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Who Won the Industrial Policy Debate?1 Ian Maitland, Senior Fellow, Center of the American Experiment, Minneapolis, Minnesota November 1994 Foreword Which nations are best equipped to succeed economically? Those in which government has a lot to say about how resources are allocated? Or those in which government has less to say? Most Americans doubtless are partial to the latter, relatively hands-off arrangement -- and surely were so inclined even before the recent, market-friendly elections. But it's also true that much has been written over the last decade about how the United States -- in light of tougher "global competition" and the like -- needs a government-led "industrial policy" in order to thrive, particularly in high technology. This country (so goes the claim) needs more direction from Washington in order to compete, say, with Japan, insofar as Tokyo plays just such a shaping role. What of this contention? Questions of political and economic ideology aside, is it empirically sound to argue that the American electronics industry, for example, would now be better off if the federal government had been as involved in picking commercial winners and losers in recent years as Japan's national government has been? More broadly, is it in fact sound to assume that political and bureaucratic leaders have the wherewithal to accurately and consistently predict which technologies will prove "strategic" and, therefore, worthy of additional public investments? These are two of the questions discussed by Prof. Ian Maitland in this very carefully argued paper, "Who Won the Industrial Policy Debate?" "In the early 1980s," he writes, "in the midst of unprecedented national navel-gazing -- provoked by America's perceived economic decline and flagging international competitiveness -- an influential group of scholars and journalists began to preach the virtues of an American 'industrial policy' to reverse the nation's supposed decline." Such "activists," including major Clinton administration players such as Robert Reich, Laura D'Andrea Tyson and Ira Magaziner, "saw a necessity for -- indeed they embraced -- an active role for government in promoting particular industries or firms whose health was vital to the welfare of the economy as a whole. . . . [T]hey argued that our ideological attachment to laissez-faire economics had blinded us to the fact that the rules of the game in international trade had changed." That's how Dr. Maitland begins. Using semiconductors as his prime vehicle for analysis, this is how he wraps up:
Likewise, he concludes that American "impatience," as opposed to longer-term Japanese planning, can be a decisive virtue in such an environment. And for good measure, he writes that Japan's telecommunications industry lags far behind that of the United States, at least in part because of excessive Japanese regulation. In sum, Dr. Maitland has written a copiously detailed essay which provides vital steel and ammunition for resisting ever-threatened governmental intrusions in America's economy. ("Copiously detailed," by the way, and the previously noted "carefully argued" are ways of saying that portions of what follow are necessarily complex, dealing as they do with RAMs, DRAMs and other computer gizmos. But Dr. Maitland handles them with clarity, and has added a very useful Glossary.) Ian Maitland has been an American Experiment Senior Fellow since December 1992, and has led numerous Center programs, including a series of candidate workshops in 1993 and early 1994. In his full-time professional life, he has taught in the University of Minnesota's Carlson School of Management since 1979, focusing on questions of business and government, international business, and business ethics. He did his undergraduate work in French and German at Oxford, and his doctorate in sociology at Columbia. He also has been known to run for Congress from Minnesota's Fourth District. A number of folks routinely argue that American Experiment should do more in the area of economics. Within the limit of our own resources, I agree -- and thanks to this important contribution by Dr. Maitland in reconfirming the unmatched power and promise of free markets, we have complied. American Experiment members receive free copies of all Center publications, including "Who Won the Industrial Policy Debate?" Additional copies are $4 for members and $5 for nonmembers. Bulk discounts are available for schools, civic groups and other organizations. Please note our phone and address on the first page of this Foreword for membership and other information, including a listing of other Center publications and audio tapes. Thanks very much and I welcome your comments. Mitchell B. Pearlstein Glossary Chip: See "semiconductor." DRAM: "Dynamic random access memory" chip, often known simply as RAM. The dominant type of memory chip. First mover: The first firm to adopt a particular technology. Industrial policy: Public policy that selectively promotes particular industries or sectors of the economy, believed to be strategic industries, with a view to achieving technological advances or international competitiveness. Linkage industry: Industry having substantial "positive externalities," typically in the form of enhanced technological competitiveness diffused through the economy. Used interchangeably with "strategic industries." Market failure: The failure of the market system to channel resources to their most valued uses, e.g., because of the existence of "positive externalities." Memory chip: Semiconductor that stores information for use in modern electronic products. See "semiconductors." Microprocessor: The "brains" of modern electronic products. Sometimes described as "a computer on a chip." See "semiconductor." MPP (Massively parallel processing supercomputers): Supercomputers which divide up their calculations among hundreds or thousands of small but cheap processors. Peripherals: Computer-related equipment, like printers and monitors, other than computers (i.e., processing units) themselves. Positive externalities: Beneficial side effects of an action on the welfare of non-paying secondary parties. Because the parties who engage in activities that generate such beneficial side effects do not get compensated for them, they do not have the incentive to produce a socially desirable level of such benefits. Thus "positive externalities" are an example of "market failure." (Also known as "external benefits" and positive "spillovers.") RAM: "Random access memory" chip. See "DRAM." Semiconductor (aka "chip"): The basic building block of modern electronics. Small rectangular "chip" of silicon, no bigger than a fingernail, on which are imprinted microscopic circuits capable of storing and processing vast quantities of information. There are two principal types of semiconductor: "Memory chips," which store information; and "microprocessors," which serve as the brains of modern electronic products. Spillovers: See "positive externalities." Strategic industry. Industry having substantial "positive externalities," typically in the form of enhanced technological competitiveness diffused through the economy. Used interchangeably with "linkage industries." Supercomputers: Traditionally, computers which perform high-speed calculations on a handful of extremely powerful processors. Contrasted with "MPP," or "massively parallel processing" supercomputers. Technology drivers: Products or processes which have as a side effect the generation of additional technical or manufacturing knowledge. TRON: A Japanese microprocessor design deliberately conceived as a rival to the dominant designs owned by U.S. firms, Intel and Motorola. Introduction In the early 1980s, in the midst of unprecedented national navel-gazing -- provoked by America's perceived relative economic decline and flagging international competitiveness -- an influential group of scholars and journalists began to preach the virtues of an American "industrial policy" to reverse the nation's supposed decline. These advocates of industrial policy (whom I will call the "activists"2) were swimming against the tide of the times. In an era when big government, here and globally, was increasingly defined as the problem, the activists were saying more big government was the solution. The activists' case for an American industrial policy came in for some sharp criticism.3 In particular, critics rejected the claim that America was "de-industrializing," and they expressed skepticism about the supposed omniscience of the bureaucrats at Japan's Ministry of International Trade and Industry (MITI). Still, the activists have had a definite impact on the public policy debate. (Though, I should add, their views have consistently found a more receptive audience among politicians and the media than among academics.) Some of the activists' themes were echoed in Bill Clinton's 1992 presidential campaign rhetoric, and Ross Perot was all ears. After long years in the wilderness, three of the activists -- Robert Reich, Laura D'Andrea Tyson and Ira Magaziner -- hold senior posts in the Clinton Administration. Even under the Reagan and Bush Administrations, the activists scored some successes, notably the two semiconductor agreements negotiated with Japan. The activists saw a necessity for -- indeed they embraced -- an active role for government in promoting particular industries or firms whose health was vital to the welfare of the economy as a whole. They did not shrink from the conclusion that such an "industrial policy" would necessarily involve government in picking winners and losers. Quite the opposite, they argued that our ideological attachment to laissez-faire economics had blinded us to the fact that the rules of the game in international trade had changed. In the activists' view, comparative advantage was no longer a result of a nation's immutable endowments like climate and natural resources, as classical theory held, but was created by deliberate policy choice. Our slowness in recognizing this new reality left U.S. firms at a disadvantage competing against foreign rivals which had their own governments in their corners. This was a matter for public concern because what was good for U.S. corporations was good for the United States -- and vice versa 4 Two key assumptions Two key assumptions underlie the case for industrial policy: First, some industries and firms are more important -- in terms of their impact on national welfare or international competitiveness -- than others. And second, these strategic or "linkage" industries are too important to be left to the private sector. The activists argued that a strong base in certain technologies generates significant benefits for the performance of the rest of the economy,5 but private capital markets fail to channel sufficient resources to these technologies. This is so because of various "market failures" (as economists call them), notably the existence of spillovers or positive externalities and the short-term biases of private investors. Precisely because these spillover benefits are diffused across the economy, rather than captured by private investors, the market has little incentive to invest in these technologies, goes the argument.6 As a result, without the active involvement of government in identifying and promoting this base (the activists continue), these benefits would be lost to the economy. Research-intensive, high-technology products are especially subject to such spillovers. Critics of the activists countered that even if such linkage industries or technologies existed, there were no criteria that would permit policy makers to recognize them. After all, almost all industries are interconnected, so the fact of linkage by itself cannot establish such a presumption.7 And, in any case, the critics further objected, any program of public support for industry would wind up getting captured by politically well-connected businesses rather than linkage ones. So picking winners and losers was best left to the market. Activists were impatient with such objections. Sure, it might be difficult to specify rigorous criteria for detecting the presence of such spillovers or linkages, but that objection ignored the substantial consensus about what industries were going to play a critical role in revolutionizing tomorrow's products and processes. In short, the activists said: We may not be able to define a linkage industry, but we'll know it when we see it. Semiconductors Almost unanimously, the activists identified semiconductors (and particularly "memory chips" or Random Access Memories -- RAMs) as a linkage industry. Three scholars affiliated with the Berkeley Roundtable on the International Economy (BRIE) -- home base for many of the activists -- stated this view most clearly:
Likewise, according to Laura Tyson:
What makes chips special? Semiconductors were seen as a classic linkage industry with substantial spillovers for other technologies. The strategic nature of semiconductors -- and particularly memory chips -- derived from their role as "technology drivers." That is to say, the technical and manufacturing knowledge generated in the process of making memory chips was critical in the design and manufacture of more sophisticated chips.10 In turn, leadership in more complex chips was seen as the key to competitive advantage in user industries. Accordingly, the activists warned that, "If the United States loses its ability to compete effectively in semiconductors, it may lose its ability to innovate in both the semiconductor industry and in related electronics industries and its ability to diffuse electronics-based product and process innovations in a whole variety of actual and potential user industries." 11 In other words, if the United States did not remain a player in memory chips, then it would miss the boat when it came to a whole generation of new chip-based technologies. Early Japanese victory in semiconductors In the early 1980s the Japanese stunned Americans by capturing the lead from the United States in the memory chip business. Memory chips -- principally "Dynamic Random Access Memories," or DRAMs or D-rams -- are semiconductors that allow computers to store and exchange data. They are also critical components in autos, telecommunications equipment and consumer electronics. The Japanese victory set alarm bells ringing around the nation. It was predicted that the U.S. electronics industry would shortly go the way of cars, steel and shipbuilding. According to Kenneth Flamm of the Brookings Institution, "The D-Ram victory was seen as a precursor of the demise of American electronics."12 Former U.S. trade negotiator Clyde Prestowitz intoned: "The story of . . . the semiconductor industry, invented in the United States and symbol of its dynamism, . . . is both a paradigm of the rise of Japan and the decline of the United States and one of the great dramas of the latter half of the twentieth century."13 Apart from a few custom chips, he anticipated that by the early 1990s the Japanese would dominate every segment of the market worldwide. "Nothing American industry can do will stop them," he declared.14 Lester Thurow also talked of the loss of the American semiconductor industry.15 In 1985, Charles Ferguson predicted that within a few years the U.S. merchant semiconductor industry would be bankrupt.16 He later discovered evidence that "U.S. competitiveness in downstream industries is already suffering, and that the decline of U.S. semiconductor technology contributes to this trend."17 The weakened competitive position of the industry was seized on by "declinists" like Paul Kennedy who cited the United States's dependence on foreign countries for critical microchips to illustrate his thesis that the nation's wealth and strength were endangered.18 The American "defeat" in semiconductors became both a metaphor for America's decline and the supposed engine of that decline. The activists used the defeat to rally support for an industrial policy targeting semiconductors and to support their demand for a more aggressive U.S. trade policy. A natural experiment The subsequent history of the semiconductor industry -- and of the user industries -- provides us with a natural experiment for testing industrial policy. If industrial policy is to be workable, then an obvious prerequisite is the ability to recognize strategic or "linkage" industries. Simply put, policy makers cannot selectively promote strategic industries if they cannot tell them apart from non-strategic industries. As we noted, the activists did not actually develop a set of criteria to help us identify strategic industries. So it might seem that their theory -- that national competitiveness can be enhanced by an active government role -- is untestable. But even if the activists did not tell us how to recognize a strategic industry, they did the next best thing -- they nominated a strategic industry, namely memory chips. That enables us to "test" the case for industrial policy by tracing the subsequent history of chip-based technologies to see if the activists' predictions panned out. If the activists are right, then the Japanese should have been able to use their advantage in the strategic memory chip business as a springboard to make advances in other segments of microelectronics. If the activists are wrong, and the Japanese were unable to translate their strengths in memory chips into strong positions in related industries, then the idea that there exist "strategic" or "technology driver" industries must come under suspicion. Or, at least, doubts must be raised about whether expert policy makers can improve on the market in recognizing and fostering such industries. Accordingly, the first question this paper tries to answer is: Did dominance in memory chips prove to be critical to national competitiveness in other high-technology sectors? The subsequent history of the industry may also let us test related claims made by the activists: Did Japanese industry's ability to invest in projects with long-term payoffs -- due to its access to cheap, stable capital -- give it a crucial advantage over its American competitors? Has the Japanese government successfully incubated world-class competitors by protecting them from foreign competition in their domestic market? Finally, does the evidence of the past decade support the claim that MITI succeeded in creating national competitive advantage for Japan by managing or controlling competition among Japanese firms in strategic industries? The view from 1985 In the mid-1980s it appeared as if the U.S. electronics industry was retreating across a broad front. In memory chips, Japanese producers had driven seven out of the nine American producers out of the business.19 As a result of this rout, said Prestowitz, "MITI [was] now the arbiter of the world semiconductor industry. By controlling Japanese production, it determine[d] world prices and the availability of critical devices."20 Japanese firms were also building on the experience they had accumulated in mass-production of memory chips to mount a challenge to the American lead in the microprocessor, microcomputer and peripherals markets. Japanese firms were collaborating on the development of a Japanese design standard (TRON) for microprocessors intended to break the U.S. lock on the chip.21 Meanwhile, U.S. chip makers had "retreated" from the high volume commodity memory markets into design-intensive "niche" businesses. And some observers feared that, without a presence in "technology driver" commodity markets, it was only a matter of time before American producers were flushed out of these niche markets as well.22 Fujitsu had overtaken IBM as the top seller of mainframe computers in the Japanese market and was expected to start challenging its dominance in foreign markets as well. Similarly, in supercomputers, the Japanese were mounting an aggressive program to catch up with America's Cray Research. Japan was considered an unstoppable force in laptop and notebook PCs. NEC Corp. dominated the Japanese market for desktop computers. The U.S. lead in software was under siege from Japanese software "factories." Under the protective wing of Japan's telephone monopoly (NTT), favored Japanese telecommunications companies were rapidly nurturing and commercializing new technologies, while their foreign rivals were held at bay.23 MITI was sponsoring an ambitious program in artificial computing intelligence (the Fifth-Generation Computer Project), and the Japanese Broadcasting Corporation (NHK) had launched a research program into high-definition television (HDTV) involving Sony, Toshiba, NEC and other technology leaders. As a result, the Japanese held an unquestioned lead in HDTV. As BRIE's Michael Borrus later remarked, "it looked like just a matter of time before the Japanese owned the global electronics industry"24 The 1990s: U.S. comeback Five to ten years later, there has been a startling turnaround in the fortunes of the Japanese and American industries. The long Japanese advance through U.S. electronics has been halted -- even thrown back. By many measures, the United States has maintained or stretched its lead in high technology. The nation runs a healthy trade surplus in what the Commerce Department terms leading edge products.25 The principal prediction of the activists -- that the Japanese would leverage their dominant position in memory chips to make inroads in other industries -- has not come true. The Japanese dominance of memory chips is still largely intact but, so far at least, they have been unable to translate it into improved competitive positions in downstream markets. The biggest surprise is the American recovery in semiconductors. Confounding the pundits, in 1992 U.S. chip makers regained the world lead in semiconductor sales. The U.S. comeback in chips was due primarily to rapid growth in the market for microprocessors, the chips that act as the "brains" of personal computers. That market is dominated by Intel and Motorola. Intel's semiconductor sales increased from $1 billion in 1986 to about $4 billion in 1991, a gain that by itself is responsible for the U.S. share of the world market being about 5 percent higher than it otherwise would be.26 The Japanese attempt to develop its own microprocessor design standard -- TRON -- failed in large part because there was no software to support it. Japanese market share in semiconductors has been seriously hurt by slumping revenues and prices for memory chips. Almost unheard of, some Japanese firms are abandoning the memory market. Minebea Company is leaving the chip business. Oki Electric Company suffered such heavy losses in its semiconductor business that its top management was replaced last year. Sanyo has stopped mass producing memory chips. It is reported that Matsushita will "concentrate on producing more specialized chips for its own products."27 Japanese dominance in memory is still intact, but its hold on the low end of the market is coming under pressure from new market entrants. The Koreans and Taiwanese are threatening to do to the Japanese what the Japanese did to us. And Japan is lagging in new chip technologies like flash memories. As a result, Intel -- which was pushed out of the memory chip market by the Japanese in 1985 -- may yet get its revenge. In 1992, Intel held 85 percent of the rapidly growing world market for flash chips. These chips retain data even when power is turned off, 28 and so they are popular for portable personal computers like notebooks. U.S. firms also dominate the small but rapidly growing market for application-specific chips. All in all, as BRIE's Michael Borrus says, "Now it is possible to build a case that you couldn't make five years ago -- that the American semiconductor industry is in a better position than the Japanese."29 In the mainframe computer business, Japanese firms, like Fujitsu and Hitachi have invested heavily in catching up with IBM. But just as they have closed the gap, the mainframe business has weakened as customers have switched to smaller machines like personal computers and work stations. Japanese firms bet heavily on mainframes and are now paying the price. Joichi Aoi, the president of Toshiba, has said, "Unless [former IBM CEO] Mr. Akers laughs, we can't laugh either."30 Comeback continued . . . The story has been much the same in supercomputers. Just as Fujitsu, Hitachi and NEC seem to be closing in on Cray Research, the whole supercomputer business appears to be shifting toward machines based on thousands of less powerful processors:
The ambitious Japanese program (sponsored by MITI) to develop artificial intelligence -- the Fifth Generation Computing Project -- has been disbanded after having largely failed to achieve its goals. In microcomputers, the Japanese threat is on hold. Instead of the announced Japanese invasion of the U.S. market for laptop and notebook computers, it is the Japanese market that is under assault. Apple, Compaq and Dell are cutting into the Japanese market share of the domestic leader NEC Corp.32 NEC is also struggling to hold on to its 50 percent share of the Japanese personal-computer market in the face of American pressure. In the new market in Japan for computer workstations, the two top sellers are Sun and Hewlett-Packard Co. The Japanese also lag in promising fields like computers that can read handwriting. In telecommunications, the Japanese push for world leadership has stalled. U.S. firms, especially Motorola, lead the world in cellular phones, pagers, videophones and other devices. "U.S. producers have led the development of the new commodity semiconductor markets in digital signal processing and telecommunications chips. As the analog world enters an era of digital networking, both . . . are high growth markets for the future . . . ."33 The United States is far ahead of Japan in the use of electronic mail, computer networks, households receiving cable programming, and use of cellular phones.34 In spite of heavy investment over two decades, the Japanese program to lead the world in HDTV has flopped. American firms have leapfrogged their Japanese rivals and have produced a technically far more advanced version of HDTV using digital technology. The U.S. version appears likely to be adopted by Japan and Europe.35 In other areas, too, there are signs of a U.S. recovery. American companies that make the equipment used in semiconductor production appear to be making a comeback. Applied Materials Inc. has rebounded to become the world's largest maker of semiconductor manufacturing equipment. And in some former Japanese strongholds, U.S. companies have excelled: Hewlett-Packard is the world leader in computer printers, AT&T is first in the $1 billion U.S. market in cordless phones. Finally, Japan's threat to the highly profitable U.S. software industry has not materialized.36 Why the reversal of fortunes? Now, it is important not to read too much into these trends. That would be to fall into the same trap as the doomsayers of the 1980s. Just as the earlier U.S. decline was grossly exaggerated because of incautious extrapolation from the freakish conditions of the mid-1980s, so too does a snapshot of the Japanese industry in the early 1990s give a distorted picture. The fall in the value of the dollar from its vertiginous heights in the 1980s and the corresponding sharp appreciation in the yen have made U.S. goods more price-competitive. In addition, the Japanese electronics industry has been hurt by the recent general recession in Japan -- by Japanese standards a particularly prolonged and harsh one -- and in particular by the slump in consumer electronics. Above all, the Japanese industry is suffering from the aftermath of the collapse of its "bubble economy." While it lasted, the extraordinary run-up in stock prices meant that capital was almost free for Japanese firms,37 and the resulting investment binge helped to create the illusion that the advance of Japanese industry was irresistible. The present difficulties are in part a hangover from that investment binge and the huge overcapacity it saddled Japanese industry with. Did government play a part in the revival of U.S. fortunes? In response to the panic over the imminent Japanese takeover of U.S. microelectronics, Washington took a number of initiatives to help the industry: It sponsored a number of industry consortia (MCC, U.S. Memories, Sematech) and it negotiated two semiconductor trade agreements with the Japanese. A detailed assessment of these policies would require a separate paper, but there is fairly broad agreement that their impact was at best marginal and in some cases actually harmful to the American electronics industry (e.g., the first trade agreement).38 Ironically, in large part the U.S. revival can be credited to what the government did not do; that is, step in and save the U.S. memory chip industry. The trade agreements with Japan came too late to bring the industry back from the dead. The United States's (involuntary) exit from the memory chip business turned out to be a blessing in disguise. As one account puts it:
For example, Japanese producers may have inadvertently done Texas Instruments a favor by knocking it out of the memory business. After losing market share for several years, the one-time leader in the chip market has rebounded as the company shifted its strategy to emphasize higher-margin specialized chips over commodity memory chips.40 By contrast, it was Japanese overdependence on memory chips that left them vulnerable in the early 1990s. The increase in American market share and fall in Japanese market share largely resulted from declines in the prices of memory chips. In real terms, U.S. imports from Japan were largely unchanged.41 In one sense, then, nothing has changed -- the Japanese still dominate memory chips. In another sense, everything has changed. Far from being the entering wedge of a Japanese takeover of microelectronics, memory chips are a low-margin, commodity product whose oversupply has become an albatross around the neck of the Japanese electronics conglomerates. Patience is not always a virtue The fundamental factor that worked to the advantage of the American microelectronics industry (and to the disadvantage of its Japanese rivals) in the early 1990s was that advances in product technology refused to stand still. According to the well-known product life cycle (PLC) model of technological change,
So in the initial stage of the PLC, when product technology is still in flux, competitive advantage depends more on product innovation and superior design and performance than on cost and quality. That plays to the strong suit of the generally smaller, less vertically integrated American companies. And it neutralizes the advantages enjoyed by the large Japanese electronics conglomerates. We saw that the activists argued that Japanese firms' ability to invest in projects with long-term payoffs -- due to their access to cheap, stable capital -- gave them a critical advantage over their American competitors. But it is not clear that this advantage must hold equally at every stage of the product life cycle. It is the later, "mature" stage of the PLC -- when mass production of a standardized product begins -- that is highly capital-intensive. Then, the ability to quickly mobilize vast quantities of capital is likely to provide a critical advantage. If the technology is characterized by significant experience curve effects,43 then the Japanese edge at raising capital is likely to be even more critical to competitive success. Access to capital means that a firm can build more production capacity than its rivals, which in turns permits it to more fully exploit the experience curve and so realize the lowest production costs. In summary, the activists' claim is likely to hold for technologies at the mature stage of the product life cycle. From the standpoint of the product life cycle model, memory chips (specifically, Random Access Memories or RAMs) appear to be almost ideally matched with the distinctive strengths of the large Japanese electronics conglomerates.44 They are the largest volume commodity product of the chip industry. One producer's memory chip is almost perfectly substitutable with another's. The mass production of memory chips requires massive capital investment and displays significant experience curve effects. As much as 30 percent of sales is spent on capital equipment, and unit costs typically fall by 30 to 40 percent with every doubling in volume.45 As Michael Borrus has noted:
But, in different circumstances, the great manufacturing strengths of the Japanese electronics firms -- lubricated by their access to cheap, stable capital -- may not give them an advantage, or may even turn into liabilities. This study has described several such cases. First, the Japanese strengths in mass production count for little when it comes to low-volume, design-intensive, and/or customized products. As a result, Japanese firms have largely missed out on the fastest-growing and most lucrative segment of the chip business in the past decade -- application-specific chips (ASICs) -- which are designed to meet a customer's specific needs.47 Harvard Business School's Michael Porter notes that "Basic product innovation is often less scale-sensitive than the introduction of new product types and the incorporation of new features."48 Second, if U.S. first movers are able to lock up their technology, then their Japanese followers may be denied the opportunity to exploit their manufacturing strengths, or may be able to do so on much less favorable terms. This is basically the story of microprocessors. Intel, with over half the world market, and Motorola, have refused to license their most advanced designs to other firms.49 Third, capital investment in plant and equipment dedicated to the production of a given product, or embodying a particular product technology, is vulnerable to major innovations in product design or technology. That is to say, there is nothing deterministic about the product life cycle -- it is reversible.50 We saw earlier how sometimes the best-laid plans of Japanese firms were upset by technological advances by their nimbler American competitors. The Japanese fixation on making faster supercomputers than Cray and more powerful mainframes than IBM left them vulnerable to being blind-sided by MPP (massively parallel processing) machines and the shift to PCs and microcomputers. As one observer of the supercomputer industry comments, "The technology is new and changes very rapidly. The Japanese planning process just doesn't accommodate two-year [technology] cycles."51 After 20 years in development, Japan's HDTV system is now coming to market just as breakthroughs in digital television technology are making the Japanese analog approach obsolete.52 And MITI has abandoned its fifth-generation computer project with little to show in the way of tangible results for all the taxpayers' money swallowed up by the program. In short, the key to competitive advantage in memory chips -- heavy investment in capacity in order to refine the manufacturing process and so improve yields and bring down costs -- may become a liability in a dynamic technological environment where a new product or design may make that investment obsolete virtually overnight. The price the Japanese paid for their patience -- indeed the choice they made -- was lack of flexibility. Robert Lawrence's criticism of industrial policy back in 1984 was prescient on this point: "The alleged U.S. weaknesses may actually be strengths for an economy at the technological frontier operating in an uncertain environment. In contrast, the foreign adherence to long-range planning may better suit less developed countries with clear schedules of change in comparative advantage to follow." 53 But, fourth and last, even if product technology is stable, the fabled staying power of Japanese firms may turn into a liability if a number of firms with deep pockets try to outlast one another. While a strategy of trying to achieve cost leadership by buying market share may be rational for one firm, it can lead to huge overcapacity if many firms try it. That is what happened to memory chips in the mid-1980s when the Japanese producers ran up losses of $4 billion.54 Five years later, the Japanese were back at it, investing in additional capacity in the face of a glut of memory chips and setting the stage for a precipitous drop in prices. "The truth is, nobody's giving up," said Hitachi executive Takeshi Sasaki, referring to overproduction in the memory chip business. "So we are worried."55 The memory chip business is not alone. The same cycle has played itself out in one Japanese industry after another: shipbuilding, petrochemicals, color televisions and cameras, and now photocopiers and facsimile machines.56 Are memory chips technology drivers? By now the answer to the central question posed in this paper is obvious: Memory chips did not function as "technology drivers" paving the way for Japanese inroads in other industry segments. Quite the opposite, Japanese firms have experienced great difficulty making the transition from memory chips -- which don't require a lot of changes in the design and manufacturing process -- to specialty chips, each of which requires a special design and process. American firms, too, have confounded predictions by finding ways to uncouple the "linkage" between component production and systems. Some of them have chosen to concentrate exclusively on design and perform only limited prototype production. They farm out finished designs to foundries or foundry lines of captive merchant producers for production.57 As Ferguson now concedes, "System design is run by Americans while the components are made by the Japanese. Five years ago, the pessimist school, including me, thought that it was an unstable situation and, in the end, the tale (sic) would wag the dog. I'm considerably more optimistic now." 58 Instead of foreshadowing a takeover of microelectronics, then, Japan's success in memory chips was more like a replay of its successes in other mature industries -- like automobiles, color television or VCRs -- where strength at mass production is crucial. As in the past, the Japanese advantage lies in industries where product designs are standardized and competition is based on incremental manufacturing refinement and marketing.59 In the words of a MITI official, "The strength of Japanese companies is in manufacturing large volumes of hardware."60 This fact is reflected in the emerging international division of labor that we observe in Japanese-American joint ventures. Typically, the Japanese partner's contribution is its manufacturing capability. Thus, Sharp is helping Intel with the manufacture of flash chips. NEC, Toshiba and Fujitsu are making microprocessors for American companies. Similarly, the Japanese have held on to their lead in manufacturing-intensive segments of the industry like consumer electronics, robotics and display screens, and Japanese firms still possess an unrivaled expertise in making small things in great quantities.61 Can government create comparative advantage? As we saw, another claim of the activists is that the Japanese government has been able to incubate world class competitors by insulating them from foreign (and domestic) competition in their home market. At one time protection from foreign competition was accomplished by overt import restrictions; today it is more likely to be implemented by discriminatory regulation and procurement. The textbook case of such an infant industry strategy is Japan's domestic telecommunications market: "[T]he absence of sustained foreign competition there . . . has given Japanese companies a critical advantage in international competition," Borrus and Zysman have argued.62 According to Tyson, "By blocking Motorola's access to Japan's rapidly growing market, Motorola's Japanese competitors have been able to keep their prices up, earn high profits and develop competing products. Based on their sanctuary at home, they have been able to launch competitive strikes against Motorola in the U.S. and third-country markets."63 But today this same "strategic reregulation" of Japanese telecommunications is blamed for over-regulating the industry and stifling innovation.64 Because of government regulation, rates for cellular phone service in Japan are among the highest in the world. As we saw earlier, the result is that the number of users of cellular phones is less than one-third of that in the United States. Japan also lags in the use of electronic mail, computer networks, and households receiving cable programming. The underdevelopment of its domestic telecommunications market puts Japanese industry at a disadvantage. It is forced to make its most advanced products for use abroad. In the words of a Western telecommunications company executive in Japan, "What's lagging is not the technology. What's lagging has been more the changes in the competitive environment."65 What about the claim that one of the industrial policy tools used by the Japanese government (more particularly MITI) to promote national competitive advantage is "controlled" or managed competition among domestic firms? 66 On this view, competition takes place under the watchful eye of, and within strict parameters set by, MITI. This is accomplished by various means, including MITI's sponsorship of industry R&D programs (most famously the VLSI project) intended to stimulate specialization and communication among leading firms in an industry. It's also done via so-called "recession cartels" to provide for orderly cutbacks in capacity in periods of market slowdown, lax enforcement of anti-trust laws, procurement policies, and other more opaque practices. In their study of trade in semiconductors, Tyson and Yoffie find tell-tale signs of cartel-like or collusive behavior everywhere in the Japanese chip industry.67 But that leaves a great mystery unsolved. Where was MITI when it was needed? As we have seen, neither MITI, nor the allegedly cartel-like structure of the Japanese semiconductor industry, was able to restrain the price war that broke out among Japanese chip makers in the early 1990s. The norm in the industry has not been restrained competition under MITI's watchful eye. Rather it has been intense rivalry as each firm has invested heavily in an attempt to build market share in order to, in turn, exploit the resulting economies of scale. In industry after industry in Japan the result has been the same: overcapacity and losses for everyone.68 Ironically, the only clear-cut evidence of cartel-like behavior on the part of Japanese chip makers came when the industry was threatened with U.S. trade sanctions if it did not raise its prices. Where MITI had failed to rein in excessive competition, U.S. trade negotiators succeeded -- and in the process earned the Japanese industry $4 billion in additional annual profits in 1988, according to Kenneth Flamm's estimate.69 As a result of the 1986 Semiconductor Trade Agreement, the average price per bit of memory increased for the first time in history. The proposition that Japan creates comparative advantage for itself in its high technology sector by manipulating both international and domestic competition isn't supported by the evidence reviewed here. Where government has had some success in regulating competition -- as in telecommunications -- the result has been relative stagnation. In Japan's case -- as in the 10 leading trading nations studied by Michael Porter 70 -- the principal source of competitive advantage has been intense domestic rivalry rather than controlled competition. Indeed, the intensity of that competition explains the perennial Japanese concern about "excessive competition." Conclusion The evidence reported here tends to cast doubt on certain key claims of the proponents of an American industrial policy -- the activists, as I have called them. The semiconductor industry does not seem to have played the critical role in national technological competitiveness that the activists anticipated. This finding raises questions about the capacity of policy makers to identify industries that deserve public support because of their strategic importance to national competitiveness. At least at the frontier, technology may be too fluid and dynamic to be managed by technocrats in Washington, DC -- or Berkeley. The remaining findings need to be stated more cautiously, but they too run counter to the predictions of the activists. First, the ability to invest in projects with long-term payoffs -- due, for example, to access to cheap, stable capital -- is not necessarily a source of national competitive advantage in high technology. Indeed, if product technology is in flux, patience may be a vice. Second, the case casts doubt on the activists' claim that the Japanese successfully incubate world class competitors by insulating them from foreign competition. In the case of telecommunications, where the barriers to foreign competition are highest, the Japanese lag far behind the United States, and overregulation is the likely culprit. Finally, the war of all against all that broke out among Japanese memory chip producers in the early 1990s can't be reconciled with MITI's supposed power to regulate competition in the national interest.
2 This crude classification lumps together people who might be variously described as trade hawks, techno-nationalists, technocrats, neo-mercantilists, strategic trade theorists and more besides. My own list of "activists" includes Michael Borrus, John Zysman, Jeffrey Hart, Clyde Prestowitz, Pat Choate, Lester Thurow, Charles Ferguson, Ira Magaziner, Chalmers Johnson, George C. Lodge, Bruce Scott, James Fallows, Laura D'Andrea Tyson and Robert Reich. I am sure that none of them would agree with my characterization of them. 3 For particularly incisive contemporaneous critiques see Robert Z. Lawrence, Can America Compete? (Washington, DC: Brookings, 1984); and Charles Schultze, "Industrial policy: A dissent," Brookings Review, fall 1983. 4 Ira Magaziner and Robert Reich, Minding America's Business (New York: Vintage, 1982), p. 66. On its face this may seem like a truism. But critics of industrial policy point out that policies intended to help some U.S. corporations often end up injuring other corporations -- not to mention consumers. As we shall see, restrictions on Japanese computer chip imports appear to have helped U.S. chip makers at the expense of U.S. computer manufacturers. 5"In critical sectors, like semiconductors, on which the competitive positions of numerous other activities depend, a country's gain or loss in competitive position can result in a cumulative gain or loss across a whole spectrum of connected industries." Michael Borrus, Laura D'Andrea Tyson and John Zysman, "Creating advantage: How government policies shape international trade in the semiconductor industry," in Paul Krugman, ed., Strategic Trade Policy and the New International Economics (Cambridge, MA: MIT Press, 1986), p. 94. 6 Magaziner & Reich, p. 338. 7 "But the economy is an interdependent system of industries. Almost all industries are interconnected; therefore this criterion does little to narrow the selection process . . . . It is widely acknowledged that private markets fail where there are spillovers (or externalities), such as pollution, which are not accounted for in private incentives. Simply because one sector supplies inputs to another, however does not imply the presence of such spillovers . . . ." Lawrence, Can America Compete?, p. 99. 8 Michael Borrus, James Millstein and John Zysman, "U.S.-Japanese competition in the semiconductor industry," Institute of International Studies, Berkeley: University of California, 1982, p. 2. 9 Laura D'Andrea Tyson, "Ask the right tough questions about America's strategic industries," Harvard Business Review (November-December, 1988), p. 105. 10 "Experience gained [in DRAMs] has heretofore provided U.S. firms with the manufacturing know-how to move ... to the competitive production of more complex devices." Michael Borrus, Laura D'Andrea Tyson and John Zysman, "Creating advantage," p. 103. Also, "A technology driver was generally a high volume product that had a relatively simple design. When a firm mass produced a technology driver, it would hone its manufacturing skills, and then transfer its learning to more complicated, lower-volume, higher value-added devices. [Dynamic Random Access Memory chips] were particularly well suited for this task . . . . [Consequently the] targeting of DRAMs helped create knowledge in large-scale production process technology that had spillover benefits for Japanese companies in their efforts to break into other less standardized product lines in the 1980s." Laura D'Andrea Tyson and David B. Yoffie, "Semiconductors: From manipulated to managed trade," BRIE Working Paper No. 47 (University of California, Berkeley, 1991), pp. 6;15. 11 Borrus, Tyson and Zysman, "Creating advantage," pp. 91-113. The same point is made by Clyde Prestowitz: "[T]he Japanese knew that if they could grow faster than the Americans in the [Random Access Memory chip] segment of the market [by using the power of the experience curve], they could become low-cost producers of RAMs. And if they controlled RAMs, they would have taken a long step toward dominance in other semiconductors. And if they had semiconductors, semiconductors equipment, materials, and everything that semiconductors went into, such as computers would be next," Trading Places: How We Allowed Japan to take the Lead (New York: Basic Books, 1988), p. 42. The concepts of "strategic industries" and "technology drivers" drew scorn from critics of industrial policy, notably Herbert Stein and George Gilder: "The whole notion that some industries are basic is hollow . . . . If the most efficient way for the U.S. to get steel is to produce tapes of "Dallas" and sell them to the Japanese, then producing tapes of "Dallas" is our basic industry," Stein, cited in Lawrence, Can America Compete?, p. 106. Gilder derided the notion of technology drivers: "To say that huge conglomerates will take over the world information industry because the most efficient chip factories or the purest silicon is like saying Canadians will dominate world literature because they have the tallest trees." "The revitalization of everything: The law of microcosm," Harvard Business Review (March-April 1988), p. 60. 12 G. Pascal Zachary, "U.S. high-tech firms have begun staging little-noticed revival," Wall Street Journal, December 14, 1992. 13 Prestowitz, Trading Places, p. 28. 14 Business Week, August 18, 1986, p. 63. 15 Lester Thurow, Head to Head: The Coming Economic Battle Among Japan, Europe, and America (New York: William Morrow, 1992), p. 116. 16 Tyson and Yoffie, "Semiconductors," p. 23. 17 Charles H. Ferguson, "From the people who brought you voodoo economics," Harvard Business Review (May-June 1988), pp. 58. 18 Paul Kennedy, "A guide to misinterpreters," New York Times, April 17, 1988. 19 Tyson and Yoffie, "Semiconductors," p. 18. The Semiconductor Industry Association (SIA) says that from 1980 to 1986, nine out of 11 U.S. manufacturers were forced to abandon the DRAM business. SIA Chairman Gilbert F. Amelio, "U.S. trade policy must be results oriented," n.d. 20 Trading Places, p. 68. 21 Borrus, Competing for Control: America's Stake in Microelectronics (Cambridge, Mass.: Ballinger Publishing Company, 1988), pp. 176-77. TRON stands for Real Time Operating-System Nucleus 22 Thomas R. Howell, William A. Noellert, Janet H. MacLaughlin, and Alan W. Wolff, The Microelectronics Race: The Impact of Government Policy on International Competition (Boulder, CO: Westview Press, 1988), pp. 89-90. See also Prestowitz, Trading Places, p. 54. 23 Michael Borrus and John Zysman, "Industrial development policy in Japan," Japan's Economy and Trade with the United States, selected papers submitted to the Subcommittee on Economic Goals and Intergovernmental Policy of the Joint Economic Committee, U.S. Congress (Washington: U.S. Government Printing Office, 1985). 24 Borrus cited by Jacob Schlesinger, "Electronics industry in Japan hits limits after spectacular rise," Wall Street Journal, April 28, 1992. 25 Zachary, "U.S. high-tech firms." 26 Andrew Pollack, "U.S. chip makers stem the tide in trade battles with the Japanese," New York Times, April 9, 1992. 27 Andrew Pollack, "Japanese shakeout in chips," New York Times, January 22, 1993. 28 Stephen K. Yoder, "Future appears bright for flash chips," Wall Street Journal, February 6, 1992. 29 Pollack, "US chip makers stem the tide." Emphasis added. 30 Andrew Pollack, "'Fifth generation' became Japan's lost generation," New York Times, June 5, 1992. 31 David P. Hamilton, "U.S. supercomputer makers poised for Japanese sales," Wall Street Journal, September 15, 1993. 32 Schlesinger, "Electronics industry in Japan hits limits." 33 Borrus, Competing for Control, p. 181 34 Andrew Pollack, "Now it's Japan's turn to play catch-up," New York Times, November 21, 1993. 35 Pollack, "Fifth generation;" Economist, "Do not adjust your set," February 27, 1993. 36 David P. Hamilton, "U.S. companies rush to fill Japanese software void," Wall Street Journal, May 7, 1993. 37 George Melloan "Japanese firms are losing one key advantage," Wall Street Journal, March 29, 1993. 38 Two Sematech officers acknowledge that much of the U.S. rebound in the semiconductors and equipment markets "may be due to market dynamics beyond SEMATECH's influence." William J. Spencer and Peter Grindley, "SEMATECH after five years: High-technology consortia and U.S. competitiveness," California Management Review (summer 1993), pp. 9-32. U.S. Memories and MCC (Microelectronics and Computer Technology Corp.) have since been dissolved. For a range of views see Tyson and Yoffie, "Semiconductors," p. 23; Zachary, "U.S. high-tech firms;" Bob Davis, "U.S. chip firms seem to lead Japanese ones in sales this year, but experts aren't sure why," Wall Street Journal, December 24, 1992; Bill McEvily and Susan Feinberg, "Trying to forget U.S. Memories," Strategic Management Research Center working paper, University of Minnesota, 1992; and Economist, April 2, 1994, "Uncle Sam's helping hand." 39 Davis, "U.S. chip firms." 40 Hal Lancaster, "TI is spending up to $1 billion on chip facility," Wall Street Journal, August 20, 1993. 41 Tyson and Yoffie, "Semiconductors," p. 47. If prices of U.S.-made chips increase relative to prices of Japanese chips, then U.S. producers will gain market share at Japan's expense, even if each country's output of chips measured in physical units remains unchanged. 42 Michael Porter, Competitive Advantage (New York: Free Press, 1985), p. 194. See also William J. Abernathy, Kim B. Clark and Alan M. Kantrow, Industrial Renaissance: Producing a Competitive Future for America (New York: Basic Books, 1983), ch. 2. 43 That is, if the cost of producing each additional unit declines sharply as volume increases. 44 Or, for that matter, large integrated U.S. electronics firms like IBM, which kept pace with its Japanese competitors in memory chips when American merchant producers were forced out of the business. 45 Tyson & Yoffie, "Semiconductors," pp. 6, 15. 46 Michael Borrus, "U.S.-Japanese competition in semiconductors: Current issues for American policy," Industrial Policy, Hearings before the Subcommittee on Economic Stabilization of the Committee on Banking, Finance and Urban Affairs, House of Representatives (Washington: U.S. Government Printing Office), 1983, p. 279. 47 "Japanese manufacturers have not shown a conspicuous advantage in highly uncertain innovations involving new conceptualizations of market potential and highly specialized scientific approaches. Nor have they acquired a competitive edge in industries where there is customized production of newly designed products." Masahiko Aoki, "Toward an economic model of the Japanese firm," Journal of Economic Literature, March, 1990, p. 9. Susumu Tonegawa, a recent Japanese Nobel Prize-winner in medicine, told the New York Times that "any free-spirited researcher must leave Japan to thrive. Universities here are too authoritarian, too focused on seniority, too inflexible to let young researchers pursue unproved but potentially innovative ideas." November 8, 1987. 48 Competitive Advantage, p. 184. 49 Tyson and Yoffie, "Semiconductors," p. 40. 50 See Abernathy et al., Industrial Renaissance, chapter 2, on "the logic of de-maturity." 51 Howard Richland of the Gartner Group, cited in David P. Hamilton, "U.S. supercomputer makers." 52 Pollack, "Fifth generation." 53 Lawrence, Can America Compete?, p. 143. Lawrence's point is that "long range planning" or industrial policy may be viable only where a technological road map is available. By definition that is not the case for U.S. firms pioneering new technologies, but it may be true for less developed countries that are following the trail blazed by American pioneers. 54 At the time this was seen as a masterstroke because it left the Japanese with a near-monopoly on memory devices. Although the losses at U.S. firms were half the size of the Japanese losses, that was sufficient to drive them from the business. According to Prestowitz (Trading Places, p. 69), "Despite $4 billion in losses over the past few years, no one [in Japan] was thinking of abandoning the semiconductor industry . . . . The Japanese said the semiconductor industry is a strategic one in which they intend to remain, regardless of profits or losses." 55 Schlesinger, "Electronics industry in Japan hits limits." See also Economist, "Falling off the learning curve," Feb. 23, 1991. 56 Economist, "The myths of corporate Japan," May 27, 1989. 57 Borrus, Competing for Control, p. 156. But Borrus was reluctant to concede that such a strategy is viable: "[T]here is a question as to whether such firms can maintain their market position as technology changes if they do not manufacture." (Id.) 58 Charles Ferguson, cited in John Markoff, "Mobile computing is all American," New York Times, November 23, 1992. 59 Borrus, Competing for Control, 147-48. 60 Electronic Business, November 1992. 61 Zachary, "U.S. high-tech firms." 62 Borrus and Zysman, "Industrial development policy in Japan," p. 158 63 Tyson, "Japan's trade surplus matters," Wall Street Journal, March 1, 1994. See also Tyson, Who's Bashing Whom? Trade Conflict in High-Technology Industries (Washington, DC: Institute for International Economics, 1992), ch. 3. 64 Pollack, "Now it's Japan's turn to play catch-up." 65 Ibid. Protectionist policies also impose costs on downstream user industries. Thus the Japanese computer industry's ability to compete in export markets was hurt because it had to forgo U.S. semiconductors that were available "at lower prices and at higher quality, capability and reliability levels than the Japanese." Tyson and Yoffie, "Semiconductors," p. 13. See also Sylvia Nasar, "The risky allure of 'Strategic Trade,'" New York Times, February 28, 1993. 66 For example see Borrus et al., "Creating advantage," pp. 97-8. 67 "Semiconductors." 68 Economist, "The myths of corporate Japan." 69 Cited by Tyson and Yoffie, "Semiconductors," p. 31. 70 Michael E. Porter, The Competitive Advantage of Nations (New York: Free Press, 1990). |