Lessons From the Past

History Says the Future of U.S. Industrial Competitiveness Is Brighter Than We Think

Share Print Related RSS

 

When it comes to competing for jobs, third-world countries like China and India seem to be unstoppable juggernauts. They are not, and a little historical perspective shows why.

In his 1987 book, "The Rise and Fall of the Great Powers," Paul Kennedy claims, throughout history, successful nations have recognized and accepted global waves of change and have managed to adapt and thrive. Nations that instead resisted by isolating themselves from global forces have failed miserably.

Individuals are faced with the same choices. Fight the inevitable and inevitably fail, or recognize change and use it to advantage.

MITI Made a Stand

Perhaps the most familiar example of failure by fighting is the economic performance of Japan from 1990 to 2002.

Back in 1990, most observers saw Japans Ministry of Industry and Trade (MITI) as a collection of infallible government mandarins expertly guiding their country to one success after another. The U.S. was portrayed as a declining nation at the mercy of malevolent global market forces.

Both Japan and the U.S. experienced substantial economic stress during the 90s and the first few years of the millennium. Japan chose to cope with these stresses by preserving the status quo and ignoring global forces.

MITI made preservation of jobs in aging and unproductive sectors such as steel, shipbuilding, farming, construction, and second-tier auto manufacturing (Subaru, Suzuki, Mitsubishi) a priority. They "encouraged" banks to lend money to such sectors, even though this lending was not for investment, but for covering operating losses and repaying prior loans.

MITI ensured that investment in Japan would remain locked in unproductive areas of the economy with no long-term futures. Promising new firms and technologies were starved for capital.

The U.S., whether through benign neglect or intelligent planning, chose to let unproductive firms fail. These firms were consolidated (Mobil), sold to foreign investors (Chrysler), or allowed to go bankrupt (too many to list). The trillions in capital freed by stopping existing and new investments in these firms were redirected to growth areas such as biotechnology, pharmaceuticals, and software.

Market Forces Won

So how did the MITIs mandarins fare against the "invisible hand" of U.S. markets? In 1990, the unemployment rate stood at 2.1% in Japan and 5.6% in the U.S. By 2002, the unemployment rate reached 5.4% in Japan and 5.8% in America. While the U.S. rate of unemployment remained relatively stable, Japans almost tripled.

In 1990, general government gross financial liabilities (national debt) as percents of nominal GDP were 68.3% in Japan and 66.6% in the U.S. In 2002, the national debts as percentages of GDP were 147.2% in Japan and 61.0% in the U.S.

Junk Bond Status

The U.S. national debt relative to GDP declined by 5.6% while Japans more than doubled. Japans national debt now has junk-bond status and is rated one step below Botswana. Its by far the highest of any developed country, and is projected to increase to an astounding 164% of GDP by 2004.

At the end of 1990, Japans main stock market index, the Nikkei 225, stood at 23,849 compared to the U.S. Dow Jones Industrial Average of 2,634. At the end of 2002, the Nikkei had plunged to 8,579, while the Dow Jones stood at 8,342.

The U.S. stock market (and many of its investors portfolios) more than tripled, while Japans main stock market index dropped by almost two-thirds.

According to the World Bank, Japans average annual per-capita GDP growth rate from 1992-2002 was 1.1%. The recent trend is even worse, as Japans per capita GDP shrank by 0.6% in 2001 and by 0.7% in 2002. The U.S. average annual per-capita GDP growth rate from 1992-02 was 3.5%, and despite widespread recession, growth was 0.3% in 2001 and 2.3% in 2002.

Average annual per-capita growth is a good proxy for average annual raises, so the average Japanese worker saw his or her income increase by about 9% from 1992 to 2002. The average American worker enjoyed a rise in income of about 27% over the same time period.

Let It Be

If our economy had performed like Japans over the past 13 years or so, the U.S Dow Jones average at the end of 2002 would have stood at 948 instead of 8,342. Just think what this would have done to your investment portfolio!

Your annual salary would also be about 20% less than it is now, and you would be two and half times more likely to be out of work because our unemployment rate would be over 14%.

Finally, our national debt at the end of 2002 would have been $13,805 billion instead of $6,405 billion. At an interest rate of 5%, payments on the additional $7,400 billion in debt would add $370 billion per year to our national deficit, nearly doubling the project current national budget deficit of $401 billion in 2003 (Congressional Budget Office).

The 5% interest rate is higher than what the U.S. government now pays for borrowings, but interest rates rise as total debt increases, especially as debt approaches junk status.

If we had severely curtailed immigration per the Japanese model, we would have ignited the same demographic time bomb that is currently ticking in Japan. Largely because of draconian immigration policies, 27% of Japans population is projected to be 65 and over in the year 2020. Young immigrants to the U.S. will give us a much more manageable ratio of retirees: projections say 16% of the U.S. population will be 65 and over in 2020.

It is ironic that many are now calling for the U.S. to implement many of the same policies instituted by Japan in 1990. Some would have us close our shores to immigration and international outsourcing, do everything possible to protect existing jobs and industries, and spend lavishly on government infrastructure projects to maintain "full" employment.

The New Bogeyman

Of course, Japan is no longer the international bogeyman. China and, to a lesser extent, India, now fill those roles. Japan was seen as unstoppable in the early 90s, and now China is projected to be the inevitable champion of the world economy.

China will probably become the worlds largest economy some time during this century, but not on a per-capita basis. Japan was faced with change in the early 90s and failed to adapt. China, India, and other third-world countries that many fear as inexhaustible sources of cheap labor will also have to make massive changes if success is to continue.

What might these changes be, and how might China and its ilk react? One change will be a need for tremendous investment in infrastructure. A recent article in the international newsmagazine, The Economist, details how a chronic shortage of electric power is threatening to derail economic expansion in China.

According to The Economist, some 19 of Chinas 31 provinces and municipalities, including the most economically dynamic, are rationing electric power in 2003. Next year may be even worse.

Electricity demand in the first half of 2003 rose by 15%, led by power-hungry industries such as steel and aluminum. Hydroelectric power stations are suffering from lack of water, and air-conditioners are straining overburdened grids.

A state-run newspaper, the 21st Century Business Herald, reported that some 200 steel, fertilizer, and other factories in coastal Jiangsu Province had simply been closed down for the summer. Four-day work weeks have become commonplace in power-starved provinces.

Despite recent moves to boost competition, the power sector is still largely controlled by the state and ignores market forces, continues The Economist article. Scott Roberts of consultancy Cambridge Energy Research Associates says domestic investors are reluctant to build new power plants because they are now starting to share the fears of foreign power firms about the political risk of future regulatory changes.

High Population Density

Another acute problem for China and India (and many other third-world countries) is high population density. China has about the same land area as the U.S., but about 4.5 times the U.S. population. India has a population density of 827 people per square mile, more than 10 times U.S. population density. Given these facts, rural land prices in China and India are sure to rise well above U.S. levels, as they already have in urban areas.

High land prices will make many new and existing land-intensive investments, such as large-scale manufacturing, economically unattractive. China and others will have to react by abandoning such manufacture to free capital for other investments with better returns. Will they have the political will to accomplish this?

Finally, China and India will need to let investment flow to areas of greatest return. This proved impossible in Japan during the last 15 years, and China and India have a much heavier hand when it comes to state-directed investment.

High-ranking party officials in China control and profit from virtually every business venture. Will these officials allow unproductive industries and their own investments to fail so capital can flow to more productive and faster growing areas of the economy?

Say No to Protectionism

Should we as a nation and as individuals react to foreign competition for our jobs? Yes, we should. But we must ensure that our actions improve competitiveness by increasing our ability to adapt to global market forces.

Policies that seek to preserve the status quo or even to restore supposed past glories are sure to fail and will saddle the U.S. with the current Japanese malaise.

If these policies are of the "beggar thy neighbor" type (quotas, tariffs, etc.), retaliation from foreign countries could set off a death spiral and lead to another worldwide depression. Protectionism implemented by the Smoot-Hawley Tariff Act of June 1930 raised U.S. tariffs to historically high levels and were one of the chief causes of the Great Depression.

Protectionism is no idle threat. One of the leading candidates for the U.S. presidency in 2006, Howard Dean, says that we must have labor and environmental standards attached to trade agreements. He says if other countries dont agree to upgrade their standards to match ours, that will be "the end of free trade" with those nations. Of course, this would immediately reduce our trading partners to Europe, Canada, New Zealand, and Australia, and isolate us from all of the worlds fastest growing and most dynamic economies.

Furthermore, protectionist policies and other actions that temporarily insulate the U.S. from global market forces cut the very strength of our economy, according to management consultants McKinsey & Co. They say the openness of the U.S. economy and its inherent flexibility--particularly that of its labor market--are two of its great recognized strengths. Diana Farrell, the director of the McKinsey Global Institute, says, "The current danger is that public policy will make the US economy less flexible and endanger American economic well-being."

Intelligent Immigration & Employment

Useful national policies for dealing with globalization would include a point system for immigration. Point systems are used in New Zealand and Canada to make sure that immigrants contribute to the economy.

Points are accrued for each individual based on factors such as level of education, wealth, and youth. The point system is a systematic method for attracting the best and brightest. To see how it works, go to www.immigration-service.com/calculate.html for Canada or www.immigration.net.nz/immig_points.html for New Zealand.

On the employment front, retraining laid off workers for positions in growth industries is more effective and less costly than trying to maintain employment in sectors of the economy that can no longer compete on a global basis.

Companies could be required to purchase insurance covering the wage losses of workers displaced by offshore outsourcing. The McKinsey Global Institute estimates that for as little as 4-5% of the savings realized by offshore outsourcing, companies could insure all full-time workers who lost jobs as a result.

The proposed insurance program would compensate those workers for 70% of the wages they missed, and offer health care subsidies. Compensation and subsidies would last for two years after layoff or until re-employment.

Continuing on the health care front, cutting the growth rate in health care costs would help those without coverage to purchase medical insurance, and also reduce non-wage expenses for U.S. employers.

Constructive Public Policy

Although U.S. capital markets are among the worlds best, much can be done to improve regulation, transparency, and efficiency. This would restore confidence in the U.S. capital market system, retain competitive advantage, and continue to induce abundant inflows of world capital.

Individual prosecutions in some high-profile securities fraud and obstruction of justice cases have been a good start, but more are needed. Similarly, the emerging scrutiny of the mutual fund industry is long overdue and invites more systematic review of related sectors.

Drop the Pork Barrel

The U.S. also needs to drastically reduce dysfunctional pork-barrel subsidies and protection of sectors where the country has fundamentally lost comparative global advantage. Some of these measures are sour medicine for process control professionals, but the right thing to do in the long run.

Recently, and wisely so, President Bush rescinded the tariffs heplaced on imported steel. Not only did the initiation of these tariffs force the World Trade Ornaization to threaten retaliation, many in the steel consuming industries blamed them for accelerating job losses in manufacturing. Certainly, steel producers aren't exactly thrilled that the tariffs are being lifted, but most expert observers agreed at the time of the announcement that there would have been a lot more pain to go around if they had remained in place.

Leader Not Follower

Finally, the U.S. needs to be the leader in strengthening the world trading system to promote freer, fairer trade and consequent efficiency gains. Most urgent is for the U.S. to improve its diplomacy within the Doha Round of the ongoing World Trade Organization talks.

Short-term preoccupation with bilateral and regional agreements should not be allowed to sidetrack successfully extending and improving the far more important multilateral system. Towards this end, the U.S. should make concessions to developing countries in agriculture and in intellectual property relief for critical medicines.

These and other public policy actions will maintain the long-term strength of the U.S. economy.

Protectionism and isolationism aim to maintain advantage in particular industries and professions, but other nations can and have emulated and bested the U.S. in selected and targeted areas, and they will continue to do so.

The strength of the U.S. is not to found in isolation from globalization. The nations strengths are instead its ability to adapt to change, its ability to attract foreign capital, and its ability to attract the best and brightest from across the globe.

As long as the U.S. maintains its unrivaled strength in these areas, pretenders to its preeminent position in the world economy will remain behind. But if the U.S. succumbs to the lures of isolationism, nationalism, and protectionism, long-term decline is assured.

Share Print Reprints Permissions

What are your comments?

You cannot post comments until you have logged in. Login Here.

Comments

No one has commented on this page yet.

RSS feed for comments on this page | RSS feed for all comments