Who Owns the Twenty-First Century?

In the United States, most of the last half century has been devoted to worrying about the Soviet Union. Democracy and capitalism faced off against dictatorship and communism. Suddenly, the threat disappeared. The Berlin Wall came down; East Germany and West Germany were united; democracy and capitalism arrived in the formerly communist countries of middle Europe and then in Eastern Europe. Democracy and capitalism had won.

In 1945 there were two military superpowers, the United States and the Soviet Union, and one economic superpower, the United States. In 1992 there is one military superpower, the United States, and there are three economic superpowers, the United States, Japan, and Europe (centered on Germany), jousting for economic supremacy. Without a pause, our national challenge has shifted from being military to being economic.

From everyone’s perspective, replacing a military confrontation with an economic one is a step forward. No one gets killed; vast resources don’t have to be devoted to negative-sum activities. The winner builds the world’s best products and enjoys the world’s highest standard of living. The loser gets to buy some of the world’s best products — but not as many as the winner.

However, this shift in focus does create difficulties for the United States. Attempting to be both a military and an economic superpower is ambitious: it requires Spartan self-discipline. Both enterprises call for major investments in infrastructure, research and development, and education. Yet the United States is increasingly a consuming rather than an investing society. If it is to win the economic battle ahead, its investment and consumption patterns must change drastically.

A New Economic Game

Looking backward, historians will see the twentieth century as a century of niche competition and the twenty-first century as a century of head-to-head competition. In 1950 the United States had a per capita GNP four times that of Germany and fifteen times that of Japan. Imports from Germany and Japan did not seem to threaten the good jobs that Americans wanted, and America’s exports did not threaten good jobs in Germany and Japan.

The 1990s is a very different time. In broad terms there are three relatively equal contenders — Japan, the European Community, and the United States. Each country or region now wants the same industries to ensure that its citizens have the highest standards of living in the twenty-first century: micro-electronics, biotechnology, the new materials sciences, telecommunications, civilian aviation, robotics and machine tools, and computers and software.1 Niche competition is win-win. Head-to-head competition is win-lose. Not everyone can control those seven key industries.

Individualistic vs. Communitarian Capitalism

The economic competition between communism and capitalism is over, but another competition between two forms of capitalism is underway. Using a distinction first made by George Lodge, a Harvard Business School professor, I believe that the individualistic British-American form of capitalism is going to face off against the communitarian, German and Japanese variants of capitalism.2

America and Britain trumpet individual values: the brilliant entrepreneur, Nobel prize winners, large wage differentials, individual responsibility for skills, ease of firing and quitting, profit maximization, and hostile mergers and takeovers. In contrast, Germany and Japan trumpet communitarian values: business groups, social responsibility for skills, teamwork, firm loyalty, industry strategies, and active, growth-promoting industrial policies. Anglo-Saxon firms are profit maximizers; Japanese firms play a game that might better be known as “strategic conquest” — they are more focused on market share than on profit.

These different visions of capitalism have profound effects on everything from labor relations to public education.

New Sources of Strategic Advantage

Historically, individuals, firms, and countries became rich if they possessed more natural resources, were born rich and enjoyed the advantages of having more capital per person, employed superior technologies, or had more skills than their competitors. Putting some combination of these four factors together with reasonable management was the route to success.

New technologies and institutions are combining to substantially alter these four traditional sources of competitive advantage. Natural resources essentially drop out of the competitive equation. Being born rich becomes less of an advantage than it used to be. Technology gets turned upside down. New product technologies become secondary; new process technologies become primary. And in the twenty-first century the education and skills of the work force will be the dominant competitive weapon.

New Rules3

The GATT-Bretton Woods trading system that has governed international trade since the end of World War II is dead. It died not in failure, but at the normal end of a very successful life. Logically, a new Bretton Woods conference should now be underway. But politically it cannot be called. Such a conference can occur only if there is a dominant political power that can force everyone to agree. In 1944 the United States was such a power; today there is no such power.

The required economic changes cannot wait for the right political moment. As the Europeans negotiate the rules for their internal common market and decide how outsiders relate to that market, they will effectively if informally be writing the rules for world trade in the next century. Those who control the world’s largest market get to write the rules. When the United States had the world’s largest market, it wrote the rules.

The Europeans are writing rules for a system of managed trade and “quasi-trading blocks.” The countries within any one block, such as Canada within the American market, will get special trading privileges not given to outsiders. I call these “quasi” blocks because, unlike the trading blocks of the 1930s, they will not attempt to reduce or eliminate trade between blocks; rather, they will attempt to manage it.

The sections that follow compare the strategic advantages and disadvantages each major player brings to this new economic game. In the final section, I propose a game plan for the United States.

The House of Europe: Catalyst for Change

Two events make Europe the focal point of attention in the 1990s.4 In Western Europe at the stroke of midnight on 31 December, 1992, the European Community integrates, and with that integration it instantly becomes by far the world’s largest economic market — 380 million people, now that the members of the European Free Trade Area have effectively been added to the 337 million inside the EC.3 And in middle and Eastern Europe communism has dissolved and is being replaced by capitalism. In both Eastern and Western Europe something is being attempted that has never before been done — in the former, a move from central planning to a free market, and in the latter, a voluntary integration of a very large, linguistically heterogeneous market of former military enemies.

The rest of the world watches these events with some ambivalence. Third world countries note that the ex-communist countries have low wages, well-educated populations, and a convenient location next to the world’s largest market. Any special access the ex-communist countries receive will effectively close Europe’s market to mid- and low-income countries elsewhere in the world. Japan and America worry that economic integration will make it harder to sell their products in Europe — and they’re right. When talking to each other, Europeans acknowledge that if they did not gain some special privileges relative to die rest of die world, there would be no reason to integrate. Realistically, outsiders have to face the fact that European integration will hurt them. It wouldn’t work if it didn’t.

The federation of Europe will take a long time, and progress will be erratic It is easy to make a long list of difficult issues that will have to be resolved. The list could be used to argue that real European integration will never occur. But the formation of the House of Europe is now unstoppable. First, the opportunities to create an integrated House of Europe are just too good to pass up. Second, the need to compete against the Americans and the Japanese in a global economy almost demands that the House of Europe be built. If it isn’t, the individual countries will find themselves economically marginalized between two much bigger, more aggressive economies. Third, enough integration has now occurred to make withdrawal very difficult. Fourth, an internal dynamic has been established whereby each step forward essentially forces the participants to take further steps forward.

The development of a market economy in middle and Eastern Europe — and this economy’s partial integration with Western Europe — is also fraught with difficulty and is far from inevitable. Yet strong links between the two Europes could be the key to the House of Europe’s winning the economic war.

Will Europe Own the Twenty-First Century?

Europe was the slowest mover in the 1980s, but it starts the 1990s with the strongest strategic position on the world economic chess board. If Europe makes the right moves economically, it can become the dominant economic power in the twenty-first century, regardless of what Japan and the United States do. The moves are easy to see but very difficult to make.

If Europe can truly integrate the EC (337 million people) into one economy and gradually move to absorb the rest of Europe (more than 500 million people), it can put together an economy that no one else can match. Its 850 million people are the only group of that size in the world that are both well educated and not poor. Some of the countries that need to be added to the EC, such as Sweden, Norway, and Austria, are in fact some of the richest in the world.

Europe’s major advantage is that almost everyone starts out well educated. The communists may not have been able to run good economies, but they ran some of the best K-12 educational systems on the face of the earth. Europe is the only region where one country (Germany) is a world leader in production and trade, and another country (the former Soviet Union) is a leader in high science. In many areas of theoretical science it leads the world. Germany’s trade surplus in 1990 was the largest in the world; on a per capita basis it was almost three times that of Japan. A decade from now, when eastern Germany is fully integrated and up to western German productivity standards, Germany will be even more formidable Germany’s traditional markets, middle and Eastern Europe, are apt to be the fastest growing in the world in the early twenty-first century.

If the high science of the former Soviet Union and the production technologies of the German-speaking world are added to the design flair of Italy and France and a world-class London capital market efficiently directing funds to Europe’s most productive areas, something unmatchable will have been created. The House of Europe could become a relatively self-contained, rapidly growing region that could sprint away from the rest of the pack.

Since the European countries represent both the communitarian and the individualistic strains of capitalism, the compromises necessary for Europe’s integration could lead to a mixture of the best parts of each.

This does not mean, however, that Europe will win. It just means that it can win if it makes exactly the right moves. But doing so involves two major problems. The economies of Western Europe really have to integrate, and that integration has to be quickly extended to middle and Eastern Europe. The ex-communist countries have to become successful market economies. Neither is an easy task. Both will require European citizens to make sacrifices today to create an economic juggernaut tomorrow. Western Europe will have to give large amounts of economic aid to the ex-communist countries in order to get capitalism started.

Ancient border and ethnic rivalries in both Eastern and Western Europe will have to be put aside. The English and the Germans will both have to become Europeans.

These obstacles aside, the House of Europe holds the strongest starting position.

Japan: The Challenge of Producer Economics

When facing American or European competition, Japanese firms always seem to win. Their market share always goes up, never down. Inexorably, they defeat the pride of American and European industry. Yet practices such as age-based seniority that don’t take individual merit into account should make Japanese business firms inefficient. What are handicaps for other economies seem to be strengths for the Japanese.

Are they playing the same game but doing it better by working harder, saving more, and being smarter than everyone else? Or does their success spring from having organized a better system? Is Japan just better, or is it exceptional? If Japan is exceptional, and I believe it is, it will force major changes in how capitalism is played around the world.

Before we examine Japan’s strategic position vis-a-vis America and Europe, we need to discuss the underpinnings of its form of capitalism.

Profit Maximization vs. Strategic Conquest

The profit-maximizing Anglo-Saxon business firm is based on the idea that more consumption and more leisure are the sole economic elements of human satisfaction. Higher productivity at work is desirable because it gives individuals higher incomes to buy more goods and the ability to obtain more leisure without sacrificing consumption.

This model is not wrong. Individualism and the desire for consumption and leisure are parts of human nature. However, they are not all of human nature. Individuals are also social builders who want to belong to empires that expand, and firms can be based on that need, too.

As social builders, individuals may rationally decide to have fewer consumption goods in their home so that they can have more production goods at work. To them, ownership of investment goods can generate just as much pride as ownership of consumption goods. A higher standard of living at work may be even more important than a higher standard of living at home. Such behavior is seen in American farmers, who often choose to have the fanciest tractor in the neighborhood, not the fanciest car. In the language of bumper stickers, humans may be born to shop, but they are also born to build. This desire to build generates what I will call Japanese “producer economics,” to distinguish it from consumer economics.6

Producer-economics firms and profit-maximizing firms both want profits, but the role played by those profits is very different.7 In the profit-maximizing firm, profits per se are the goal. In the empire-building firm, profits are a means to the end of a larger empire. The goal is market share. A profit-maximizing firm will devote its profits to individual consumption; an empire-building firm will devote its profits to investment in expanding its empire.

If one thinks of a continuum with profit-maximizing firms at one end and empire-building firms at the other, the exact placement of a nation’s firms would be controversial, but the order of their positions is not. American firms are closer to the profit-maximizing end, and Japanese firms are closer to the empire-building end. German firms are on the empire-building end, although not so far along as the Japanese, whereas British firms are perhaps even further along the profit-maximizing continuum than American firms.

An economy interested in producer economics will organize itself to lower consumption and raise investment. Japan has systematically built a society to raise investment (plant and equipment, R&D, human skills) at the expense of individual-consumption privileges.

The system starts with company unions, the bonus system, and the annual spring wage offensive that holds down labor’s share of national income. Japan’s work force gets the lowest share of national income in the five leading industrial countries, and its share is falling. At the same time, the average Japanese worker enjoys an expense account that is generous when compared with that of American workers: consumption activities that contribute to team building at work are encouraged; consumption activities at home are discouraged.

With lower wages, more income is left to the corporation, but little of that income goes to the shareholders. The returns to external shareholders are limited to the capital gains that accrue from rising share prices. After paying wages, essentially everything is reinvested in future growth.

Firms that invest more must be willing to accept lower rates of return on their investments. Studies show that the returns on investment required for American firms to invest in robotics are 50 percent higher than those of Japanese firms.8 Many very successful firms in Japan (Honda, for example) have in fact made rates of return over the past two decades lower than they could have made by simply investing in government bonds.

To maximize the income going to businesses, consumer prices are held far above what would prevail in a “free” market. Relative to New York, the Tokyo consumer pays three times as much for rice, beef, and potatoes. Other aspects of the system force individual consumers to save a large portion of their incomes.

The system has worked. In the last five years of the 1980s, Japan invested 35.6 percent of its GNP, while the United States invested 17 percent.9 If housing investments are left out (technically investment but actually consumption), the two-to-one investment gap becomes a three-to-one gap.

Interestingly, the Japanese see the American desire for profits as a major cause of America’s weakness in international competition.10 What they see as a weakness tells us something about what they see as a strength in themselves.

Japanese firms’ emphasis on building market share is supported not only by their investment patterns but also by how they structure business groups, perceive various stakeholders, treat workers, view training and R&D, and structure national-level trade policies.

Business Groups.

To lengthen time horizons and accept a lower rate of return, impatient consumption-oriented stockholders must be controlled. The Japanese business groups, or keiretsu, have been organized to do that. They’re organized into vertical groups made up of suppliers, producers, and retailers, and into horizontal groups made up of firms in different industries. Seventy-eight percent of the shares listed on the Tokyo stock exchange are owned by keiretsu members.11 Because a majority of the shares of each member are owned by other members of the group, no member can be bought by outsiders. Each member is part operating company, part holding company, and part investment trust.12

Members gain not by being paid dividends but by getting and giving preferential treatment as suppliers and customers. Direct discrimination does not occur; the preferential treatment comes in the form of buyers and sellers willing to work together to ensure that the Japanese keiretsu supplier is in fact the best supplier. If the Japanese don’t treat American firms equally when it comes to buying parts or selling parts in short supply, they are not being unfair. They are simply doing what everyone does — playing ball with die people on their team.

Countries that believe in producer economics make it easy to form business groups. Countries that believe in profit maximizing don’t. In the United States, Japanese-style business groups are illegal under die antitrust laws.

Priority of Stakeholders.

If the executives of profit-maximizing firms are asked to state the order in which they serve various constituents, shareholders come first, with customers and employees a distant second and third. Most managers will argue that the sole purpose of the company is to maximize shareholder wealth. If Japanese firms are asked the same question, the order of duty is reversed: employees first, customers second, and shareholders third.13

Treatment of Labor.

The empire-building firm sees labor as a strategic asset to be nurtured;14 the profit-maximizing firm does not. In the last two decades U.S. firms have reduced wages even as sales and profits were rising. Partly to force wages down, U.S. firms have rapidly moved to offshore production bases. Lower-wage part-time workers have replaced higher-wage full-time workers. Japanese firms did not move production abroad, nor did they move to part-time employment, to anywhere near the same extent. When a sample of Japanese firms was asked what they had done to reduce labor costs, only 2.6 percent listed discharging workers or employing part-time workers.15

Studies show that when automation goes up in America, wages go down. In contrast, when automation rises in Japan, wages rise as well.16 In Japan, these investments are used to enhance labor productivity rather than to replace skilled labor with unskilled labor, as happens in the United States. For U.S. firms, lower wages equal higher profits.

When it comes to training, very different expenditure patterns emerge in Japanese and U.S. firms, as well.17 Americans invest less per worker and concentrate their investments heavily in management education. They invest less in general background skills and more in the narrow job skills required for the next task; that pattern is reversed in Japan.

Bonus systems are also different. The American system is keyed to rewarding individual performance, whereas the Japanese system is keyed to stimulating teamwork. Narrow profit centers are much more widely used in the United States than they are in either Japan or Europe. Quarterly profits in narrowly defined profit centers are the American way. In Japan, bonuses are not normally keyed to profitability but to the growth, productivity, and market share of the entire company. The U.S. system fits into a world view in which individuals are motivated solely by their income and group efforts are not important. The Japanese system fits into a world in which the group’s output is the dominant factor in total production.

In keeping with consumption maximization, we would expect U.S. CEOs to be paid more than those running similar firms in the world of producer economics. And so they are.18 In 1990 U.S. CEOs made 119 times as much as the average worker; Japanese CEOs made only 18 times as much as the average worker.19 When Steve Ross, the CEO of Time-Warner, pays himself $78 million and then lays off 600 people because of declining ad revenues, he is just practicing what Americans preach.

Cycles in Investment, R&D, and Training.

In the United States, private research and development spending falls in recessions and rises in booms.20 In Europe and Japan, it does not. To an American firm, cutting R&D is a technique for maintaining profits during a period of declining sales. The same spending patterns exist in investment and training.

These different patterns are reflected in the respective accounting systems. In U.S. accounting conventions, since R&D is expensed, cutting R&D leads to higher bottom-line profits immediately. In Japan, where R&D is capitalized, it does not. Thus die Japanese accounting system discourages short-term behavior, and the American system encourages it.

Will Japan Own the Twenty-First Century?

If one looks at the last twenty years, one would have to consider Japan the betting favorite to win die economic honors in die next century. Japan’s home market is the smallest of the three, but it has the advantage of a long, unified history. Cohesion and homogeneity give Japan an ability to focus that few others can rival. No single nation can organize better to march toward well thought out, common goals. Japanese high school students come near the top in any international assessment of achievement, and die nations ability to educate die bottom half of the high-school class is unmatched anywhere.

No nation is investing more in its future. Plant and equipment investment per employee is three times as high as in the United States and twice as high as in Europe; civilian R&D spending as a fraction of GNP is 50 percent above that of die United States, slightly above mat of Germany, and far above that of Europe as a whole.

Japan’s strength — its powerful, cohesive internal culture — is also its weakness. Japanese firms manage foreign workers well, but, to the extent that the twenty-first century requires firms to integrate managers and professionals from other cultures into a homogeneous team, it has a problem. Japan’s traditions and language (which is hard to master) make it very difficult to integrate foreign managers and professionals as equals.

Another weakness is the lack of new product innovation. While every nation struggles to catch up some of the time, those that have become leaders also learn how to pioneer breakthroughs. Japan has yet to demonstrate this ability. If products have to be copied from abroad, Japan’s own economic advance will be limited by the pace of its competitors’ inventions.

Japanese success has been based on an export-led economy, but that cannot be the route to success in the future. The rest of the world could tolerate Japan’s growth so long as its exports were relatively small. But the country is now so large economically that the rest of the world cannot allow Japan’s exports to rise and capture markets at die rate mat Japan will need in order to continue to grow much faster than anyone else. The rest of die world will simply stop Japan from being an export-led economy by instituting overt restrictions, if necessary. So if Japan is to grow faster than anyone else in die twenty-first century, it has to find a way to do so while its exports grow more slowly than its GNP. Essentially, it must become an economy pulled ahead by its domestic demands rather than an economy pushed ahead by exports.

Japan’s producer economics may be the smartest form of capitalism in the twenty-first century’s economic game, but for the Japanese to win, some consumer economics will have to be grafted on. The ultimate owner of the twenty-first century will have to balance the drive to consume with die drive to build.

Japan comes into the competition with momentum on its side. It is growing faster and investing more in the future than anyone else.

The United States of America: The Great Wall Is Down

In the years after World War II, the United States was effectively living behind a wall built of five overwhelming advantages: it was the largest market, and it had the highest-skilled workers, the most money, the best technology, and the best managers in the world. Put these factors together, destroy the rest of the world in a major war, and the result is effortless economic superiority. However, both inside and outside these protective walls, changes were occurring. Americans did not notice and did not change their behavior.

As the rest of the world began to catch up with income levels in the United States, the relative size of the American market got smaller and smaller. Today America is technologically only average if one includes both product and process technologies. Our level of nonmilitary R&D investment is low relative to our competitors. Unless one believes that Americans are smarter than the Germans or the Japanese, today’s spending levels will eventually lead to a secondary position for American science and engineering and to lower rates of productivity growth.21

The rest of the world noticed the payoff from America’s system of mass education, copied it, and upped the ante. Comparative international exams reveal that Americans at all age levels know less than citizens in other advanced industrial countries. The older the secondary-school student, the larger the educational achievement gap. Those who graduate from college catch up with their foreign counterparts because most of the industrial world has not yet made the investments necessary to shift from elite to mass education at the university level. Yet relative to the rest of the world, we produce too few engineers and scientists. Much of this can be traced to bad math and science education in high school. But that is not an excuse for failing to insist that every college graduate be numerate — that is, mathematically literate.

For those who do not go on to college, a poor educational starting position is compounded by less on-the-job skill investment than their foreign counterparts receive.

Technically, the United States has not been the richest country in the world for some time, but its purchasing power is roughly equivalent to that of its competitors. However, because of America’s private and public consumption levels, investment in education, R&D, and the infrastructure run well behind those of our competitors.

American management talent and experience are no longer clearly better than those in the rest of the world. If measured by outcome — trade deficits and slow productivity growth — they are worse.

Will the United States Own the Twenty-First Century?

Having been rich longer than anyone else, the United States starts the twenty-first century with more real economic assets than anyone else. Technologically, it is seldom far behind and often far ahead. Its per capita income and average productivity are second to none. Its college-educated work force is the best in the world. Its domestic market is far larger than that of Japan and far more homogeneous than that of Europe.

But it squandered much of its starting advantage by allowing its educational system to atrophy, by allowing itself to run a high-consumption, low-investment society, and by incurring huge international debts. No one is preparing less for the competition that lies ahead.

American investment is simply not world class. Plant and equipment investment per labor force member is half that of Germany, one third that of Japan.22 Civilian R&D spending is 40 percent to 50 percent less than that of Germany or Japan. Physical infrastructure investments are half those of the late 1960s.

In the 1980s America’s slow productivity growth was hidden by a rapidly growing labor force and an unused borrowing capacity that raised real standards of living higher than was warranted by productivity growth. In the 1990s, America’s labor force will not grow rapidly, and its borrowing capacity is already close to utilization. As a result, the unseen and unsolved problem of the 1980s, slow productivity growth, will move front and center in the 1990s. America’s chances of owning the twenty-first century depend upon the answer to a simple question: Can it get its productivity growth rate up to the standards of its chief rivals?

Paradoxically, if America wants to have a world-class consumption standard of living in the twenty-first century, it will have to shift from being a high-consumption, low-investment society to being a high-investment, low-consumption society. To raise investment, consumption (public and private) must grow more slowly than output for an extended period of time so that investment (public and private) can rise as a fraction of GNP.

When it comes to workforce skills and education, the picture is mixed. The college-educated part of the work force is excellent. The part of the U.S. work force that does not go on to college, however, is not world class, and the part of the work force that does not graduate from high school (29 percent) is positively Third World when it comes to educational skills.

At the same time, the United States has some real cultural strengths. If Japan’s culture makes it the country where foreigners find it hardest to participate as equals, America’s culture makes it the country where outsiders can most easily become insiders. And Americans may not be great exporters, but they are the world’s best when it comes to running offshore production facilities. If the sales of offshore production facilities had been treated as exports, the 1986 U.S. trade deficit of $144 million would have become a trade surplus of $57 million.25 Americans quickly turn offshore employees into successful American businesspeople.

In crises, such as Pearl Harbor, or in situations that can be made to look like crises, such as Sputnik, Americans respond magnificently. Clear problems get clear, clean, well-managed solutions. America is perfectly capable of claiming the twenty-first century for itself. America’s problem is not winning — but rather forcing itself to notice that the game has changed and has to be played by new rules, using new strategies.

An American Game Plan

President Bush is fond of saying that the United States has “more will than wallet” when he discusses domestic issues. The truth, of course, is exactly the opposite. Americas per capita real GNP is two and one-half times as large as it was when it began to finance the Marshall Plan, which rebuilt the world. America has a lot more wallet than will and could easily invest the sums necessary to give it a competitive economy.

But Americans are particularly resistant to changing their system because they tend to believe that they got it right the first time. “When the American system fails, as of course it does from time to time, Americans don’t look for system failures. They look for human devils who have mucked up a perfect system. Thus, instead of reforming America’s financial system when it essentially collapsed at the end of the 1980s, Americans found devils (Mike Milken, Charles Keating, Neil Bush) who needed to be punished. Nothing was done to change the system.

While rebuilding America’s systems will have to take tradition and culture into account, it will also require constructing something new. The sections that follow propose systemic changes in four key areas: savings and investment, education, business groups, and national strategy.

Savings and Investment

It does not take a deep understanding of economics to know that America cannot have a competitive productivity growth rate when it invests half as much as the Japanese and two-thirds as much as the Europeans. That would be possible only if Americans were substantially smarter than everyone else. From an economist’s point of view, it is easy to restructure America to ensure greater investments. But all routes to that objective require someone, somewhere, to consume less. That won’t happen until there are political leaders willing to talk realistically to the American people. I will return to the question of leadership shortly.

Step one is for Americans as individuals to quit borrowing to finance consumption purchases. Step two is for Americans as a group to quit running government deficits. Step three is to adopt a tax system with powerful incentives for saving and powerful disincentives for consumption. Step four is to establish strong incentives for private investment and larger government budgets for public investment. All of these steps point to the federal tax system as the place where America’s consumption diet must be designed.

Americans believe they pay the highest taxes in the world, when in fact they are at the bottom of the industrial league — ranking twenty-fourth among twenty-four major industrial nations in terms of tax collections as a fraction of GNR Every U.S. tax (income, payroll, property, and indirect) is far below those of most of the developed world (see Table 1).24 Simply raising taxes to eliminate the federal deficit would not be the end of the world. Americans would still be paying fewer taxes than their compatriots in most of the rest of the industrial world.

At the same time, there are real opportunities to cut spending. If fears of the Soviet Union more than doubled defense spending in the 1980s, the disappearance of the Soviet Union can more than halve defense spending in the 1990s. America does not need to spend more than 12 percent of its GNP on health care — one-third more than the next-highest-spending country.

Americans love to fight about government spending, but the real issue is not public versus private spending. The real issue is investment, public and private, versus consumption, public and private. America should set it-self a goal to design a tax and expenditure system in which consumption, public and private, rises 1 percent per year less rapidly than the GNP25 If this were done for a decade, America would have world-class savings and investment at the end of the decade, and no one’s consumption would have to fall — it would just grow slightly more slowly. One does not need to devastate the present to protect the future. One just needs to be concerned about the future.

A system to raise investment by 1 percent of GNP per year could be designed from either a liberal or a conservative perspective. My optimal system would include value-added taxes to encourage exports and discourage consumption.26 To make this tax progressive, an offsetting income-tax credit would be established for the first $10,000 in consumption for a family of four. There would be tax-free savings accounts, but individuals would have to prove that they were adding to their savings accounts by reducing their consumption, not simply moving money from one account to another, as happened with IRAs. If tax rates were then raised on that fraction of income not saved (consumption), tax-free savings accounts would be a powerful vehicle. Savings would effectively be exempted from taxation, and this would turn America’s progressive income tax into a progressive consumption tax.

My ideal system would also eliminate payroll taxes to encourage investment in human resources and eliminate the corporate income tax to stimulate physical investment.

As suggested by Senator D. Patrick Moynihan, the federal government would take the very large Social Security surplus out of its budget calculations and balance what remains. The necessary revenue for balancing would be raised with value-added and gasoline taxes.27 If one includes existing state and local surpluses, such a strategy would double national savings.

Consumer and mortgage down payments would be raised to inhibit those who consume more than their income. Germany requires a 40 percent down payment on a house; Italy a 50 percent down payment. If Americans can get everything they want without saving, why should they save?

These suggestions reflect only my own preferences. America would have to design a system that could be supported by both liberals and conservatives, so that, as the political tides come and go, the tax system could continue to provide stable, long-run incentives for investment and growth.

This brings us back to the issue of leadership. Polls show that Americans are worried about their economic futures but confused as to why their incomes are falling relative to the rest of the world.28 For many, economic failure is somehow linked with moral failure — crime in the streets, drugs, family breakdowns. They cannot make sense of the jumbled stew of economic and moral problems. They want to be led to a solution if the burdens are fairly shared across the population.

To sort out this stew of jumbled beliefs will require an American establishment that can articulate the demands of the future and that can suggest unselfish programs for responding to them. To do this, a U.S. president will have to unlearn what every politician, Republican and Democrat, has been taught by former President Reagan. He taught them one fact of political life: that in American politics, optimists beat pessimists. And then he did the real damage by redefining the word optimism. In the Reagan political dictionary, an optimist is someone who denies that America has any problems. To admit that it has fundamental problems is to be a pessimist and unfit for political office.

By this definition of optimism, President Kennedy was a pessimist when he admitted the Russians were ahead of America in space and had been growing faster economically in the 1950s. But at the time Americans thought of him as an optimist. He had solutions, and they worked. Americans got to the moon first, and productivity grew at record rates in the first half of the 1960s. Today, President Kennedys advisers would warn against man-on-the-moon speeches.

Americans cannot strengthen their economic team unless the president is first willing to tell them that the news from the economic battlefield is bad. In America, the existence of an establishment that works for the public good (instead of its own enrichment) depends on having a president willing to lead. America is not Japan, where an establishment among elite civil servants can keep the country on track, whatever the politicians do.

Skill Building

If the “British disease” is adversarial labor-management relations, the “American disease” is the belief that low wages solve all problems. When under competitive pressure, U.S. firms first go to the low-wage, nonunion parts of America and then on to a succession of countries with ever-lower wages. But the strategy seldom works. For a brief time lower wages lead to higher profits, but eventu­ally others with even lower wages enter the business, prices fall, and the higher profits generated by lower wages vanish.

The search for the holy grail of high profitability lies in a relentless upscale drive in technology to ever-higher levels of productivity — and wages. Since rapid productivity growth is a moving target and therefore hard to copy, high long-term profits can be sustained with such a strategy. But to get the necessary human talent to employ new technologies, large skill investments have to be made and high wages have to be paid. Paradoxically, high wages leave firms with no choice but to go upscale in technology. High wages and high profits are not antithetical — they go together.29

To create the productivity that can justify high wages, American K-12 education will have to improve. The problem is not lack of information or studies.30 The problem is generating action in a system with 15,000 independent local school boards whose incentives lie in other directions. To bring about the necessary reforms, a grand bargain needs to be struck.

In their part of the bargain, the taxpayers would agree to bring the wages of schoolteachers up to the levels found in Germany or Japan — $40,000–45,000 per year versus $30,000 in America.31 When schools had a captive female labor supply, high-quality teachers could be hired without high wages. Today, quality and wages are directly linked. In a capitalistic society, if one wants skilled teachers in the classroom, one has to pay for them.

The teachers, for their part, would have to agree to world-scale work effort and efficiency. The school day would be lengthened by a couple of hours per day in high school, and the school year would be at least 220 days long. German teachers work 220–240 days, not the 180 days common in America.

Competitive wages would force Americans to spend more, but not a lot more. America now spends 4.1 percent of GNP on K-12 education. Germany spends 4.6 percent, and Japan, 4.8 percent.32

Another part of the bargain is to set a quality standard for the noncollege bound. Here the high-wage business community in each state should write an achievement test that would cover what they think high-school graduates need to know to work at Americas best firms. Local school boards could continue to graduate whomever they please, but those students who had passed this “business achievement test” would have their diploma so stamped. (This would be one way around the excessive power held by Americas 15,000 local school boards.)

In addition, communities would agree to quit using schools as a dumping ground for social problems that cannot be solved elsewhere. The frontlines of the war on crime, drugs, teenage pregnancy, or housing desegregation should be established elsewhere. Better nutrition, drivers’ training, and sports are secondary. The energy of our school systems should be focused on education, period.

Better schools are just the beginning. American firms do not invest as much in training as firms abroad, and what they do invest is much more heavily concentrated on professional and managerial workers.33 “Following Joe around,” the American system of on-the-job training, simply isn’t a system.

A number of avenues exist for increasing the skills of the average worker. One possibility is to pass the American equivalent of the French law that requires business firms to invest 1 percent of their sales in training. Firms must pay a tax on this amount but can deduct their internal training costs. Since all firms have to pay for training, they might as well train.

Business Groups34

In today’s world economy, where American businesses must match up with the business groups of Germany and Japan, U.S. firms need to be able to form the same strategic alliances, the same self-help societies, and the same joint strategies for conquering world markets. To give them the necessary weapons, America’s laws and regulations must be drastically overhauled.

American finance should be put in an institutional straight-jacket so that it cannot succeed unless American industry succeeds. Key to this is changing the financial regulations that prevent American banks and other financial institutions from becoming merchant banks — financial institutions that own and control industrial corporations or are owned by them.

Today’s laws draw too sharp a distinction between loans and equity. To avoid the appearance of conflict of interest, executives from banks, insurance companies, and other lenders are not supposed to be financially involved participants. But that flies in the face of reason. It is precisely the institutions that provide major long-term loans to companies that should take an active role in the strategic direction of those companies. They should be interested directors, not outsiders. To bring this about, long-term loans should carry voting rights.

Allowing financial institutions to take stakes in industrial companies, or the reverse, will over time lead to the formation of business groups that are equivalent to those that now exist in Germany and Japan. These groups are simply necessary in today’s world.35 A framework of mutual support is needed not only to make raiding difficult, but also to give directors, who represent real owners, the clout to fire bad managers.

In reformulating banking and antitrust laws, conglomerate groups or vertical supplier-customer groups, such as those in Japan, should be permitted.36 What should be prohibited are the single-industry groups that J.P. Morgan sometimes organized, where almost the entire steel industry would be organized into one company. The latter leads to monopoly; the former leads to more competition.

Since stockholders will have access to inside information, the new laws should see to it that all institutional or individual dominant stockholders are locked in to their investments. Anyone who owns a dominant position in any company — say, 20 percent or more — should be forced to give the public one day’s advance notice of the intention to sell any shares. Such notice would almost inevitably trigger a general rush to sell that stock before the major investor could, leaving the investor to sell at much reduced prices. Locked-in investors would think long and hard before trying to bail out of a company in trouble. Instead, they would have a major incentive to minister to the sick company, designing the strategies necessary to return it to health.

To reinforce the distinction between traders and investors, the voting rights of equity shares should rise over time. Major investors subject to the 20 percent rule would become instant owners, but others would gain full voting rights only over a period of time. Stock traders could still be traders, getting rich by buying and selling shares, but those who want to be short-term traders would be separated from those who want to be long-term owners.

While the tyranny of the quarterly profit statement as a deterrent to good management is probably exaggerated, it should be repealed as a symbol. Japan has gradually moved from quarterly to half-year to annual reports. Nothing has been lost. The same should be done in the United States. Managers should not be placed in a position in which, if they incur expenses this quarter to make future prospects better, they will be penalized with falling stock prices.

In any reformulation of the rules governing America’s industrial structure, one central goal must be kept in mind. Put real capitalists back in the driver’s seat of the American corporation. Then lock them in so that they have no choice but to improve their firms and hence the nation’s productivity and competitiveness.

National Strategy

It is the official U.S. position that no economic strategy at the national level is needed — and that such policies simply don’t work. But this belief is increasingly untenable if one looks at the industries that have been lost, such as robots, or the industries under threat, such as aircraft manufacturing.

The key difference between the United States and the rest of the industrial world is not the existence of protection. About 25 percent, double what was true twenty years ago, of all U.S. imports are now affected by nontariff trade barriers.37 International businesspeople see Japan as the world’s most unfair trading nation, but they see the United States as the third most unfair (behind Japan and Korea).38 But these barriers add up to, as the Japanese say, a “loser-driven” industrial policy — the product of random political lobbying to gain protection for dying industries.39 The rest of the world’s industrial policies involve strategic thinking and are winner driven.

The results show. Although a big decline in the dollars value reduced the Japan-U.S. trade deficit, the high-tech, high-wage part of the trade deficit is expanding.40 America depends increasingly on low-wage, low-tech, commodity exports to balance its trading accounts.

In the real world — the world of falling real wages, stagnant productivity growth, and a growing high-wage trade deficit — defensive industrial policies are unavoidable. Such policies are not designed to help American corporations; they are simply part of a general strategic growth policy designed to help the American people. In fact, public investments to gain sustainable advantage should be limited to investments staying in America, such as investments in skills or the domestic infrastructure.

Beyond such investments, the search for strategic advantage abroad now revolves around process R&D investments. In Japan, MITI has shifted from foreign exchange and capital allocations strategies toward pushing key technologies. The Europeans have set up an alphabet soup of cooperative R&D projects designed to do the same thing. While the details differ, the basic organizational structures are the same.

The strategies are industry led; groups of companies, not government civil servants, propose the technologies that should be pushed. Governments never provide more than 50 percent of the total funding. Companies have to put together their own consortia so that the government is not subsidizing a special favorite. The idea is to magnify private funds with public funds, not to publicly finance R&D. The projects have finite lifetimes and clearly stated objectives. The purpose is never to advance knowledge for its own sake. The bureaucracy that makes the funding decisions can be very small because the firms themselves are making the basic decisions when they decide whether to risk their own money.

Economic analyses show that there are gains to be made with strategic trade policies, especially in industries with increasing returns. If government aid drives technology faster, everyone is a winner in the long run.

An Empirical Experiment

A decade ago it was possible to argue that America could solve its problems by moving to a more vigorous form of traditional, Anglo-Saxon capitalism. Both Mrs. Thatcher and President Reagan were elected on such platforms. Both emphasized the role of the individual in economic performance. Government enterprises were privatized in Britain. American income taxes were dra­matically lowered.

Both experiments are now more than a decade old. Neither succeeded. In the United Kingdom, unemployment is higher than when Mrs. Thatcher took office, and the country continues its slow drift down the list of the world’s richest countries.41 In the United States, productivity growth was negative in the two years before Reagan took office and in the two years after he left office.42 What was a small trade surplus became a large trade deficit.

The countries that are outperforming America in international trade — Germany and Japan — do not have less government or more motivated citizens. They are countries noted for their careful organization of teams — teams that involve workers and managers, suppliers and customers, government and business. Teamwork has been an important part of American history — wagon trains conquered the West, for example, and teamwork put the U.S. on the moon. But American mythology passes it over and instead extols the individual — Rambo and the Lone Ranger. Only national mythology stands between Americans and the construc­tion of successful economic teams.

Systematic benchmarking reveals that the United States does not have to undergo a period of blood, sweat, and tears to regain its productive edge. Much of what has to be done, such as building a better K-12 education system, would make America a better place to live. Consumption, both public and private, just has to grow more slowly than the GNP. It doesn’t have to fall.

While the necessary solutions would impose small burdens on the present, the failure to adopt these small solutions will impose major burdens on the future.

The American problem is not the severity of the necessary solutions. America’s tough problem is realizing that there are problems to be solved. Without that realization, nothing can be done.


1. Nomuran Research Institute American, ’New Directions in Corporate Management and the Capital Market,” 1990, p. 1.

2. G.C. Lodge, Perestroika for America (Boston: Harvard Business School Press, 1991), pp. 15–16.

3. This section is drawn from ideas in L. Tyson and L.C. Thurow, “The Economic Black Hole,” Foreign Policy, Summer 1987, p. 3.

4. US. Congress, Joint Economic Committee, Bibliography on Europe in 1992, prepared by Hunter Monroe, 26 April 1989.

5. EC Delegation to die United States, A Guide to the European Community (Brussels: EC, 1991).

6. See L.C. Thurow, “Producer Economics,” IRRA 41st Annual Proceedings, 1989, p. 9;

J.L Baxter, Social and Psychological Foundations of Economic Analysis (New York: Harvester Wheatsheaf, 1988); and

M.A. Lutz and K. Lux, Humanistic Economics (New York: The Bootstrap Press, 1988).

7. A.H. Amsden, “East Asia’s Challenge to Standard Economics,” American Prospect, Summer 1990, p. 71.

8. E. Mansfield, “Technological Change in Robotics: Japan and the United States” (Philadelphia: University of Pennsylvania, Working Paper), p. 12.

9. Fortune, 30 July 1990, p. 109.

10. S. Yamamoto, “Japan’s Trade Lead: Blame Profit-Hungry American Firms,” Brookings Review, Winter 1989–1990, p. 14.

11. C Rapoport, “Why Japan Keeps on Winning,” Fortune, 15 July 1991, p. 85; Economist, 16 February 1991, p. 75.

12. “The Giants that Refuse to Die,” Economist, attributed to Tom Hill of SG Warburg. 1 June 1991, p. 72.

13. M. Yamazaki, “The Impact of Japanese Culture on Management,” in The Management Challenge: Japanese Views, ed. L.C. Thurow (Cambridge: MIT Press, 1986), p. 31.

14. J.C. Abegglen and G. Stalk, Jr., Kaisha, The Japanese Corporation: How Marketing, Money, and Manpower Strategy, Not Management Style, Make the Japanese World Pace Setters (New York: Basic Books, 1984).

15. K. Hirosc, “Corporate Thinking in Japan and the U.S.,” Journal if Japanese Trade and Industry A (1989).

16. D.E. Westney, “Sociological Approaches to the Pacific Region,” in The Pacific Region: Challenges to Policy and Theory, American Academy of Political and Social Science, September 1989, p. 27.

17. MIT Committee on Productivity, Made in America (Cambridge: MIT Press, 1989), p. 81.

18. Financial Times, 8 June 1990, p. 1.

19. L. Mishel and D.M. Frankcl, The State tf Working America, 1990–1991 (Washington, D.C: Economic Policy Institute, 1991), p. 121.

20. National Science Foundation, R&D Expenditures (Washington, D.C: GPO, 1990), pp. 1–20.

21. U.S. Department of Labor, The Impact of Research and Development on Productivity Growth, Bulletin 2331, September 1989.

22. Fortune, 30 July 1990, p. 109.

23. D. Julius, Global Companies and Public Policy (London: Royal Institute of International Affairs, 1990).

24. Economist, 20 September 1989, p. 105.

25. Committee on America’s Future, An “Investment Economies” fir the Kar 2000 (Washington, D.C: Rebuild America Coalition, 1988).

26. L.C Thurow, “VAT the Least Bad of Taxes,” Newsday, 9 March 1986.

27. L.C. Thurow, Zero Sum Solution (New York: Simon and Schuster, 1985).

28. D. Yankclovich, “The Competitiveness Conundrum,” The American Enterprise, September–October 1990, pp. 43 and 45;

Public Agenda Foundation, “Public Misperceptions” (New York: Public Agenda Foundation, Working Paper, 1990), Chart A.

29. Commission on the Skills of the Work Force, America’s Choice: High Stalls or Low Wages, 1990, ch. 5.

30. The following contains more than 5,000 pages of briefing papers on educational problems:

Commission on Workforce Quality and Labor Market Efficiency, Investing in People, September 1989 (Washington, D.C: The Commission, September 1989).

31. “U.S. Sets Priorities,” International Herald Tribune, 17 February 1988, p. 9.

32. M.E. Rasell and L. Mishel, “Shortchanging Education” (Washington, D.C: Economic Policy Institute, 1990).

33. Made in America (1989), p. 81.

34. This section is drawn from ideas in L. Thurow, “Let’s Put Capitalists Back into Capitalism,” Sloan Management Review, Fall 1988, pp. 67–71.

35. Commission on Workforce Quality and Labor Market Efficiency (September 1989).

36. “Keiretsu What They Are Doing, Where They Are Heading,” Tokyo Business Today, September 1990;

“Mitsubishi and Daimler-Benz Start Collaboration,” Tokyo Business Today, November 1990.

37. “Mercantilists in Houston,” Economist, 7 July 1990, p. 13.

38. W. Dullfbrce, “Japan Viewed as World’s Most Unfair Trading Nation,” Financial Times, 13 March 1990, p. 20.

39. Journal of Japanese Trade & Industry, No. 4, 1988, p. 15; and

“Fiddling while U.S. Industry Burns,” Rebuild America, February 1990.

40. CH. Farnsworth, “U.S. Is Asked to Review Japan Trade,” New York Tunes, 25 March 1991, p. 14.

41. National Institute of Economic and Social Research, National Institute Economic Review, November 1979, p. 23, and May 1991, p. 23.

42. Economic Report of the President, 1991.