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Editors' Overview RALPH LANDAU and NATHAN ROSENBERG ECONOMIC GROWTH- THE BASIS FOR ANY SOCETY'S HOPES FOR THE FUTURE The idea of progress or economic growth is a concept that arose mainly with the Enlightenment and the Industrial Revolution. Previously, expecta- tions of the general populace about prospects for improvement in the standard of living had risen slowly, at least from one generation to the next. Com- mun~cations were difficult and time-consuming, and education very limited. Data on actual growth rates were not generally available, and there were few economists to detect trends before Adam Smith's The Wealth of Nations was published in 1776. Consequently, until quite recently relative trends among nations were not soon observed, nor their implications perceived. Boskin, for example, points out that Great Bnta~n's growth rate in the first half of the nineteenth century, when it was the greatest industrial power, was only slightly less than its average from 1850 to the present, and that its growth rate relative to the United States during the latter period averaged about 1 percentage point less than that of the United States. Yet so great is the power of compounding that this growth rate enabled the United States largely rural in 1850to become He greatest industrial power in the world by 1985, while the United Kingdom sank to a position of economic inferiority even in Europe In the late nineteenth century Japan seed its rise to industrialization. It achieved a more rapid growth rate than any other major county,, and by 1985 had become the second-greatest industrial power. The growth of the United States since World War II, analyzed by Jorgenson, shows a stapling Editors' note: Please refer to the explanation at the end of the Introduction regarding the origin and purpose of this Overview. It is solely the work of the editors and does not necessarily reflect the views of the individual authors, who did not participate in its preparation. It does not represent the views of the sponsoring organizations. Those refereed to in this Overview exclusively by last name are the authors in this volume.

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2 RALPH LANDAU and NATHAN ROSENBERG decline in the late 1960s and 1970s. The revival in 1983 and 1984 may or may not herald a longer-term upward trend. If the recent differences in growth rate between Japan and the United States were to continue for not much more Han another generation, Japan would catch up with and surpass the United States in total GNP (Landau and Hatsopoulos). Would history then repeat itself, and the United States lose its industrial leadership? Expectations of the world's populations are now also clearly rising every- where, and dissatisfaction with economic conditions affects an increasing number of nations, contributing to world political instability and compound- ing the problems of operating businesses from a global standpoint, as the current economic trends inexorably dictate. Japanese companies have rec- ogn~zed this dilemma and are following a global strategy of great sophisti- cation, where control is Grin and centralized in Japan, and not in venous geographic regions as Is often the case among United States companies (Landau and Hatsopoulos). That present and recent U.S. growth rates are unsatisfactory can be seen by: Comparing U.S. grown rates not only with those of such countries as Japan, but with those of most of Western Europe prior to 1983-1984, and those of our own past; The great need for improving the standard of living of the lower eco- nomic levels of the U.S. population, where disparities between earnings and expectations are widening; O Assessing international requirements for military defense and foreign aid; The finding that U.S. grown is too low to avoid increased borrowing (which would imperil the future standard of living and raise the possibility of re-igniting inflation) (Boskin); ~ The continuing need for more job formation to provide for a growing population (even though past high rates of population increase are declining). The reasons for the recent U.S. slowdown are discussed by Boskin, Jor- genson, Katz, and Brooks. In essence, the United States, lulled by special conditions after World War ~ which engendered a sense of enduring eco- nomic supenonty, adopted the view that the cornucopia of grown was bound- less, and that there was surplus weals being created in such huge amounts that not only could this county aid He recovery of its friends all over the world, but it could also address many pressing social inequities, reduce the risks of living, and press for greater equity in the distribution of income even at the expense of possible loss of efficiency. That era began to end by the late 1960s, its demise furthered by two oil price shocks in He 1970s and by growing competition from our allies and friends in whose restoration we assisted.

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EDITORS' OVERVIEW TB BASIC FACTOR IN ECONOMIC GROWTH: TECHNOLOGY (EMBODED AND DISEMBODIED) Classical economics after Adam Smith and throughout most of the nine- teenth century focused primarily on long-term growth. In seeking He causes of growth, economists emphasized resources land, labor, and capital. A very pessimistic view was taken of the prospects for future growth. The grown of the United States in the nineteenth century was seen as arising largely from the exploitation of a continent rich in resources, undertaken by a rapidly rising population of immigrants, and with an influx of essential capital from Europe. Great Britain, a small island, sought its resources abroad, and its great empire served that purpose. Other powers followed the colo- n~zation strategy. Toward the end of the nineteenth century and during the first part of the twenties, economists shifted their focus to neoclassical economics within a relatively static closed economy, and developed tools for analyzing He op- timizahon of the use of scarce resources by firms. Long-tenn growth was ignored or taken for granted; more attention was paid to shorter-term cyclical business phenomena in an attempt to smooth out He growth process. This trend was accentuated by the effects of the worldwide depression of the 1930s, and led to-J. M. Keynes's aggregate-demand management views on how to reduce cyclical fluctuations and He resulting unemployment. After World War lI Paul Samuelson and Sir John Hicks, among others, combined Keynes's concepts win the neoclassical methods of optimum re- source allocation. This synthesis dominated economics until the 1970s, when stagflat~on and low growth exposed its fundamental weaknesses. The low savings rate of the United States compared win that of Japan and some European countnes, and the associated low investment rate, began to show up as impomnt aspects of America's relative economic decline (Boskin, Aoki). As a result of these unexpected trends new schools of economists arose: monetansts, new classicals, supply-siders. Boskin points out that in reem- phasizing longer-term grown which was the basic (and onginal) concern of classical economics economists have found that He Ply fundamental factors which can increase He rate of grown permanently are He rate of technical change (change resulting phonily from expenditures upon R&D) and the increase in He quality of the labor force. Although increasing the capital:labor raho can nonnally increase He rate of grown only temporarily, when improved technologies are available and can be incorporated in new capital, higher investment may also increase the long-run rate of grown. The latest technology is frequently embodied in new investment, and is a spur to it, whereas capital investment that merely exploits old technology does not increase the rate of growth permanently. It is most probable Hat

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4 RALPH LANDAU and NATHAN ROSENBERG tax, fiscal, and spending policies by government influence these growth factors more than shorter-term cyclical management practices points also made by Mansfield and the new classicals. Throughout much of the period from Adam Smith to the present, econ- omists treated technology as exogenous; Karl Marx, the last of the classical economists, was one of the few who recognized its endogenous nature. However, Marx saw technology as the cause of massive unemployment, which would bring about the destruction of the capitalist system. It was not until the early l950s Hat modern economists such as Robert Solow and Moses Abramovitz began to look seriously at the determinants of growth, and at the macroeconomic level encountered a large residual i.e., the huge gap between the growth in GNP and the growth in conventionally measured inputs of labor and capital. The large size of the residual pointed to the importance of a more careful examination of the contribution of technology to economic grown. This new focus therefore gave rise to the growth-accounting studies of the 1960s and later, primarily by Edward Denison, John Kendrick, and Jorgen- son. Quinn observes that, if defined very broadly, technology may create up to 70 or 80 percent of econorn~c growth, and cannot be treated as an unex- plained residual. However, such studies at He macroeconomic level failed to explain the slowdown of the 1970s. Some economists even felt the slow- down to be He result of a mysterious disappearance or drastic reduction of technological progress. Postwar government policy favored a major enlargement of support for R&D by government, especially in universities; a massive increase in support for higher education to improve human capital (via He G! Bill of Rights, for example); and great growth in technological development by private industry (Brooks). The public supported such policies and trends, viewing them as influences for improving He quality of life and standards of living (Bechtel). At the same time, as noted above, economists were recognizing He large role of technological development in economic grown. However, the late 1960s saw public attitudes begin to change as the dark side of technology toxic wastes, catastrophic accidents, carcinogenicity, and the like received greater attention (Holmer, Huber). The environmental and antitechr~ology mood (Brooks) probably contributed to He slowdown in pro- duchvity increase, which, as Jorgenson shows, began around 1966. Some economists saw that this residual of technology in growth accounting needed to be even further examined if we were to lean how to take advantage of technology, and to understand better its function in propelling economic grown. Rosenberg (who insists on the importance of getting inside this "black box'' of technology) points out that technology is quite capable of overcoming He so-called limits to growth, limits believed by many to be unavoidable because of a growing scarcity of natural resources. Thus eco-

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EDITORS' OVERVIEW 5 nomics has begun to turn from primary concentration on business cycles to a reexamination of the fundamental causes of long-terTn growth, in which technology plays a major role. Companies too have been paying, much greater attention to harnessing technology for growth. Malpas says: Harnessing technology for growth, however difficult, is essential for success, of a com- pany and a nation, particularly in a sustained period of low growth. No doubt the world is in such a period now. The 1950s and 1960s were a high-grow era in which prosperity could be achieved by a me-too approach. High growth provided ready-made markets to conquer. A low-growth era requires that products, and processes to make them, have ''edge." Both product and process edge flow from technology.... This realization of the need for edge to be provided by technology will be the main force that will Anne, together the money needed to innovate both on a small and on a grand scale. INSIDE THE BLACK BOX OF TECHNOLOGY By decomposing the macroeconomic aggregates of the postwar period up to 1979 into 35 industrial sectors, Jorgenson opens the black box somewhat and finds that the energy price increases of the 1970s and the changing net effective tax rates of corporations can be correlated very well with the decline in productivity growth. The tax rates raise the "hurdle" rates for return on investment for private companies (Landau and Hatsopoulos), and invest- ment especially that embodying new technologyis the key to rising pro- . . . oUCtlVlty rates. But this does not answer why some sectors, or even some firms within a given sector, did better than others, as Fnedlaender points out. She cites illustrations from automobile manufacture in the United States and Japan and from venous transportation systems to show how aggregates conceal real differences, win dissimilar long-term economic results quite possible. Unless one understands why there are differences, and what their magnitude is, good policy judgments are very difficult to make. Thus Boskin's and Friedlaender's questions go to the heart of the economics-and-technology interface. It is essential to disaggregate appropriately and to know why things happen inside the black box. Hannay, in presenting the results of the National Academy of Engineering's (NAE's) work on a group of representative sectors, dem- onstrates why this disaggregated approach is indeed a fruitful direction for economic research in the future. Thus. inside the larger black box there are other, smaller black boxes. Throu ah a further decomposition of the aggregates into 387 industrial sectors, Klein shows how competition, by forcing innovation to compensate for falling prices, could explain many of the variations among sectors and companies. A small number of these industries are shown to bear the brunt of the productivity decline. He stresses that dynamic, not static, models must be

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6 RALPH LANDAU and NATHAN ROSENBERG used in understanding the microeconomy and its link to the macroeconomy, and that increased competition and instability at the microlevel may in fact lead to greater stability in the macroeconomy. In so doing, Klein too concurs with the appropriateness of Friedlaender's questions. This analysis makes it clear that we must look into the smaller black boxes more closely, and learn to understand the forces that motivate Finns and individuals to innovate, to take He risks Mat bring about technological change, and to compete successfully. Among economists, Mansfield has led the way in such scrutiny, but these studies so far are still very limited and deal with a far-from-representative sample of the huge variety of American industries and companies. It is for these reasons Mat this volume includes chapters by key figures from the technological, entrepreneurial, financial, and business sectors, who describe from their vantage points inside the black boxes what they perceive as their problems, opportunities, challenges, rewards, and methods. At the same time, the chapters on economics have been prepared by economists in the academic, industrial, and financial worlds, who rep- resent a wide diversity of experience and viewpoints. THE INNOVATIVE PROCESS AND ITS PROPER CLIMATE It is evident that government has played an important role in the innovative process by aiding R&D efforts, by its procurement practices in the private sector, by supporting large-scale projects not feasible in the private sector (Brooks, Watson), and by establishing a climate favorable to investment and risk taking. On a macroeconomic level this climate entailed fiscal and mon- etary policy; on a more microeconomic or second-tier level (Boskin), tax, regulatory, made, and spending priority policies became important. At various times government policies changed, often abruptly. Writing, from his experiences as an innovator and a congressman, Zschau declares: It cannot be denied that government plays a role in technological advancement and economic growth, but we must determine govemment7s proper role. It seems to me that rather than targeting specific companies, specific industnes, or specific technologies, the proper role of government is to target the process by which those industries, those technologies and those companies are fostered the process of innovation. That is, govemment's proper role is to create in this country an environment in which new ideas and new enterprises are likely to flounsh. Zschau cites four prerequisites for such an environment: a commitment to basic research, encouragement of risk taking, an adequate supply of trained technical people, and ample market opportunities. All policiesresearch, tax, fiscal, monetary, education, trade, antitrust, and procurement among themshould `'be evaluated in terms of whether Hey strengthen these pre-

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EDrrORS' OVER VIEW 7 requisites for an environment for innovation or whether they are detrimental to it." Following upon He high inflation and poor investment environment of the 1970s, more recent policies seem to have restored some of the conditions necessary for a favorable economic climate: lower inflation, more rapid growth rate, diminishing unemployment. But as Zschau, Mettler, Boskin, Landau and Hatsopoulos, and Jorgenson point out, the outlook for He future is much less clear: there is a large and growing budget deficit; real interest rates are still very high; there is a huge and unprecedented deficit in He U.S. balance of payments; the United States has become a debtor nation for the first time since 1914; unemployment, especially among minorities, is still very high; and He dollar is still overvalued, thereby seriously handicapping the exporting capability of marry U.S. firms. Tight monetary and loose fiscal policies have produced these trends. We may thus be at a point where the economy can start to deteriorate sharply. Borrowing to cover the federal deficit threatens new inflation and further erosion of investment incentives as demands for credit reduce the available pool of domestic capital savings. For the present, at least, Hat pool is augmented by the inflow of foreign capital. The contrasting Japanese macroeconomic policies are described by Aoki, and to some extent by Okimoto. These American macroeconomic policies have had varying effects on dif- ferent sectors of the U.S. economy. Some large companies, facing reality and the severe competition from abroad, have been cutting costs ruthlessly, reducing their labor forces and adopting high technology to obtain He "edge" Malpas writes of. Mettler puts it this way: Global competition compels all industries to improve their performance. The margin that makes for success is very thin. Even a small competitive edge can make a big difference, but large and aggressive steps may be necessary to achieve even a small competitive edge. Improvements that only equal those of competitors yield no net gain. The challenge is to integrate into all of our industries, in innovative ways, the most advanced technologies in communications, metallurgy and new materials, microelec- tronics and process control, computer-aided design and manllfactu~ing, expert systems, and more, in a market-driven and cost~ffective way. And of course, Hat includes using advanced technology in managing an enterprise large or small. The challenge to managers of large and small companies is to learn how to develop (or buy) technology that is best for their specific purposes, how to control the cost of using it, and how to finance it, all the while earning enough profit to continue to invest and compete and grow in world markets on a sustained basis. In short, the challenge is to be an entrepreneur. Such efforts by large companies to remain competitive account for much of the investment boom of 1983-1984, but a substantial proportion of the equipment for these efforts Is coming from abroad (Roach), and, as Moore and Young indicate, such purchases contribute to a negative balance of

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8 RALPH LANDAU and HA THAN ROSENBERG payments in electronics. Roach, illuminating the service sector, points out that this trend has now put as much capital behind the average information worker as there is behind the average manufacturing worker. The service sector actually consists of a number of very different types of service. Fi- nancial services clearly fall into one category, being part of a group that also includes insurance, real estate, trade, transportation, communications, and public utilities. These are all part of the new information economy, which now accounts for nearly two-thirds of the total national output. This new process of industrialization has been taking place over the last 20 years, and the potential vitality of the information economy is not in doubt. Roach states that "economic performance over the next several decades now appears to depend critically on Me new realities of the information economy." On the other hand, in another category one finds the millions of small service com- panies that cannot invest so much capital and whose productivity is not increasing, (Quinn). A similar transformation occurred in this century in U.S. agriculture, in which the labor force fell from 25 percent or so to a little more than 3 percent (Ruttan), but agriculture, by adopting new technology and making heavy investments, became very competitive and productive in the process. Ruttan suggests that manufacturing must manage a transition from having about 20 percent of Me work force now to having perhaps 10 percent by the year 2000; the transition would be made by adopting new technology and raising productivity and competitiveness. Moore, however, raises the point that if, as a consequence of this change, some manufacturing must move overseas, technological leadership is very likely to follow. Where will the jobs then be, even allowing for a slowing of population increase? One answer lies in the smaller companies thus the importance of the birth and nurturing of these firms (Quinn, Mettler). Nevertheless, it should not be forgotten that big companies and smaller ones exist in a symbiotic relationship. If American macroeconomic policy can change in time, therefore, many manufacturing, agncultural, and some service sectors may show very large increases in productivity as their utilization of capacity rises above the current 80 percent to perhaps 86 or 89 percent (Reeder), and Heir export capability improves. The same would be true for large international banks (Reed and Moreno). On the over hand, Boskin points out if the dollar stays overvalued at around 35 percent, it may drive many fins and even industries out of business peImanen~dy, to He detriment of American future competitiveness and jobs. It is clear that the overvalued dollar has forced many firms to increase innovation and cut costs. The effect has been very uneven across venous industrial sectors, as the NAE studies have shown (Hannay). Some firms cannot compete because Hey are too small, inadequately fimded, insuffi- ciently innovative, or too inexperienced in world markets. Others, like many

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EDITORS' OVERVIEW 9 retail and smaller service companies, face no competition from abroad; thus their costs are rising but not their productivity. It follows that the maintenance of a low overall inflation rate depends crucially on the performance of the agricultural and manufacturing sectors, as well as on certain service sectors. How U.S. growth prospects are viewed by any particular finn depends on where it sees itself and its environment is the situation it faces susceptible to positive actions for competitive success, or is the climate for progress deteriorating? The report of the President's Commission on Industrial Com- petitiveness (Young) deals with all of these points. If the U.S. economy's performance is good relative to the United Kingdom (Malpas), it is nevertheless healthy that many Americans are concentrating on the competition from Japan and want to do something about it (Bowers). The United States should examine itself first, and also learn from the ex- perience of others (Pavitt). The Technological and Er:trepreneurzal Climate All the evidence from scientists and technologists shows the potential power of new technology if the economic climate is right (Baker, Watson, Katz). It may even dwarf what has gone before. Thus Perry suggests the possibility of a further 100-fold reduction in the cost of computers and microelectronic equipment, with a concomitant impact on all sectors of our economy. The predictive powers of economists and technologists about tech- nological change have not been good in the past, and the effects of such change have been persistently underestimated (Rosenberg). Yet we detect that there is a common theme among many of the authors in this volume: that new technology is the key to productivity growth, and that capital in- vestment employed by properly trained people is the major expression of such new technology. Technology is what makes the economy a positive sum game (Perry), and this points to a strategy at the national and firm level of harnessing technology for economic growth. Progressive managements of large companies have accordingly been restructuring their thinking to incor- porate technology at the highest level of their strategic planning and man- agement (Coover, Mettler). The challenge is to government to view policy in this same broad sense so as to encourage greater economic growth. The process of innovation involves a somewhat disorderly search between technology and markets (Kline and Rosenberg, Quinn). Probably it is because of this basic characteristic of innovation that small companies and individuals (often from outside the industries they impact) have been so successful at it. Start-up companies are frequently the exploiters of innovation, if not the innovators themselves, because they have "focus" and because small com- panies are often a more efficient instrument to get things done (Moore). However, we forget the failures that often obliterate many such efforts.

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10 RALPH LANDAU and NATHAN ROSENBERG New entrepreneurial companies have traditionally been the source of many breakthrough or revolutionary technologies (Quinn, Rosenberg, Swanson), while bigger companies have followed a more evolutionary path, which is equally important. There is now increasing recognition by large companies that they too must organize themselves in a more entrepreneurial manner (Mettler, Hewlett). Mettler observes, however, that large companies grew precisely because they were entrepreneunal. Sumrnanzing his perceptions of a successful entrepreneurial environment, Moore has this to say: First, it takes sources of ideas and people, particularly technical people. These sources are typically the large companies with extensive R&D capabilities, and sometimes uni- versities, as in the case of the biotechnolooies. Second, it requires a rapidly chancing technology, preferably with many varied applications. Third, it requires large and diverse markets to provide many opportunities for market niches to be developed by the companies getting started. Fourth, it requires risk capital which dried up in the 1970s and seemed overly prevalent in the first few years of the 1980s. Successful examples are valuable in motivating, people to overcome the inertia to start a company. And finally, it takes a society that recognizes the entrepreneur when he or she is successful. Ce~nly these are the things that we have in abundance in Silicon Valley. The Financial Climate While there has been a more ample supply of entrepreneurs and venture capital in the United States since the capital gains tax was reduced in 1978 (Swanson, Moore, Quinn), there are now signs of a change: more money is going into second- and third-stage financing, fewer good ideas seem to be arising, and there is less venture capital availability for first-round financing (Perry, Marver). R&D partnerships have also played an important financing role (Swanson, Marver). On the over hand, according to Moore, there is too much venture capital in the United States at present, just as there was too little from 1969 to 1978. He points out that big companies lose valuable personnel as a result. Swanson says venture capital is still a critical need, while Quinn, who discusses the profitability of venture capital, suggests that it is better to have too much Han too little, as exact calibration of the market is impossible. A very different, European experience is illuminated by Malpas: In Britain . . . Mrs. Thatcher has done a great deal to revive the quest for personal wealth by altering the tax system to reduce the amount government takes away from successful people. Europe in general still has too high a floor of unemployment benefit and too low a ceiling for success. Here again, it is this realization that personal wealth is an essential fuel for entrepreneurial drive, both for individuals and companies, that is causin, attitudes to change. Like large companies, rapidly growing companies, after a successful start-

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EDITORS' OVERVIEW 11 up and after reaching a critical size (about $100 million in revenues), face both a much higher cost for capital than their Japanese competitors (Mettler, Aoki, Young, Hannay, Landau and Hatsopoulos) and serious difficulties in the market for initial public offerings (IPOs) and for technology stocks gen- erally (Marver, Perry). As a consequence of successful growth, they also have management and organizational problems different from those of smaller companies (Hewlett). Equity issues generally have not been regarded as low-cost capital; instead debt issues are preferred by the larger companiesa preference arising from the fact that interest is tax deductible, whereas dividends are not. Growing companies, however, cannot risk a high debt:equity ratio because of the uncertainties of their prospects, their Japanese competitors, mostly larger companies, have high leverage and a lower cost for capital. American debt: equity ratios even for large companies are generally lower than those of the Japanese (Landau and Hatsopoulos). Large companies do emphatically play a prominent role in the U.S. econ- omy, despite their handicaps, as Mettler points out. The Japanese indeed have problems with new companies and IPOs (Okimoto), and they also face competitors from other Asian countries and the possibility that conditions may change. Yet even if technology and its applications thrive in the United States, the country still has created for itself a major disadvantage relative to Japan in regard to capital resources. And capital resources are "where economics and technology really merge'' (Young). The United Kingdom has found one novel way to improve its competitive situation in this areathe Unlisted Securities Market, described by Malpas. Since such a market is not yet available in the United States, some American firms are utilizing the London securities markets to take advantage of the system. Large banks, whose main role is with the big companies, deal only pe- ripherally with the more rapidly growing companies, and hardly at all with start-up companies (Reed and Moreno), but as financial innovators and as purchasers of high-tech equipment they still play a major role for many companies. "It is clear," Reed and Moreno state, '`that these [large financia!l institutions support technological innovation in many ways: as users of tech- nolo=,y, venture capitalists, equity underwriters, lenders, advisers and con- sultants, project financiers, and conduits to the international capital markets." Smaller exporting companies and exports generally are not greatly helped by any of these large banks. The Export-Import Bank's role is ver`; limited in comparison with the resources at the disposition of American competitors abroad, and particularly so in regard to the smaller companies (Hannay). Swanson, describing the situation of rapidly growing companies in biotech- nology, notes that the last major U.S. drug, company (Syntex) appeared in 1957; Bowers, its present chief executive officer, discusses that industry's present problems, which are not by any means limited to financial concerns.

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12 RALPH LANDA U and fJATHA1V ROSENBERG The larger established high technology companies, even if well managed and financed, are facing stiff competition from the Japanese. Europe has generally fallen behind. But the United States can learn much from the changing Japanese strategies (described by Okimoto and Aoki in detail), even though the great differences in the two cultures obviously preclude simple copying. Major features of the Japanese approach include a high savings rate, low interest rates additionally aided by a stable economic policy (Landau and Hatsopoulos), favorable tax policies (Landau and [Iatsopoulos), favor- able labor relations, and effective government-industry collaboration. In other words, Japan's is a healthy environment for business in general (Oki- moto). There is nothing neutral about Japan's economic policy, which favors high technology, Japan first, and restricted internal markets. Okimoto points out that while targeting was limited in consumer electronics, there has been more intervention in semiconductors in recent times. These factors and strat- egies, along with certain domestic macroeconomic policies, have presented a major challenge to American high technology companies even some of the largest of them. The progressive ''smokestack" industries, such as chemicals, which still compete on world markets and generate a favorable balance of pay- ments, are stepping up innovation, R&D, and cost cutting, while seeking their own own special targets or ''niches" (Coover). Mettler reminds us, however, that the distinction between high technology and smokestack industries is largely fictitious today, and that manufacturing and services are inextricably intertwined- the '~salami economy.'' As Young and Han- nay write, the general feeling is that from now on the United States will be largely dependent on global markets, especially in the manufacturing,, agricultural, and certain key service sectors, and must "get its act to- gether" on a permanent basis. With the spread of information technolo- gies, capital markets are also truly global now and exert a discipline on all governments (Reed and Moreno). OBSTACLES TO U.S. GROWTH: SUMMARY The first obstacle to U.S. growth is a macroeconomic climate that dis- courages rather than encourages economic grown and competitiveness. Jor- genson asserts that there are no fewer than three camps in the Republican party arguing about which policy to pursue and that the Democrats have yet to enunciate a clear policy. The argument about policies among economists centers on whether economic growth rates of 3 percent, 4 percent, or ~ percent are sustainable over the longer run; yet the programs being suggested largely fail to take into account the explosive potential of technology waiting to be unleashed by the proper macroeconomic policies (Reeder). The second obstacle is in the consequences of the proliferation of regulatory

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EDITORS' OVERVIEW 13 policies (Watson), and the growing public sensitivity to potential hazards- such as the nuclear and Bhopal debaclesthat threaten agriculture (Ruttan), biotechnology (Watson), chemicals (Holmer), pharmaceuticals (Bowers), and others. Related to the regulatory issue is the liability issue and the associated legal system Described by Katz and by Huber) which introduces broad handicaps to innovation and risk-taking entrepreneurship. Moore asks how, in an industry changing monthly, companies can function effectively under a legal system that is "25 years behind the times.'' Excessive litigation and a growing tendency to resolve disputes in the courts are further obstacles to growth. Litigiousness has long been a distinctive feature of American society, as Katz and Huber make clear. It was a feature noted by de Tocqueville, who associated it with the absence of a heavy-handed bureaucracy such as existed in Europe. Eads reminds us that our heavy reliance upon the courts throughout our history was one side of a coin, the opposite side of which was a strong determination to avoid the creation of an overreaching govern- ment bureaucracy. A third obstacle is inadequate technical and general education and inad- equate retraining, at all levels (Pettit, Young, Kennedy). Needed are education and retraining that can inspire a positive outlook toward science and tech- nology, and an urge to maintain the American edge in technological com- petitiveness and entrepreneurial creativity. In education and training lies an important and enduring long-term American advantage. Kennedy emphasizes the unique American research university structure, where education and re- search are located in the same place. Nevertheless, there is inadequate gov- ernment support of basic engineering, manufacturing, and process research in the universities; in this regard the new Engineering Research Centers are potentially a very important innovation (Swanson). The obsolescence of much university equipment and many facilities also represents a serious neglect (Kennedy). A fourth major obstacle to U.S. growth is the continued belief in an endless cornucopia of production and innovation, a belief that adequate levels of capital formation and technological change will somehow be forthcoming, even in the presence of policies that may adversely affect them. Thus, large deficits are tolerated and a drastic rearrangement of the entire tax structure along untested lines is again proposed, constituting, in effect, an experiment win the entire economy (Landau and Hatsopoulos). Jorgenson has shown how sensitive effective tax rates are for capital investment. COMPETITIVENESS: THE FIRST PRIORITY FOR FUTURE AMERICAN PROSPERITY A fundamental challenge is the need to make the American economy more competitive, and firms are responding in numerous ways (Mettler, Young,

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14 RALPH LANDAU and NATHAN ROSENBERG Hannay, Petty, Bechtel, Bowers, Holmer). As venous industrial sectors feel the effects of competition differently, generalizations must be very carefully made (Hannay). Clearly, the role of the large company in the economy is growing, at least in some respects. They have the cash, which smaller companies are finding harder to obtain (Malpas), and are able to take greater risks. With an aware- ness honed by intense competitionof the need to innovate, large com- panies are seeking, ways to improve their performance both internally and externally (Coover, Reeder). Perry describes "corporate partnenng," an arrangement in which large companies set up associations with small entre- preneunal firms in order to harness the advantages of both. General Motors and IBM are cited as current examples (Marver). Similar practices in Japan are described by Aoki. Mettler urges closer relations between large and small companies, citing as one of He benefits the additional job fo~ation that can result. Emerging marketing and standardization techniques also offer growth opportunities, according to Norman, who illuminates a larger truth: the suc- cessful entrepreneur listens to the market and serves it as well as possible. Mettler, in speaking of "market-driven" ways to innovate and meet com- petitive challenges, arrives at He same fundamental conclusion. If America has a unique entrepreneurial culture that must be nurtured (Quinn, Moore), individuals are still the key to creating value and have many motivations for entrepreneurial risk taking (Quinn). The diffusion of innovation is another important determinant of the impact of technological change on economic growth (David, Mansfield). At the same time, in an increasingly competitive environment, based ever more solidly in the Information Age, it is important to protect the intellectual property Hat justifies R&D expenditures and risk taking (Katz, Moore, Swan- son). A proper balance between diffusion and protection is not easy to achieve. Diffusion through the movement of people among companies is greater in the United States than in Japan, but in Japan greater cooperation among firms assists diffusion and growth (Okimoto). It is clear that government does have a key role in economic growth and competitiveness. It is our view that the U.S. economy could be strengthened if we as a nation, with government help, could take these steps: ~ Lower real interest rates, which are affected by monetary policy, def- icits, and the uncertainty of government policies. This would lead to more favorable incentives for investment activity throughout the economy. Adopt a tax structure that really would promote saving, and investment (Landau and Hatsopoulos). Tax considerations are also of great importance in motivating entrepreneurs (Landau and Hatsopoulos); the R&D tax credit has not been adequately tested, and should be extended (Swanson). Such incentives as the capital gains tax differential have been beneficial for in- novation and risk taking and should be retained (Baldwin).

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EDITORS' OVERVIEW 15 Adopt sensible regulatory policies and work to ease excessive public fears about poisons, illnesses, and other hazards by increasing the research effort in these areas and by greater openness of communication and preventive actions wherever feasible (Holmer). Wise preservation of the physical en- vironment for future generations is as important as is preservation and pro- motion of the economic and social environments. Reduce the rate of increase in government expenditures, including, per- haps even defense (Malpas, Okimoto), but increase R&D expenditures for basic arid generic research (Swanson, Watson). Avoid excessive government intervention in markets. Quinn and Zschau state that national planning and real innovation are incompatible. Mettler, conscious of the competitiveness problems generated by the low U.S. savings rates, points out that we do have an industrial policy, although it has never been publicly proclaimed, and its name is "consumer spending." Similarly, David emphasizes that the United States has a de facto set of policies, such as in Boskin's second-tier economic policies, which greatly influence in- novation and diffusion of technology. Beyond these steps economic science should look more closely at how He process of innovation translates into economic growth. It should do this by studying the actuality of the process and how it varies across Dims and sectors, as well as across national frontiers (Pavitt). From a better under- standing of the microeconomics of technical change we should be able to erect a more sensible macroeconomics the ultimate form of the feedback loops in the innovation process discussed by Kline and Rosenberg. Further, economists and technologists should work much more closely together to expand our fundamental knowledge as a prerequisite to higher growth. Mettler summarizes the real challenge involved: American jobs, economic security, and living standards, American social goals and dreams, America's place in the worldall are at stake in the decision we make. If we want to maintain an open, benevolent, and humanely productive society; improve the quality of education; restore our private and public capital resources; pay our debts; defend our national interests; and continue to be a leader in world affairs, then we must also want a competitive economy. In our culture, economic growth is a prerequisite for a more equitable society. Our own early history and that of the Japanese show that we can obtain this objective (Eads, Okimoto). Eads makes the point clearly: failure to progress means decline. But the United States is not a corporation and cannot plan rationally, and it has a constitution and a legal system in the place of the pe~anent bureaucracies of other nations. The Japanese bureaucracy has been very powerful, and thus Japan has no need for strong intervention by the courts, as Aoki observes. The U.S. legal system is de- signed to deal fairly win people, but policymakers have overemphasized equity in the recent past. Indeed, policymakers have expanded the concept

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16 RALPH LANDAU and NATHAN ROSENBERG of equity to include the failures that are the inevitable by-product of the innovation process. A new balance is needed. So far the United States has been unable to reach a national consensus on the importance of restoring our competitiveness and the need to make a commitment to do so (Bowers). Is our form of government really suited for the modern economy? The Japan that rose from the ashes after its defeat developed a system very different from oursone that will generate continuous competition from them (Aoki). In addition, unburdened by extensive defense expenditures, the Japanese have demonstrated an amazing ability to manage growth as their principal national goal by linking job security, wanes, and sectoral policies (which are coordinated with their macropolicies). Their high savings rate gives them another immense advantage. Eads is pessimistic about American capabilities for matching the Japanese resolve, and fears that our system excessively favors equity and risk aversion. This situation might lead to greater protection of uncompetitive industries, companies, and jobs through trade and government policies; such protection would further weaken the country instead of strengthening the determination to improve efficiency. For Eads, the NAE studies show the process of de- clining competitiveness all too clearly. Others Brooks, Mettler, Malpas, Quinn, Hannay are more optimustic about the possibility of recovery, par- ticularly when the promising technologies available and foreseeable are taken into account. So the question becomes: Will a system designed with an increasing con- cern for equity work as well to promote grown, in the light of the increasingly competitive global market? A provocative question, which this volume poses but does not answer. As Hannay says, in no case is technological leadership by itself sufficient to assure competitive success. But it is evident that many financiers, entrepreneurs, technologists, economists, and business leaders are confident of the U.S. ability to respond to challenge. All need to work together more closely in the future so that policymakers can be shown more clearly what paths the United States must follow, if we are to succeed in developing policies Hat will be more effective Han those of the recent past.