The Japanese Challenge and "McAdams's Laws"
We now shift focus and tone to take up a number of the economic and political issues associated with high-performance computing by employing "McAdams's Laws" to examine the nature and possible impact of the Japanese challenge in the high-technology market.
Introduction
At the end of World War II, the U.S. gross national product equaled over half of the gross product of the entire world. During the post-World War II period of American economic and military hegemony, the U.S. pursued a national policy that favored activities designed to contain "world communism" over the interests of its domestic economy. Starting from the position of overwhelming predominance, these choices seemed necessary and obvious.
Since that time, much has happened in the world to clarify our perceptions. World communism was not only successfully contained over the last 40 years, but today, in many nations, communism and socialism are being abandoned in favor of democracy and capitalism. The fall of communism in Eastern Europe and elsewhere is viewed by many as a harbinger of a "victory" over world communism and a demonstration of the superiority of American-style laissez faire capitalism to other economic systems. However, there are also many who believe that in its efforts to contain communism, the U.S. may have brought its economy—especially its high-technology sectors—to a position close to ruin.
Law 1—
That Which Is Currently Taking Place Is Not Impossible
The perception of U.S. dominance as assured and perpetual is severely flawed. The U.S. may soon cease to be the world's commercial leader in the field of supercomputers and has rapidly lost ground in other areas,
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as well, including machine tools, consumer electronics, semiconductor-manufacturing equipment, and high-performance semiconductors. Even areas of U.S. strength, such as aircraft and computer hardware and software, may soon be at risk unless strong action is taken. American competitiveness, much less dominance, in these and other high-technology areas can no longer be assumed.
Alarms have been sounded at many levels. The National Advisory Committee on Semiconductors, in its recently released second annual report, refers to the semiconductor industry as "an industry in crisis" and urges the federal government to act immediately or risk losing the semiconductor industry in its entirety and with it, the computer industry, as well. The Administration itself has just identified 22 critical technologies vital to U.S. military and economic security, a list of technologies virtually identical to those identified earlier and individually by the Departments of Defense and Commerce as vital to the future of the U.S. in world geopolitical and economic competition.
A concerted effort on the part of the Japanese, combined with complacency on the part of American industry and unfavorable trade conditions between the U.S. and Japan, have brought about this situation in which spheres of U.S. industry have lost former dominance and competitiveness in certain international markets. The world has changed. The U.S. is no longer predominant.
Japan:
Vertical Integration, Keiretsu, and Government Coordination
In 1952, when the Japanese became independent, they set a goal, embodied in the motto, "We will match the standard of living in the West." At that time, over half of the Japanese population was engaged in subsistence agriculture, and yet, by improving their output-to-input ratio, they were able to improve their productivity. Since then, the Japanese have moved from subsistence agriculture into light manufacturing, into heavy and chemical goods, and into the higher-technology areas. Today, as a result of an innovative corporate structure and governmental industrial orchestration, the Japanese have positioned themselves to become the dominant suppliers of information technologies to the world.
Japan today has a different, more sophisticated structure to its economy than our own. The major Japanese firms producing computers are all vertically integrated, meaning that a strong presence is maintained across the spectrum of computing machinery—from micros to supercomputers—and in all allied technologies: microelectronics, networking,
consumer electronics, etc. In contrast, there is only one vertically integrated company in the computer field in the U.S.—IBM.
Table 2 illustrates this situation. The three leading Japanese supercomputer firms—NEC, Fujitsu, and Hitachi—are integrated all the way from consumer electronics to microcomputers, minis, intermediates, mainframes, and supercomputers. All are large-scale producers of semiconductors. In contrast, U.S. firms producing semiconductors are either "merchant" suppliers, with the bulk of their sales and earnings coming from the sale of semiconductors on the open, merchant market, or "captive" suppliers, such as IBM and AT&T, which produce semiconductors only to satisfy internal demand. Further, when previously successful merchant suppliers have been purchased and merged into large U.S. companies to become both captive and merchant suppliers, they have uniformly gone out of the merchant business.[*] Usually they have shut down completely. No U.S. captive supplier has become a successful merchant supplier to the market. Japanese firms, however, do both successfully. They are captive suppliers to themselves, and they are merchant suppliers to the market. This suggests something amiss in our system or between our system and that of the Japanese.
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Japanese firms are not only integrated across virtually every aspect of semiconductors and computers but are also prominent members of Japanese industrial conglomerates, or keiretsu . The major Japanese keiretsu groups are each structured around a major bank.[*] The Bank of Japan supports these banks with differential interest rates for loans to "target" industries.
From their keiretsu structure, Japanese corporations get diversification, risk reduction, and a lower cost of capital, which allows them to maintain a favorable output-to-input ratio. Additionally, while competition in their home market among the keiretsu forces reduced costs and improved quality, these firms will cooperate when operating in foreign markets or when facing foreign firms in their home market. Should they temporarily fail to cooperate, the Japanese government steps in and reestablishes "harmony," especially in their dealings with outsiders, or gaijin . Thus, the Japanese have not only a team but a team with a strategy.
The U.S.:
Rugged Individualism and Trade-War Losses
In contrast, American industry has rejected a close working relationship with the government and insists on that truly American concept of rugged individualism. Whereas this arrangement has at times resulted in extraordinarily rapid growth of the American high-technology industries, it has also resulted in an uncoordinated industrial environment in which poor decisions have been made.
Economic policy decisions must be made with respect to certain economic relationships, which can be easily illustrated formally. Four variables are required for this somewhat oversimplified example:
• q = quantity of output;
• p = price of products;
• w = wages per hour; and
• i = number of hours worked.
If five computers are sold (q = 5) for $1000 each (p = $1000), total revenue will be $5000 (qp = $5000). If the wage rate of the work force is $10 per hour (w = $10) and the input of work hours is 500 (i = 500), the cost to produce the machines is also $5000 (iw = $5000), and no profit is realized:
More generally,
If we now divide both sides of this relationship by ip , we get
and canceling, we get
This ratio, in a nutshell, illustrates what is needed to break even. On the right-hand side of the equation are two factors expressed in dollars—w , the hourly wage and p , the price of the computers—whereas on the left is the ratio of q , machines produced, to i , input hours. The ratio of q / i is the rate of output per unit of input and represents what economists call the (average) production function of the process. It is a relationship determined by the technology. If the technology is the same in two countries, this ratio will be (roughly) the same for those countries. A country with lower hourly wages, w (e.g., $5), will be able to charge a lower price, p (e.g., $500) for its product and still break even. That is, with the same plant and equipment (or production function) on the left-hand side of the equation and low wage rates on the right-hand side, low prices will be possible for the products from the low-wage countries. If, however, wages are very high (say $20), then the ratio of w / p will require that p , the product price, also be high (in our example, $2000).
International competition is as simple as that. It is neither "good" nor "bad," it is simply inexorable. The simple relationship demonstrates why so many jobs are being lost by the U.S. to developing countries. Their low wages make it possible for them to produce products from relatively stable technologies more cheaply and thus charge lower prices than can we in the U.S.
There are solutions to this problem, but the U.S. has generally failed to implement them. For example, it may be possible to improve U.S. plants and equipment (and/or its management) so that employees are more productive and thereby achieve greater output (q ) per unit of input (i ). This would justify
a higher wage (w ) in relation to a given unit price (p ) for the output. This has been a major tenet of Japanese strategy for decades. Another solution involves producing a higher-quality product for which consumers will be willing to pay more, thus justifying the higher wages paid to the work force, since a higher p can justify a higher w .
Because the U.S. has as its long-term objective to maintain or increase its relative standard of living, then one or both of these strategies are required. Even then, a way must be found to inhibit the rate of diffusion to low-wage economies of an innovative, highly productive production process and/or of product quality innovations. Only in these ways can higher wages—and thus a reasonable standard of living—be sustained in our economy over the long haul. The implications of these facts are pretty clear; they are very much a part of our day-to-day experience.
A reasonable economic development strategy for the U.S. must be in the context of these major forces influencing outcomes worldwide. The major forces aren't definitive of final outcomes, but they do establish the limits within which policies, plans, and strategies can be successful.
The need to respond to the low prices offered by other countries has been recognized in this country for many years. The solutions attempted have largely been ineffectual quick fixes, in essence trying to catch up without catching up rather than facing up to the imperatives of improving product quality and productivity in general.
Law 2—
You Don't Catch up without Catching Up
Our response to the present challenge has, to date, included a miscellany of wishful thinking, "concession bargaining," and manipulating monetary factors. Concession bargaining sought to cut the wages of U.S. workers producing high-technology goods—and thus their standard of living—so that the U.S. could match the prices that low-wage countries are offering. When "concession wages" didn't work, the U.S. then decided to find another financial gimmick that would permit us to lower the price of our goods in world markets.
The U.S. decided to cut the exchange rate in half. At the bottom, the dollar was worth 120 yen, while before it had been worth 240 yen and more. In effect, this introduces a factor (in this case 1/2) between the world price before the change and the world price after, while leaving the U.S. domestic equation unchanged. Given that we have over a $5 trillion economy today, cutting our exchange rate with the world in half amounts to giving away $2.5 trillion in the relative value of our economy. The $30
billion improvement in the balance of trade due to the lower world price of our goods yielded a return on our investment of only a little over one cent on each dollar of value lost. This is not an intelligent way to run an economy.
Trade:
"Successful" Negotiations and "Potato Chips"
Another major difficulty for U.S. high-technology manufacturers is the asymmetry in U.S. and Japanese market accesses; U.S. markets are wide open through our ideology, whereas Japanese markets are not. The U.S. government, which historically has shunned "intervention," has been reluctant to "start a trade war" and insists that U.S. firms are better off standing alone. The government, whose policies might be stated as, "It doesn't matter if we export computer chips or potato chips,"[*] has been practicing what can only be called unilateral disarmament in international trade battles.
Law 3—
When Two Countries Are in a Trade War and One Does Not Realize It, That Country Is Unlikely to Win
The Japanese markets in target industries are, have been, and are likely to remain closed. In the U.S., we refer to such a phenomenon as "protectionism." This market was protected when the Japanese were behind. This market was protected while the Japanese caught up. This market remains protected even now after the Japanese have achieved substantial superiority in many of its products.
These facts violate conventional wisdom that equates protectionism with sloth. Clearly, that has not been the case for the Japanese. Protectionism for the Japanese can't be all bad; it is possible for protectionism to work to the benefit of a nation; it has for Japan. Today, the U.S. has a weekly trade deficit with Japan of about one billion dollars—almost half of which is spent on automobiles—which feeds into the Japanese R&D cycle rather than our own.
Protectionism has long been the name of the game for Japan, and the U.S. has an extremely poor track record in trade negotiations with the Japanese. There are general trade principles understood by both the U.S. and Japan, some of which are embodied in specific, written trade agreements. An important one is that each side should buy those technological
products that the other side can produce more economically. The Japanese, however, routinely violate these principles whenever it is convenient to do so, and the U.S. does not pressure the Japanese to meet their obligations. Seventeen negotiations between the United States and Japan in semiconductors have been almost completely ineffectual. These general comments are illustrated in Figure 1, which is also known to the industry as the "worm chart."
Figure 1 shows the share of the Japanese semiconductor market held by U.S. producers over the period 1973–1986 in relation to a series of "successful" negotiations between the United States and Japan to open the Japanese semiconductor market to competition by U.S. firms. It is startling to note that the U.S. market share has dropped by approximately one per cent—from 10 to nine per cent—in the wake of these "successful" negotiations.
During the early period, Japanese firms were no match for their American rivals. By the early 1980s, they had caught up in many areas and were already ahead in some. By the end of the period, Japanese firms had established general superiority. Yet, throughout the entire period, and irrespective of the relative quality of the U.S. versus Japanese products,
Figure 1.
The Worm Chart: U.S. share of Japanese semiconductor market.
the U.S. market share has remained virtually the same. It could be characterized as a "worm," lying across the chart at the 10 per cent level.
There's something about the way the Japanese manage their economy that has led to a constant U.S. share of its semiconductor business in the range of approximately 10 per cent. Given the multitude of variables involved, it is a virtual impossibility that markets alone could have brought about such a result.
Remedies
Law 4—
An Important Aspect of Change Is That Things Are Different Afterward
It is not difficult to see that no panaceas exist. Various remedies to ameliorate the situation, however, do.
The present-day situation must be recognized as a crisis. The U.S. government and, to a lesser degree, industry have failed to recognize this as a crisis. Fixing that which is wrong now is many times more difficult than would have been the case just a few years ago.
The Japanese market will have to be pried open for American products. When President Bush appointed Carla Hills to the post of U.S. Trade Representative, he gave her a crowbar to emphasize that very point. To do so, the Japanese must be held to their obligations under current trade agreements, and legislation intended to bring about a more equitable trade situation, perhaps along the lines of the High Performance Computing Initiative, should be passed. Should these measures fail, the U.S. might be wise to consider assuming some vestiges of protectionism, at least as the means to pry open the Japanese market.[*]
More qualified people are needed in Washington to attend to the problem. Both NSF and the Defense Advanced Research Projects Agency are trying to recruit such individuals, with both experiencing difficulty.
The industry has changed, and American industry must change with it. Many of the lessons to be learned in this case come directly from the Japanese. For example, to survive these days, a super computer company must be vertically integrated and must generate money to be invested in R&D.
More money must be invested in R&D. Another key to industrial survival today is a market share to generate money for investment in research and development. R&D spending in Japan went up 14 per cent during one recent 12-month period, alone, and four or five Japanese companies have R&D budgets that exceed the entire budget of NSF, including NEC, whose budget exceeds NSF's by one-third.
U.S. industry must improve its productivity, change its values, and technologically catch up. A top-down approach to the solution of eroding U.S. leadership in the area of high-performance computing will not work. Fooling with the exchange rate won't work, nor will any number of additional stopgap measures. Changing our values, above all else, means abandoning our short-term view in terms of industrial planning, education, consumer buying habits, and government involvement in industry. Incentives must be introduced if industry is to be expected to assume a long-term view. Unfortunately, industry in this country has a very short-term view. They won't take the technology that is available in the universities. The good technology that is developed there is being siphoned off to Japan, where there are interested people. Meanwhile, industry occupies itself worrying about satisfying the investors at the next shareholders' meeting.
Education—at all levels—must be improved in this country. The decline of public elementary and secondary education is well-documented and demands both increased governmental spending and fundamental changes in values. Similar reforms are necessary at the university level, as well. Improving education in America, however, can not be accomplished in short order. Sy Goodman:
The educational issue, long-term as it is, is still absolutely critical. The U.S. university community, in my opinion, is overly complacent about what it thinks it is, relative to the rest of the world.
Industry should investigate the possibility of government involvement, perhaps to the point of coordination. Summarily rejected by the U.S. government and industry, governmental coordination of Japanese industry by the Ministry of International Trade and Industry has been instrumental in Japan's postwar rise to its current position as a high-tech industrial superpower. Studies cited earlier show that all relevant elements of the public and private sectors are now agreed on those areas in which the U.S. must succeed if it is to remain a world-class competitor
nation. The U.S. must put aside adversarial relationships among government, industry, and workers.