Japan still had very little new activity in chemicals, except in fertilizers. British and American companies profited from the tariff protection they had sought after World War I. The technical excellence and the long traditions of the German companies, however, permitted I.G. Farben to continue extensive re- search and investment in new fields such as polymers, even though they were still based on coal and would prove to be ultimately noncompetitive. Despite I.G. Farben's virtual monopoly of the domestic market, innovation in the German chemicals industry did not die out, in part because of the need for substantial exports to make up for the weak domestic market. Dow Chemical Company, started in 1920, grew rapidly during the interwar period as did Union Carbide. Du Pont invested in the research and development that produced nylon, its most profitable polymer discovery, and its numerous acquisitions greatly strengthened the company. I.G. Farben was strong in several chemical sectors but under Carl Bosch, who had been head of BASE before World War I, I.G. Farben pursued an ambitious synthetic-fuels development program that consumed enormous amounts of capital. Dyestuffs and pharmaceuticals pro- vided most of the profits of I.G. Farben until the Nazi government came to power. From that point on, the firm focused more and more on the creation of synthetic fuel from coal as a part of Hitler's autarchy policies, and I.G. Farben was no longer able to dictate its own policies as it had before (Plumpe, 1990~. After World War II, the big three German chemical companies, profiting from their long tradition and the favorable circumstances created by the German government, grew very rapidly to become the three largest chemical companies in the world today. Only in the last few years has it become obvious that some parts of their businesses are unprofitable, and the first steps are being taken toward divestiture and acquisitions in order to produce a better overall profit picture. The entry of the major U.S. oil companies, including Exxon, Amoco, and Mobil, created stiff competition in the basic commodity. Britain's two oil companies, British Petroleum and Shell, also entered the petrochemical industry after World War II. The Recent Influence of Financial Markets on Corporate Governance The conditions prevailing in Britain in the early 1990s created intense stock- holder pressure on ICI, which split at the beginning of 1993 into the pharmaceu- ticals firm Zeneca, and ICI, which retained the traditional chemicals products.
THE DYNAMICS OF LONG-TERM GROWTH 37 The American firms, especially Du Pont and Dow Chemical, remain among the leaders in the global chemicals industry. After a serious plant explosion in India in 1984, Union Carbide was the object of a hostile takeover that resulted in a significant diminution of its presence in the chemical industry. Likewise, Allied Chemical, which in 1920 was the largest chemical company in the world, has virtually exited the industry as a result of short-sighted policies in the interwar years when its managers paid high dividends while virtually neglecting R&D. Aside from the new startup companies that have been responsible for the first commercial biotechnology products, established pharmaceutical companies in the United States continue to dominate the industry because of their strong marketing capabilities, whereas in Europe the conventional chemical companies are still very large in pharmaceuticals. In fact, the influence of the shareholder value philosophy can be seen in the consistently higher profitability, return on assets, and market capitalization of the major American chemical companies compared with their European competitors, where management control has persisted until recently. The strong Japanese chemicals industry has not been influential in interna- tional markets. The reasons are not only the absence of shareholder control but also an intrusive government bureaucracy, protected markets, and capital con- trols in the earlier decades; a weak domestic university system; and the fierce rivalries of the many keiretsu groups, which led to too many similar plants of less than world scale. In a society traditionally resistant to change, the international weaknesses of Japan's chemical firms also reflect the nation's historic lack of participation in international markets. The historical and expected future performance of these large chemicals firms, like industrial firms in other sectors, is reflected in their market valuation, especially for those firms whose shares are widely held and traded in liquid, effi- cient equities markets. This valuation also reflects investor expectations of management' s commitment to increase shareholder value, and international com- parisons of the relationship between sales and market capitalization reflect na- tional differences in the power of "mass shareholder" (as opposed to manage- ment, "main bank," or keiretsu shareholder) influence on management. The comparisons in Figure 7 illustrate how changes in corporate governance have changed the strategies of the major chemical companies, particularly in Eu- rope.6 In a well-rounded chemical company, sales volume should approximately equal the firm's total market capitalization. As the figure shows, however, the ratio of sales to market capitalization differs widely among five leading chemi- cals firms. The figure shows the market value of ICI before its 1993 spinoff of Zeneca as well as the combined market value of the two firms since 1993. The market obviously values the new versions of ICI much more favorably than it did 6The Appendix to this chapter compares the relationship between sales and market valuation for a number of U.S. firms in various industries.
38 4 3 2 1 o U.S. INDUSTRYIN2000 x:~ ICI ~ ZENECA ~ ICI incl. ZENECA ~ BAYER \ ~ BASE ~ HOECHST -*I INTEL ~ MICROSOFT -\\ _ ~ ~ ~A it, ~ $1 in sales requires $1.25 inve~men~ in ~ red assess ~ ~ ~ ~ ~ -~ ~ ~- ~~~ ~ ~ a- j 1 992 1 993 1994 1 995 FIGURE 7 Sales/market capitalization. Note: Sales for Microsoft are estimated based on results for the six months ended 12/31/96. Source: Chemical Manufacturers Association. 1 996 the original unified ICI. Zeneca has joined the ranks of high-technology compa- nies with a high price-earnings multiple, whereas the new ICI has drifted toward a lower level that is comparable to some of the German firms today. The new ICI is less internally balanced than the German companies, a factor that contributed to ICI's 1997 purchase of the specialty chemical businesses of Unilever and its divestiture of remaining commodity businesses. What the markets, which have valued Zeneca favorably, will think of the remainder of the old ICI that is focused on chemicals remains to be seen. In contrast the stock market was treating two of the three German firms with caution, because their total sales exceed their capitalization by almost 2:1. Bayer is exceptional in this regard, because its heavy emphasis on health care and phar- maceuticals has led the market to value the company's prospects somewhat more favorably than either Hoechst or BASE. Other factors are involved, however. Pharmaceutical companies have higher earnings per dollar of sales revenue, and therefore price/earnings ratios will be higher despite the lower sales to market capitalization ratios. German chemicals firms now are attempting to increase shareholder value amid discussion of methods to realize the underlying values of the different businesses by various devices that will not add heavy tax burdens. Corporate governance issues have now become a major factor in establishing firm strategies. In Japan, where the trend toward mergers of rather small compa- nies by international standards has been very slow to develop, these issues are gathering steam. Mitsubishi has finally succeeded in uniting its two chemical firms, and Mitsui has announced a comparable move. Such rationalization is
THE DYNAMICS OF LONG-TERM GROWTH 39 proceeding at a much more rapid pace in the European industry, where there has been a great deal of divestiture and acquisition of divisions and businesses and the formation of many joint ventures or alliances. The industry is in the midst of a major shakeup but the traditional trajectories of the major companies, influ- enced by their corporate capabilities and history, will continue to exert a domi- nant influence over their strategies. Nevertheless, these strategies differ from firm to firm, and the recent wave of mergers, alliances, and restructuring reflects the varying ways managements are striving to increase their profitability and shareholder values. CONCLUSIONS This historical survey of the chemicals industry yields conclusions that largely complement, rather than conflict with, the findings of other chapters in this vol- ume. Competitive strength in the long run, as in the two or at most three decades covered in the other chapters, rests on a robust institutional infrastructure and supportive government policies that are general, rather than highly sector spe- cific, in their target and intent. A stable, predictable, macroeconomic environ- ment and a pro-investment policy lead to higher long-term growth. The case of the chemical industry over 150 years suggests that high-technology industries develop better in a country when they can draw on strong national research and teaching universities in science and engineering. For this industry at least tar- geted government science and technology policies do not matter very much com- pared with the constellation of institutions and policies incorporated in the matrix. Although abundant natural resources may help a domestic industry get started, they do not afford a lasting lead. In a peaceful world where natural re- sources can be shipped all around the world, know-how and economies of scale are decisive factors in maintaining competitive advantages. But the climate main- tained by the national government institutions and policies is probably of equal importance. Despite the widespread diffusion of technology and capital, national interests are not always the same, and the constellation of these policies and insti- tutions contributes to or detracts from comparative advantage and growth. Thus, for example, the cost of capital in recent decades has differed in the four countries considered here, with Japan's low cost contributing to its investment boom and subsequent bust. The development of a large and sophisticated home demand in the beginning of an industry life cycle has several advantages. It allows more than one national firm to develop competitive skills and to build large-scale plants that give them a cost advantage over producers with smaller plants. Of course, readily accessible foreign markets can make up at least in part for a relatively small home market. Competition among firms has generally led to higher levels of innovation in the chemical industry. A high-technology industry seems to be most innovative when there is just enough competition to spur the creation or improvement of
40 U.S. INDUSTRYIN2000 products and processes and yet allow firms to make sufficient profits to provide the ability and incentives to invest in R&D. In an industry with increasing returns to scale and no tariff protection, early entry into the business is an important factor for long-term competitive success. Many of the firms that became early leaders in the chemical industry continue to dominate it today, despite a dramatic proliferation of new products and processes. Expansion outside the home country to newly developing countries serves to pro- vide competitive advantages to large profitable companies in the industrialized nations but is not enough to maintain dominance without continuing develop- ments in technology. As capital markets have been internationalized, corporate governance issues have become a prime concern to shareholders and managements. Thus, technical specialists, who have historically dominated the senior management of most chemical firms, may give way to more finance and business managers. Neverthe- less, technology remains a prime driving force for gaining and retaining competi- tive advantage in this industry. REFERENCES Abramovitz, M. (1956). "Resource and Output Trends in the United States since 1870." American Economic Review 46(2):5-23. Arora, A., R. Landau, and N. Rosenberg, eds. (1998). Chemicals and Long-Term Growth: Insights from the Chemical Industry. New York: John Wiley & Sons. Bush, V. (1945). Science, The Endless Frontier. New Hampshire: Ayer. Carson, R. (1962). Silent Spring. Greenwich, CT: Fawcet Crest. Jorgenson, D. and R. Landau, eds. (1993). Tax Reform and the Cost of Capital. Washington, DC: The Brookings Institution. Krugman, P. (1996). "A Country is not a Company." Harvard Business Review 74(1): 40-51. Landau, R., T. Taylor, and G. Wright. (1996). The Mosaic of Economic Growth, Stanford: Stanford University Press. Lau, L. (1996). "The Sources of Long-Term Economic Growth: Observations from the Experience of Developed and Developing Countries." In The Mosaic of Economic Growth, R. Landau, T. Taylor, and G. Wright, eds. Stanford: Stanford University Press, 63-91. Plumpe, G. (1990). Die I. G. Farbenindustrie AG: Wirtschaft, Technik und Politik 1904-1945. Berlin: Duncker & Humblot. Romer, P. (1994). "The Origins of Endogenous Growth." Journal of Economic Perspectives 8(1):20. Spitz, P. (1988). Petrochemicals. New York: John Wiley & Sons. Walker W., W. Lewis, and W. McAdams. (1923). Principles of Chemical Engineering. New York: McGraw-Hill. APPENDIX The analysis of market capitalization and sales for selected companies, to- gether with industry averages provides insights into corporate performance in other U.S. industries. A preliminary assessment reveals similar interfirm and interindustry differences in investors' assessments of the prospects for future
THE DYNAMICS OF LONG-TERM GROWTH 41 growth. The data discussed in this appendix are taken from the Business Week issue of March 30, 1998, and are shown in Appendix Table 1. Complete financial analysis is, of course, more sophisticated than this simplified approach, but these results are still useful. As mentioned, in some industries such as pharmaceuticals, profits are higher per dollar of sales than in others. Although the stock markets have risen substantially since March 1998, the relative positions have been main- tained and this may continue to be the case when the markets decline. Of course, the wave of mergers and acquisitions will affect the relative positions of some of these companies. What can be deduced from these data? One must bear in mind the observa- tions of Albert D. Richards in our volume on Chemicals and Long-Term Eco- nomic Growth: Insights from the Chemical Industry markets do a pretty good job of forecasting the future of companies. 1. Some chemical companies, such as DuPont and Monsanto, are seen as not having reached maturity, despite their large size. In both cases, these favorable valuations reflect the firms' increased emphasis on R&D and product development in the life sciences. By contrast, Dow is more heavily committed to basic commodity chemicals and is seen as average and relatively mature, while Union Carbide's prospects are not as bril- liant. 2. Among pharmaceutical companies, which clearly are the favorites of in- vestors for the reasons stated earlier, Merck and Pfizer shine. Among the other firms in this industry, particular note should be taken of Amgen, the most successful of the biotechnology companies. Its successes are seen as giving it the potential to rank eventually with the major pharmaceutical companies, but it is at an earlier stage of development. 3. Investors see good prospects in the financial services industry and are watching smaller, well-managed banks, such as Bank of New York. 4. In the steel industry, the decline of the former colossus USX-US Steel illustrates the diminishing outlook for a mature company in an industry where technological innovation is modest and the focus is on cost cutting. The newer minimill Nucor comes out as much better in the eyes of inves- tors. Alcoa is an example of a large metals company that continues to innovate and manage well. 5. The extraordinary records of Microsoft and Intel are noted in Figure 7. Nonetheless, the more traditional computer companies such as IBM and Hewlett-Packard still find much favor in investors' eyes. The improved valuation of IBM is a particularly dramatic example of the effects of a management shakeup. 6. The retailing industry presents a wholly different picture; the large groups are unable to improve their market capitalizations greatly, with the excep- tion of specialty retailers, such as the Gap.
42 APPENDIX TABLE 1 Capitalization Ratios U.S. INDUSTRYIN2000 Capitalization Sales Ratio $ billion Feb. 27, 1998 $ Billion 1997 Chemical companies DuPont 1.5169,37345,079 Monsanto 4.0330,3177,514 Dow 1.0420,74820,018 UCC 0.885,7226,502 Industry average 1.6212,6677,801 Pharmaceutical companies (health care) Merck 6.48153,37423,670 Pfizer 9.15114,45312,504 Bristol-Meyers-Squibb 5.9699,61516,701 Johnson & Johnson 4.46100,81322,629 American Home Products 4.2960,86914,196 Amgen 5.8213,9832,401 Industry average 3.7627,5397,329 Financial services: Banks Citicorp 1.9860,06230,300 Chase Manhattan 1.9752,23127,365 Bank America 2.5053,32421,318 Bank of New York 4.2821,9555,124 J.P. Morgan 1.7121,07012,353 Industry average 2.7320,5597,533 Financial Services: Non-banks Morgan-Dean Witter 1.5341,51827,132 Merrill-Lynch 1.6963,69637,609 Industry average 1.7416,3789,394 Metals and Mining USX-U.S. Steel 0.443,0266,871 Nucor 1.084,5274,185 Alcoa 0.9512,65513,319 Industry average 0.913,4363,782 Computers and Software and Office Software Microsoft 15.67205,26513,098 IBM 1.29101,53278,508 Hewlett-Packard 1.5769,75044,416 Intel 5.85146,73025,070 Industry average 2.6323,3118,875 Retailing Walmart 0.88104,015117,958 Gap 2.7117,6596,508 Federated Dept. 0.639,83515,608 Sears Roebuck 0.5020,77641,469 Industry average 0.8014,57318,182 Aerospace Boeing 1.1552,81045,800 Industry average 0.9922,13422,359 Transportation FedEx 1.867,33512,571 Ryder Systems 0.562,8654,894 Industry average 1.009,1379,097 Miscellaneous GE 2.80254,45590,840 Exxon 1.29157,201122,089
THE DYNAMICS OF LONG-TERM GROWTH 43 7. Aerospace, the other major manufacturing industry with a significant posi- tive balance of payments in the United States, is led by Boeing whose performance is comparable to some of the large chemical companies that continue to innovate. 8. The transportation stocks are too few in number to be very meaningful, but, with the exception of Fedex, they fall into an average that suggests no great promise for growth. 9. A few exceptional companies are shown for purposes of comparison. The case of GE is especially interesting. A relatively old, highly diversified manufacturing company, GE has become the largest company on Wall Street in terms of its market capitalization, with a capitalization/sales ratio that is remarkable for such a giant. Exxon, another large capitalization company, is more normal, perhaps, but still shines by comparison with some of the others in the table. The overall conclusion from this table is quite clear. Investors are rewarding those companies and industries that they perceive to have a technological and managerial capability for growth. This table does not present foreign companies because the data are more difficult to locate, but there is little doubt that the same general trends prevail there too. The influence of the financial markets is spread- ing, and so is shareholder value. As capital becomes more and more global, this trend is inevitable.