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Technology and Global Industry: Companies and

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Bruce R. Guile and Harvey Brooks, Editors
ISBN: 0-309-55501-9, 280 pages, 6 x 9, (1987)
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Technology and Global Industry: Companies and Nations in the World Economy

Technology and Global

Industry
Companies and Nations in the World Economy

Bruce R. Guile and Harvey Brooks Editors

NATIONAL ACADEMY PRESS

Washington, D.C. 1987
Technology and Global Industry: Companies and Nations in the World Economy

ii

National Academy Press 2101 Constitution Avenue, NW Washington, DC 20418

The National Academy of Engineering was established in 1964, under the charter of the
National Academy of Sciences, as a parallel organization of outstanding engineers. It is autonomous
in its administration and in the selection of its members, sharing with the National Academy of Sci-
ences the responsibility for advising the federal government. The National Academy of Engineering
also sponsors engineering programs aimed at meeting national needs, encourages education and
research, and recognizes the superior achievements of engineers. Dr. Robert M. White is president
of the National Academy of Engineering.
The president of the National Academy of Engineering is responsible for the decision to pub-
lish an NAE manuscript through the National Academy Press. In reviewing publications that include
papers signed by individuals, the president considers the competence, accuracy, objectivity, and bal-
ance of the work as a whole. In reaching his decision, the president is advised by such reviewers as
he deems necessary on any aspect of the material treated in the papers.
Publication of signed work signifies that it is judged a competent and useful contribution wor-
thy of public consideration, but it does not imply endorsement of conclusions or recommendations
by the NAE. The interpretations and conclusions in such publications are those of the authors and
do not purport to represent the views of the council, officers, or staff of the National Academy of
Engineering.
Funds for the National Academy of Engineering's Symposium Series on Technology and
Social Priorities are provided by the Andrew W. Mellon Foundation, Carnegie Corporation of New
York, and the Academy's Technological Leadership Program. The views expressed in this volume
are those of the authors and are not presented as the views of the Mellon Foundation, Carnegie Cor-
poration, or the National Academy of Engineering.
Library of Congress Cataloging-in-Publication Data
Technology and global industry.
(Series on technology and social priorities)
At head of title: National Academy of Engineering.
“Most of the material in this book was presented at a National Academy of Engineering sympo-
sium titled ‘World Technologies and National Sovereignty' held on February 13 and 14, 1986”—
Pref.
Includes index.
1. Technological innovations—Economic aspect—Congresses. 2. Technology and state— Con-
gresses. I. Guile, Bruce R. II. Brooks, Harvey. III. National Academy of Engineering. IV. Series.
HC79.T4T438 1987 338'.06 87-7765
ISBN 0-309-03736-0
Copyright © 1987 by the National Academy of Sciences
No part of this book may be reproduced by any mechanical, photographic, or electronic process, or
in the form of a phonographic recording, nor may it be stored in a retrieval system, transmitted, or
otherwise copied for public or private use, without written permission from the publisher, except for
the purposes of official use by the United States government.
Printed in the United States of America
First Printing, June 1987
Second Printing, August 1989
Third Printing, December 1990
Fourth Printing, July 1991
Fifth Printing, June 1992
Sixth Printing, March 1993
Technology and Global Industry: Companies and Nations in the World Economy

PREFACE AND ACKNOWLEDGMENTS iii

Preface and Acknowledgments

Many of the strains in today's world lie in the conflict between a global
economy that is more and more integrated and a political environment in which
national sovereignty is still the dominant motivation. Production and delivery of
goods and services is increasingly transnational and will become more so as
communications and transportation capabilities increase and their costs continue
to decline relative to other costs. Additionally, many new technologies require
global markets to recover R&D and initial production costs.
Nations are, however, still reluctant to depend on other nations for key
manufacturing inputs. The concept of key technologies that each nation feels it
must master inside its own boundaries in order to retain its political
independence remains a driving force in international economic relations.
Additionally, increasing international economic activity has brought the
technological activities of corporations and governments into closer
relationships than ever before. National independence is becoming more and
more problematic in an interdependent world.
A wide variety of economic, social, and industrial issues are brought
forward by the confluence of new technologies, the high-level international
interdependence, and the diverse concerns and activities of nations trading in
world markets. Modem communications and transportation permit wide
dispersal and decentralization of design and production, whereas certain
production processes seem to require collocation. How are these two opposing
influences reconciled, and how do they vary by industry? What technology
policies—by government or by industry—allow the creation
Technology and Global Industry: Companies and Nations in the World Economy

PREFACE AND ACKNOWLEDGMENTS iv

of comparative advantage? Does the ability of a nation to handle the adverse

social impacts of increased trading in currently nontraded goods lie in the
integrity of its social programs or in its skill in international negotiation? This
volume addresses these questions and a variety of similar ones.
The principal focus of this volume is on technologies deployed primarily
by private firms for commercial purposes—technologies that are altering the
structure of the world economy and the location of various types of productive
activity—and on the conflicts that arise among national states as a consequence
of these shifts. Although the overview and eight chapters in the volume cover a
broad range of issues, it is important to mention two issues at the confluence of
technology and sovereignty that are not dealt with in this volume. First, there is
little explicit treatment of technologies that are inherently global in character,
technologies such as satellite communications, remote sensing from space,
international commercial air travel, and world oil trade with supertankers.
Second, there is no discussion of national security concerns with trade or
technology transfer between nations. It is our hope that the focus allowed by not
dealing with these two aspects of the global economy yields advantages greater
than the disadvantage of not including these obviously important issues.
Most of the material in this book was presented at a National Academy of
Engineering symposium rifled "World Technologies and National Sovereignty"
held on February 13 and 14, 1986. On behalf of the Academy, I would like to
thank the advisory committee (listed on page 257) that designed the
symposium, and the individuals who participated. I would like to offer special
thanks to Robert A. Frosch, John Harris, Cyril Tunis, Jesse H. Ausubel, Ronald
S. Paul, Marie-Therese Flaherty, Helen B. Junz, and Pierre R. Aigrain. With
regard to the preparation of the manuscript for publication, special thanks are
due to H. Dale Langford, the NAE's editor, and to Marjorie D. Pomeroy,
administrative assistant in the NAE Program Office.

H. GUYFORD STEVER
FOREIGN SECRETARY
NATIONAL ACADEMY OF ENGINEERING
Technology and Global Industry: Companies and Nations in the World Economy

CONTENTS v

Contents

Overview 1
Harvey Brooks and Bruce R. Guile

Innovation and Industrial Evolution in Manufacturing Industries 16

James M. Utterback

Revitalizing the Manufacture and Design of Mature Global Products 49

Alvin P. Lehnerd

Capturing Value from Technological Innovation: Integration, Strate- 65

gic Partnering, and Licensing Decisions
David J. Teece

International Industries: Fragmentation Versus Globalization 96

Yves Doz

The Impacts of Technology in the Services Sector 119

James Brian Quinn

Coping with Technological Change: U.S. Problems and Prospects 160

Raymond Vernon

Does Technology Policy Matter? 191

Henry Ergas
Technology and Global Industry: Companies and Nations in the World Economy

CONTENTS vi

National and Corporate Technology Strategies in an Interdependent 246

World Economy
Lewis M. Branscomb

Symposium Advisory Committee 257

Contributors 259

Index 261
Technology and Global Industry: Companies and Nations in the World Economy

vii

Technology and Global Industry

Technology and Global Industry: Companies and Nations in the World Economy

viii
Technology and Global Industry: Companies and Nations in the World Economy

OVERVIEW 1

Overview

HARVEY BROOKS AND BRUCE R. GUILE

In the last decade it has become increasingly clear that the character of the
world economy—and the role of the United States in the world economy—is
changing. Two characteristics of global economic change are particularly
important. First, over the last 35 years there has been substantial relative growth
(in pan simply postwar reconstruction) of national economies in Europe and
Asia. In the years immediately following World War II the United States
dominated world economic affairs, but the U.S. economy is no longer singularly
important in the world economy. The United States is now only one element,
albeit still a large one, in an increasingly global economy.
The second important change derives, in pan, directly from the increasing
relative industrialization of other national economies. The growth of other
national economies has allowed production and distribution to become
increasingly transnational. For a variety of products, fabrication, assembly,
distribution, and maintenance activities are organized in such a manner that
information, funds, materials, components, final products, and people cross
national boundaries as pan of everyday commerce. The same is true for service
industries, though probably to a lesser degree. Technological advances have
played a central role in this economic and technological integration. In
particular, technological advance has decreased the relative price of
communication and transportation and increased the capacity of transnational
systems carrying information, goods, and people.
Increasing global economic and technological integration raises issues
Technology and Global Industry: Companies and Nations in the World Economy

OVERVIEW 2

concerning the interaction of technological change, economic activity, and the

prerogatives of sovereign governments. What are the effects of changing
technologies on the production and distribution of goods and services in a
global economy? How do technological advances contribute to shifts in the
relative competitive advantage of nations, regions, and firms? How do
governments and enterprises respond to the dynamic of technological advance
in a global economy, and what are the likely consequences, both direct and
indirect, of their efforts? This volume explores these and similar questions,
focusing primarily on the actions of multinational companies and the policies of
industrialized nations.

PATTERNS OF TECHNOLOGICAL CHANGE AND

INDUSTRIAL EVOLUTION
It has long been understood that technological change, through its impact
on the economics of production and on the flow of information, is a principal
factor determining the structure of industry on a national scale. This has now
become true on a global scale. Long-term technological trends and recent
advances are reconfiguring the location, ownership, and management of various
types of productive activity among countries and regions. The increasing ease
with which technical and market knowledge, capital, physical artifacts, and
managerial control can be extended around the globe has made possible the
integration of economic activity in many widely separated locations. In doing
so, technological advance has facilitated the rapid growth of the multinational
corporation with subsidiaries in many countries but business strategies
determined by headquarters in a single nation.
Fundamental to an understanding of the relation of global industrial
structure to technology is the existence of a "technological life cycle." Although
the life cycle concept is widely recognized, there is a chronic problem with the
unit of analysis. It is not clear whether the appropriate unit of analysis is a
highly discrete invention and its subsequent ramifications, a particular product
line, or a whole industry. The answer is probably all of the above; particular
technological advances may be considered as nested in a larger technological
system, which in turn can be viewed as an element of a cluster of related
technologies constituting an entire industry.
The chapter by James Utterback introduces the concept of technological
life cycles in this volume, a concept that recurs throughout the subsequent
chapters. Utterback chooses as his unit of analysis a "productive unit"—
something that includes not only a product line or cluster of products closely
related by either technology or function but also the processes and
Technology and Global Industry: Companies and Nations in the World Economy

OVERVIEW 3

procedures used in their production. He examines parallel paths of evolution of

technologies and organizations (in several industries) and makes a case for
considering industrial structure and effective strategy as directly related to
location of both the product and process technology in a technological life
cycle. The general issues raised by Utterback are extended to the mature phases
of product and process cycles in the chapter by Alvin P. Lehnerd, who provides
a dramatic account of how fundamental reconsideration of both product and
process design for a mature product line can revolutionize the competitive
position of that line in the international marketplace.
Lehnerd describes a program at the Black & Decker Company during the
1970s. The program substantially improved the company's productivity in the
manufacture of power tools by designing products for production using new
materials and new manufacturing techniques, greatly reducing the number of
parts and standardizing components common to the various products within the
product line. During the 1970s when non-U.S. manufacturers began to dominate
in many traditional manufactured goods, Black & Decker picked a strategy—
linked to new technology—that allowed them to become a high-value, low-cost
producer in some lines of small power tools. The success of Black & Decker's
program raises the possibility that production of many "mature" products could
be revolutionized by attention to design for improved manufacturability.
Lehnerd's example also suggests that a heavy investment in in-place facilities
for manufacturing a mature product becomes a barrier both to product
innovation and to the introduction of more advanced low-cost production
processes, especially when the mature product line appears to be still doing well
in the market. In the case described by Lehnerd, this was exactly the time when
a radical redesign of an existing product line and its associated manufacturing
process proved essential to the competitive position of the firm.
The relationships between technological advance and industrial structure
that Utterback and Lehnerd address are extended to questions of global
organization and technology in the chapters by David J. Teece, Yves Doz, and
James Brian Quinn.

TECHNOLOGY AND THE STRUCTURE OF GLOBAL

INDUSTRY
David Teece's chapter deals with returns to innovation and the
arrangements—integration, partnering, and licensing—that determine whether
the potential economic returns from an innovation will be realized by the
innovator or an imitator. In his discussion, Teece draws on a different set of
examples and reinforces and elaborates the points made by Utterback
Technology and Global Industry: Companies and Nations in the World Economy

OVERVIEW 4

concerning technological trajectories, efficient industry structure, and the

importance of matching structure and strategy to the location of each product
line in the technological life cycle. Teece also cautions against economywide
generalizations about innovation or technology—driven markets. In a world of
many nations of nearly equal levels of industrialization and technological
prowess, the likely impacts of movement along a technological trajectory are
not obvious. For example, the product life cycle has significantly different
consequences for the European automobile industries than for their Japanese
and American counterparts. The European market is more of a ''niche'' market
than the Japanese and American markets, which are more commodity—like,
and technology plays a different role in the two cases. In Teece's words:

[T]he product life cycle in international trade will play itself out differently in
different industries and markets, in part according to appropriability regimes
(the degree of appropriability of the potential economic gains from
technological innovation) and the nature of the assets needed to convert a
technological success into a commercial one .... [I]t is not so much the
structure of markets as the structure of firms, particularly the scope of their
boundaries, coupled with national policies for the development of
complementary assets, that determines the distribution of profits among
innovators and imitator-followers [Teece, this volume, p. 94].

Teece also suggests that lack of attention in the United States to aggressive
investment in new manufacturing technology may have enabled skillful imitator-
followers, particularly in Japan, to appropriate a disproportionate share of the
gains from U.S. inventions arising out of its uniquely broad-based R&D
programs, both public and private. As reflected also in the chapter by Doz (and
in the chapter by Henry Ergas later in the volume), the too-exclusive emphasis
of public policy in both Europe and the United States on R&D and
technological prowess as the principal remedies for lagging competitiveness
may be misplaced; without appropriate complementary assets and capacities
that allow a nation to capture returns from innovation, national technological
superiority is of little economic consequence.
The trend during the last 30 years has been toward global homogenization
of markets and transnational integration of production. Yet there are signs of the
emergence of countervailing pressures resulting from technological,
managerial, and political developments that appear to be giving a competitive
advantage to more localized production and distribution. For example, the
relative importance of close interaction between producers and users seems to
be growing as products become more complex and customized. Effective
product design, prompt maintenance service, and consultation services to
customers in increasingly sophisticated applications all require close links
between sellers and customers.
Technology and Global Industry: Companies and Nations in the World Economy

OVERVIEW 5

Additionally, the increased use of just-in-time inventory principles in

production and distribution has enhanced the competitive advantage of
collocation of suppliers and distributors with manufacturing operations. The
chapter by Yves Doz reviews these countervailing influences in the global
economy.
In his analysis Doz points out that trends in new technology permit
enormous flexibility and diversity in the way global enterprises are actually
managed. Firms with widely dispersed facilities tightly integrated in a global
strategy exist side by side with firms having single production sites geared to
serving dispersed markets or specialized market niches that are spread globally.
Because modem technologies are both flexible and diverse, other factors may
be more important than technology as a determinant of organizational structure.
The costs associated with production and distribution may be less important in
determining the structure of an industry than the organizational and political
imperatives of partnership opportunities, investment for market access, or
access to localized concentrations of specific technical skills. Therefore, despite
forces that push for either fragmentation or homogenization of markets, the
dominant characteristic of the structure of industry in the global marketplace
may be diversity.
In his chapter on technology and the service industries, James Brian Quinn
addresses many of the issues raised by Doz and Teece, but from a somewhat
different perspective. His focus is less on the international structure of
industries and more on the interaction of technological advance with the
evolution of organizational structure in a variety of service industries. In
particular, Quinn approaches the delivery of goods and services to the consumer
as a long chain of labor, capital, location, and organization, each adding value
to create the final product. He uses this framework to challenge the common
perception that service industries have both low labor productivity and low
productivity growth, add little value, and provide only low-wage, insecure jobs.
Quinn offers many examples of the importance of technology to the
development and restructuring of service industries, to the emergence of whole
new services, and to the impressive growth in productivity in some service
sectors.
Both Doz and Teece treat major service activities—finance, transportation,
communication, and wholesale and retail activities—as integrated parts of an
organization delivering a product to a consumer. Neither distinguishes between
value added to a product through the act of assembly (manufacturing) and value
added through the act of delivery (service). Technological advance is important
in both activities, and in both it can increase efficiency and provide new
opportunities for organization. Indeed, the similarities between technological
and organizational issues in man
Technology and Global Industry: Companies and Nations in the World Economy

OVERVIEW 6

ufacturing and service industries make distinctions between services and

manufacturing seem arbitrary. Quinn argues persuasively that much
conventional wisdom about service industries is based on little empirical
evidence and a lack of recognition of the heterogeneity of the activities grouped
under the heading of services. A reexamination of the sector is at present
inhibited by poor statistics and especially by inadequate and obsolete
categorization.
The chapter by Quinn also raises the question of whether national success
in services can replace manufacturing as the engine of national economic
progress and international competitiveness, much as manufacturing had
replaced agriculture and resource industries as a source of growth and
employment in an earlier period. As illustrated in Quinn's chapter, many service
industries—medical care, transportation, communications, and banking, for
example—are technologically dynamic and crucial to national economic
performance. The services sector now accounts for almost 70 percent of U.S.
gross national product, and the United States has persistently enjoyed a positive
net balance of trade in services and income from foreign investment. On the
other hand, U.S. trade in services, though probably underestimated at present, is
small in relation to U.S. trade in manufactures and agricultural products, and it
seems unlikely that an industrialized nation the size of the United States can
export enough services to cover the cost of importing a predominance of the
manufactured goods it demands. Additionally (as discussed in Raymond
Vernon's chapter in this volume), the fraction of U.S. GNP accounted for by
manufacturing output, when proper allowance is made for the lower rate of
price increase for manufactured than for nonmanufactured output, has remained
approximately constant—between 20 and 23 percent with no clear trend up or
down—for the past 30 years (Economic Report of the President 1987, Table
B-11, p. 257). This observation belies the argument that the United States is
rapidly becoming solely a service producer. Indeed, the degree to which the
domestic economy of any large industrialized nation can become a "service
economy" is further complicated by the complex technological and economic
interdependence of services and manufacturing.
Service industries are both suppliers to and buyers from manufacturing
industries. As buyers of manufactured goods, service industries are increasingly
dependent on the rapid deployment of technology-intensive capital goods for
improving productivity. It is not clear whether any nation can remain
competitive in services if it becomes too dependent on foreign sources for this
complementary capital embodying the most advanced technology. There is, of
course, the potential that national governments may use various kinds of
controls on the export of services-related capital
Technology and Global Industry: Companies and Nations in the World Economy

OVERVIEW 7

goods to ensure the competitive advantage of domestically based services in

international trade. On the other hand, the developers of much of the technology
used in services are manufacturers who are strongly motivated to introduce and
sell their technologies as widely and rapidly as possible worldwide to recover
heavy development costs. Proximity to the sources of innovation in services-
related capital goods may or may not contribute to national competitive
advantage in any service industry.
As suppliers to manufacturing industries, many service activities may have
to be intimately linked to customers and adapted to unique local needs if they
are to be effective. If that is indeed the case, then a vital manufacturing sector
may be a necessary prerequisite for service industry development and hence for
national economic health. Manufacturing competitiveness may in its turn be
critically dependent on the efficiency and cost of the services locally available
to manufacturing plants—services essential to the smooth functioning of tightly
integrated manufacturing and distribution systems. For example, the operation
of manufacturing and distribution systems with minimal inventory costs and
buffer stocks requires a highly efficient low-cost service infrastructure.
It is not clear for which sectors the complicated linkages described above
are most important and which goods or services, if any, a large nation can
afford to import over the long run from distant locations. Still unanswered,
therefore, is whether the "postindustrial society," the "information society," or
the "service economy" are catch phrases that rationalize the relative decline of
manufacturing employment, or whether they truly represent the ''wave of the
future" and a sufficient foundation of future national prosperity and wealth.
What is clear is that the application of technological advance to service
industries can be central to improved economic performance in both service and
manufacturing industries. To keep pace with productivity improvement in other
industrialized nations, a nation must direct its trade and economic policies
toward supporting fast and flexible deployment of technologies in service
industries regardless of the location of the source of the technology.
Taken together, the chapters by Teece, Doz, and Quinn do not suggest a
trend toward either homogenization or segmentation of world markets and
world industries. While some product and service markets are becoming global,
driven by ever-increasing economies of scale, other markets are fragmenting
and differentiating. New manufacturing and service delivery technologies, new
methods of work organization, and a new importance of local market
responsiveness all can decrease the significance of scale economies and favor
decentralized production. The long-term norm may be loose global coordination
and frequent temporary alliances among particular units in different countries
for different, and usually
Technology and Global Industry: Companies and Nations in the World Economy

OVERVIEW 8

highly product-specific and market-specific, purposes. The global economy

appears to be moving toward a complex (and often highly interdependent)
coexistence of centralized and decentralized markets and production systems.
Corporations—in their national or transnational activities—depend on the
laws, infrastructure, and political stability provided by national governments. In
turn, governments of industrialized nations in the noncommunist world depend
on private enterprise to provide employment, income growth, and goods and
services for the nation's citizenry. The growth of transnational organization in
production raises new concerns about the interdependence of nations and
companies.

NATIONAL ECONOMIC DEVELOPMENT AND MARKET-

DRIVEN DEPLOYMENT OF WORLD-SCALE
TECHNOLOGIES AND INDUSTRIES
The growth of industrialized economies in Europe and Asia since World
War II has eroded the importance to the world economy of both U.S. domestic
economic policies and unilateral U.S. foreign investment and wade policies.
This change has consequences for virtually every aspect of the world economy
as the importance of multilateral negotiation and agreement grows apace.
Though national foreign policies have a variety of purposes, it is almost always
true that the primary goal of national participation in international economic
affairs is national economic development. Recently, the concerns of
industrialized nations over economic development in a world economy have
been expressed mostly in terms of national competitiveness. However, as
economic institutions become more global in scope, whether through networks
of alliances across national boundaries or through large centrally controlled
transnational corporations, the concept of a competitive national economy
becomes uncertain and obscure.
One measure of competitiveness may be the average level of real wages
that labor can command in a given country (and the potential for future growth
of this level), but it can be argued that measures such as employment growth,
technological capability, productivity growth, or corporate profitability are
better proxies for what is meant by competitiveness. These measures do not,
however, reflect the same concept of competitiveness. Though real wages are a
gross indicator of standard of living, employment growth may be a better
measure of the opportunities available to the citizenry. Technological capability
and productivity growth relate to the productive resources physically located in
a given country's territory, whereas corporate profitability reflects the
performance of firms with their headquarters and primary ownership in a given
country, regardless of the
Technology and Global Industry: Companies and Nations in the World Economy

OVERVIEW 9

location of production or distribution.* These various measures of economic

development—and the policy goals implicit in the measures—are central to
national policy debates. Three chapters in this volume—by Raymond Vernon,
Henry Ergas, and Lewis M. Branscomb—deal extensively with national
economic development policies.
Vernon's chapter reviews some basic and inevitable changes in the position
of the U.S. economy in the global marketplace and addresses many of the
concerns expressed by the U.S. public and U.S. policymakers about
international competitiveness. Vernon raises two issues that are not discussed
elsewhere in the volume. The first is a concern with the internal distribution of
the national costs associated with U.S. participation in an open global economy.
Particularly important is his assessment of tradeoffs within the U.S. economy.
Some industries and groups in the United States have suffered from the
exposure of U.S. markets to foreign producers, such as those associated with the
steel and auto industries; but others have benefited, such as low-income groups
—who enjoy better prices for clothing, household appliances, food, and other
basic goods—or workers in successful export industries. By the same token,
factory workers in some traditional industries may have fared poorly, but
management consultants and computer software specialists have done well.
The second policy issue unique to Vernon's chapter in this volume is his
assessment of the challenge to U.S. policymakers to avoid triggering a
cascading sequence of beggar-thy-neighbor actions that would change the
policies of governments from the fostering of positive-sum games to mutually
destructive actions designed to protect the interests of politically influential
domestic constituencies. The U.S. political tendency is to respond to localized
domestic industrial distress with political action. The current furor over the U.S.
wade deficit is a good example. As the U.S. trade balance has worsened, there
has arisen a widespread belief in the United States that other nations are not
playing by the rules of the open

* Because of the ambiguity of the term "competitiveness," the picture with regard to
U.S. competitiveness is not clear. By a number of these measures—in particular
productivity growth and increases in real wages—the U.S. economy has not been
performing as well as other industrial economies in the last 15 years (Scott, 1985;
President's Commission on Industrial Competitiveness, 1985). In employment growth,
however, the U.S. economy has done better than other industrial economies, having
created many more new jobs over the same period, though questions have been raised
about the "quality" of these jobs (Bluestone and Harrison, 1986). In scientific and
technological capability, the United States is still the world leader (Brooks, 1956), but
there are significant questions (as raised by Teece in this volume) regarding U.S.
application of technology. Finally, there are analyses that indicate that, although the
United States as a location of production may have lost world market share, U.S.-based
multinationals have gained market share in world markets (Lipsey and Kravis, 1985).
Technology and Global Industry: Companies and Nations in the World Economy

OVERVIEW 10

trading system that the United States helped to establish after World War II.
The perception that the United States respects these rules while other nations do
not has generated a chores of demands for unilateral or coercive U.S. actions to
create a "level playing field." Are these demands legitimate? Most scholarly
studies of nontariff trade barriers indicate that the fraction of the total value of
U.S. imports affected by such barriers is as large as or greater than the fraction
of imports affected in notable rivals such as Germany and Japan (Saxonhouse,
1983; Cline, 1984). If the United States is different from its industrialized
competitors in this regard, it is only in the fact that the barriers appear to follow
a less coherent or consistent pattern than those of some other industrialized
nations.
The concern in the United States is not an unusual or surprising response
to trade problems. There is a tendency for every nation to see itself as unfairly
disadvantaged by world competition in sectors in which it is doing poorly while
taking for granted its success in sectors where it is doing well. Thus, each nation
attempts to intervene politically in these disadvantaged areas and is troubled by
the inadequacy of its political influence over the policies and actions of other
nations.
Among the policies that nations use for economic development are those to
promote technological advance. The chapter by Henry Ergas presents a cross-
national comparison of technology policies. The thrust of Ergas's argument is
that various strategies are open to countries, or to businesses within countries,
based on where they choose to seek competitive advantage in the product or
technology cycle. In Ergas's assessment, the United States, France, and the
United Kingdom have chosen (if such an active word can be applied to a set of
policies that have evolved in a fairly decentralized manner) to seek competitive
advantage in the stage at which a new technology is just emerging, whereas
Germany, Switzerland, and Sweden have chosen to configure their public
policies and their industrial structure to take maximum advantage of the more
mature phases of development in products and processes. Japan, Ergas argues,
has chosen to try to profit from the "consolidation" or "take-off" phase, and in
large measure its strategy is something of a hybrid between the emerging
technology strategy of the United States and the diffusion strategy of Germany.
Ergas writes:

This discussion suggests that there are different paths to happiness, as

countries' institutional structures and social arrangements facilitate
specialization in differing stages of technological evolution. Each of these
stages has advantages and disadvantages in providing for the growth of real
income, but countries also differ in the extent to which they succeed in
securing the greatest benefits from any given pattern of specialization.
[L]ocation on a technological trajectory may be less important than the
efficiency
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OVERVIEW 11

with which the advantages of that location are pursued. This, in turn, depends
on institutional features (broadly defined) that may be more or less appropriate
for a given pattern of specialization [Ergas, this volume, pp. 230-231].

This categorization is important from the U.S. perspective, especially when

combined with Ergas's argument that the emerging-technology phase does not
usually produce large gains in per capita income or value-added per worker.
The implication is that there may be, from an economic development
perspective, a comparative overemphasis in the United States on creativity,
originality, novelty, and sophistication at the leading edge of technological
advance. This overemphasis comes at the expense of what could be called the
"creative imitation" or rapid incremental improvements that the Japanese are
especially good at.
It is worth noting that Vernon and Ergas, writing from macroeconomic and
public policy perspectives, both reinforce points made by Teece from a
microeconomic perspective. In a world in which technological innovators
cannot hope to capture more than a small fraction of the gains from their
innovations, and in which the successful exploitation of a technological advance
depends on tapping global markets, a national economy that invests in the
creation of new technologies must constantly ask itself where the economic
returns to such advances are likely to be captured. The ability of a nation to
generate technological advances is insufficient by itself, and may not even be
essential, for improving national competitive position.
Branscomb, in the final chapter in the volume, compares the technology
development and deployment strategies of companies and governments.
Branscomb discusses the existence of both synergy and conflict in the interests
of nations and corporations. Governments and transnational companies share an
important common interest in economic growth and development, but each has
ancillary goals not necessarily consistent with those of the other. Governments
care—for a variety of legitimate reasons— about national self-sufficiency,
whereas corporations care primarily about profitability and autonomy of action.
Though these interests do not always conflict, there are inevitably situations
where the goals and methods of the two types of organizations diverge. In other
words, the imperatives of global economic and technological interdependence—
often manifest in transnational production and distribution activities—
sometimes run against legitimate nationalistic concerns.
In a global economy, the autonomy and importance of multinational
corporations can restrict the ability of national governments to carry out
independent economic and social policies within their boundaries. Therefore, an
ongoing important international policy question is: What mechanisms will
allow a group of nominally independent sovereign nation-states—working with
a parallel group of nominally autonomous trans
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OVERVIEW 12

national companies—to deal with a global-scale economy in a way that is just

and equitable for all the different publics involved? There are no simple or even
obvious solutions. National limitations on the autonomy of multinationals may
come at the expense of national and global economic growth. On the other
hand, corporate autonomy may come at the expense of painful domestic
adjustments and localized welfare losses as well as losses of national self-
esteem and cultural autonomy. The challenge is to develop an international
political regime that provides for negotiation over the needs of different
national constituencies without choking off the open exchange of goods and
services. This has important implications for the policies of nations and
companies in relation to political constituencies; a stable system of governance
for the international economy cannot long accommodate to severe adverse
economic effects on individual nations or influential constituencies within
nations. In particular, effective social policy—temporary assistance to
disadvantaged groups, for example—may help to mitigate constituency
resistance to change and afford national negotiators a freer hand in representing
truly national rather than vocal parochial interests.

CONCLUSION
Taken together, the chapters in this volume raise many issues about
patterns of technological change and evolution in the structure of organizations
—and styles of management—in the global economy. These chapters contribute
to a growing literature—built on ideas expressed by N. D. Kondratiev and
Joseph Schurnpeter in the first half of this century—that explicitly links
technological trajectories or life cycles to industrial development. Because of
the complexity created by nested and overlapping technological advances, the
interpretation of what constitutes a technological trajectory is rather vague and,
though there have been substantial contributions to our understanding
(Abernathy and Utterback, 1978, and Dosi, 1982, for example), no composite
theory has ever been worked out in detail. Despite this, there appears to be some
common understanding of a three-stage pattern of technological development.
The first stage— the "emergent" or "fluid" phase—is viewed as a period of
great ferment during which the various actors, particularly inventors and users,
carry out a trial-and-error search for the application of an initial concept that
works—both technically and in terms of customer acceptance. In this phase
there are often many competing firms and technical ideas and no clearly
superior design.
The second stage is characterized by the emergence of a dominant design
(or application that appears to meet the requirements of the mar
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OVERVIEW 13

ketplace). At this point the pace of diffusion of the new technology quickens,
and at first many new competitors "swarm" into the market. As diffusion
continues, price competition becomes more important and there is less product
differentiation on the basis of product characteristics. The pure economics of
production and delivery come to dominate competition. Simultaneously product
innovation becomes more incremental, based on the now dominant design
concept, and there is more stress on innovation to bring down costs and increase
quality and uniformity of the product. The search for improvements narrows,
but the rate of reduction of costs accelerates and, with it, the rate of market
penetration because of price elasticity of demand. At the same time the race for
cost-reducing improvements drives many competitors out of the market, and a
much more stable division of market shares among the remaining competitors
results.
The third stage is reached when the market begins to saturate, new
applications and new markets give way to replacement of previous generations
of the same technology, and further cost-reducing improvements become harder
and more expensive to find. What happens, or should happen, in this mature
phase of a life cycle is the subject of much less agreement. It is a period in
which the leading competitors are much more vulnerable to the appearance of a
radical innovation, which may constitute the initiation of a new technological
paradigm. In this phase the organization tends to be optimized for mass
producing and marketing a commodity-like product. This form of organization
is likely to be unsuitable for introducing and rapidly improving a product or a
new manufacturing process that is in its dynamic growth phase. Lehnerd's
example from the Black & Decker Company seems to be the exception rather
than the rule.
Although, as mentioned above, there is little agreement on the specific
characteristics of the technological life cycle and the level of aggregation of
economic activity to which it is relevant, the loosely defined notions of a
technological trajectory or product life cycle have proved useful in dividing
technological advance into stages that can be linked to trade patterns, economic
structure, and national technological strategies in the global economy. The
product life cycle theory developed by Raymond Vernon in the late 1960s
(Vernon, 1966), and subsequently elaborated by many authors, is a prime
example. The chapters in this volume are consistent with that tradition. They
strongly suggest that the technological character of product lines, production
processes, and delivery systems in an industry evolves in a consistent, though
subtle, manner in a way that dramatically influences both the range of viable
business strategies and the likely market outcomes in the global economy.
In addition to addressing industrial and technological change, the chap
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OVERVIEW 14

ters in this volume delineate a chronic tension in global. economic and

technological affairs. The principles of relatively unrestricted world trade—
carried out most often through multinational firms and benefiting consumers
and in many cases the firms' managers and shareholders—conflict with the
legitimate interests of important producer and other interest groups within
nations. With increasing globalization of economic activity, bilateral and
multilateral negotiations over trade and foreign investment practices—already
an important aspect of national foreign policy—will be increasingly important
components of national domestic economic and social policy. How can a
national government accommodate the interests of important groups that are
seriously affected by developments in the international economy? Are policies
targeted toward particular key industries and technologies more significant for
national economic health than government support for education and basic
research, the development of generic technologies, or the upgrading of basic
infrastructure? Is a multinationally coordinated approach to more general
policies such as macroeconomic policies, national tax structures, regulatory
philosophies, policies toward human resource development, and labor market
adjustment a desirable goal? These questions will never be settled in the large;
future policy will exist primarily in the resolution, or lack of resolution, on
specific negotiations. The questions, however, are likely to be important
national policy issues for decades.

REFERENCES
Abernathy, W. J., and J. M. Utterback. 1978. Patterns of industrial innovation . Technology Review
80:7 (June-July):40-47.
Bluestone, B., and B. Harrison. 1986. The Great American Job Machine: The Proliferation of Low
Wage Employment in the U.S. Economy. A study prepared for the Joint Economic
Committee, December.
Brooks, H. 1986. National science policy and technological innovation. Pp. 119-167 in The Positive
Sum Strategy, R. Landau and N. Rosenberg, eds. Washington, D.C.: National Academy
Press.
Cline, W. R. 1984. Exports of Manufactures from Developing Countries. Washington, D.C.:
Brookings Institution.
Dosi, G. 1982. Technological paradigms and technological trajectories. Research Policy 11(3):
147-162.
Economic Report of the President, 1987. Washington, D.C.: U.S. Government Printing Office.
Lipsey, R. E., and I. B. Kravis. 1985. The Competitive Position of U.S. Manufacturing Firms.
National Bureau of Economic Research Working Paper 1557. Cambridge, Mass.: National
Bureau of Economic Research.
President's Commission on Industrial Competitiveness. 1985. Global Competition: The New
Reality. Volumes I and 2. Washington, D.C.
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OVERVIEW 15

Saxonhouse, G. 1983. The micro-and macroeconomics of foreign sales to Japan . Pp. 259-263 in
Trade Policy in the 1980s, W. R. Cline, ed. Cambridge, Mass.: MIT Press
Scott, B. R. 1985. U.S. competitiveness: Concepts, performance, and implications. Pp. 13-69 in U.S.
Competitiveness in the World Economy, B. R. Scott and G. C. Lodge, eds. Boston, Mass.:
Harvard Business School Press.
Vernon, R. 1966. International investment and international trade in the product cycle. Quarterly
Journal of Economics 80(2):190-207.
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 16

Innovation and Industrial Evolution in

Manufacturing Industries

JAMES M. UTTERBACK
Historically, studies of innovation have had a linear viewpoint. That is,
they have seen innovation as something that begins with a company possessing
a certain technology and then investing in that technology, and the
accompanying ideas, and implementing them in the market. This approach,
however, assumes that all innovations occur in the same way in all companies
and disregards the fact that organizations change throughout their lifetimes. It
also fails to distinguish between product and process innovations, each of which
may follow a different path. In short, the interaction of technological change
and the marketplace is much more complex and dynamic than linear models can
describe. The dynamic model discussed below describes how change in product
innovation, process innovation, and organizational structure occurs in patterns
that are observable across industries and sectors. The dynamic model allows
consideration of the different conditions required for rapid innovation and for
high levels of output and productivity. The argument describing this model is
built on historical studies of innovations in their organizational, technical, and
economic settings. Such data are necessarily incomplete, but at the same time,
they yield a rich variety of insights.

Parts of this chapter draw upon the following previously published

sources: Abernathy and Utterback, 1978; Hill and Utterback, 1979; Utterback,
1978; and Utterback and Abernathy, 1975.
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 17

UNIT OF ANALYSIS
Product and process innovation are inextricably interdependent; in
considering manufacturing innovation, both a product line and an associated
production process must be taken together as the unit of analysis. Termed a
productive unit in this chapter, this unit of analysis is a slightly different
concept than a business or a firm For a simple firm or a single-product firm, the
productive unit and the firm would be one and the same. In a diversified firm,
however, a productive unit would usually report to a single operating manager
and normally be a separate operating division. When the word ''firm'' is used in
this chapter, it should be taken narrowly to mean productive unit as defined here.
Competition in the marketplace is not only between firms, but often
between products or product lines. Even an enterprise classified as a single
industry might find itself competing with many disparate groups of firms with
different product lines or lines of business. Thus, to group productive units
sensibly into industry or market segments, one must ask: In what product lines
do units view each other as direct competitors? Within a segment, productive
units that view each other as direct competitors face a similar business
environment and set of competitive requirements for their technology. The
terms "industry" and "market segment" will be used here in this limited sense.
A key idea is that productive units may be arranged in a dependent
hierarchy from final market to equipment and materials suppliers. Thus, what is
viewed as a product innovation by a unit at one level is part of the production
process or product of a unit at the next higher level (Abernathy and Townsend,
1975). This means that most innovations affect productivity directly. It also
means that the markets to Which innovations respond are often defined by the
characteristics of other firms' production processes. Operations management
and management of technological innovation and change are inextricably linked.
The fact that one firm's product is another's manufacturing equipment or
material, and the fact the major product changes are often introduced from
outside an established industry and viewed as disruptive by the existing
competitors, means that the standard units of analysis of industry— firm and
product type—are of little use, for as technology changes, the meaning of these
terms also changes. Analysis of change in the textile industry requires that
productive units in the chemical, plastics, paper, and equipment industries be
included. Analysis of electronics firms requires review of the changing role of
component, circuit, and software producers as they become more crucial to
change in the final assembled product. Major change at one level works its way
up and down the chain because
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 18

of the interdependence of product and process change within and among

productive units. Knowledge of the production process as a system of linked
productive units is a prerequisite to understanding innovation and competition
in an industrial context.
Earlier work on the management of technology has focused at a micro
level, dealing with similarities among particular successful cases of product or
process innovation (Utterback, 1975), whereas work on the economics of
technological change has focused at a macro level, dealing with changes in
productivity and technology among industries (Rosenbloom, 1974). Neither has
aimed at understanding the dependence of product innovation on process
innovation and its crucial importance for operations management and strategy.
Use of the idea of a productive unit as the unit of analysis requires focusing on
their critical interaction, both within a unit and between units linked by physical
flows of equipment, material, and parts (Abernathy and Townsend, 1975).

PRODUCT INNOVATIONS
What is needed is a view of innovation that will aid the decision-making
process of company managers, government policymakers, and researchers. Out
of this need has arisen a theory holding that the interaction between technology
and the marketplace is much more complex and dynamic than the linear view
would have us believe. It is our contention here that the conditions required for
rapid innovation are extremely different from those required for high levels of
output and productivity: Under demands for rapid innovation, organizational
structure will be fluid and flexible, whereas under demands for high levels of
output and productivity, organizational structure will be standardized and
inflexible. Thus, a firm's innovation attempts will vary according to its
competitive environment and its corresponding growth strategy. It will also be
affected by the state of development of both its production technology and that
of its competitors (Abernathy and Utterback, 1978). Therefore, we can expect to
see different creative responses from productive units facing different
competitive and technological challenges, which, in turn, suggests a change in
the way of viewing and analyzing possible policy options for encouraging
innovation.
A dynamic model of innovation (Figure 1) includes a pattern of sequential
and cross-sectoral change in product innovation, process innovation, and
organizational structure. Firms that are new to a product area will exhibit a fluid
pattern of innovation and structure. As the market develops, a transitional
pattern will emerge. Finally, the market stabilizes, fostering a specific pattern of
behavior. Therefore, a radical innovation— one that can create new businesses
and transform or destroy existing ones—
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 19

is often the result of the addition of entirely new requirements to a previously

stable set of dimensions (Normann, 1971).
In the fluid phase of a firm's evolution, the rate of product change is
expected to be rapid, and operating profit margins are expected to be large. The
few existing competitors will be either small new firms or older firms entering a
new market based on their existing technological strengths. A firm might be
expected to emphasize unique products and product performance in anticipation
that the new capability will expand customer requirements. The new product
technology will often be crude, expensive, and unreliable but will fill a function
in a way that is highly desirable in some market niche. Prices and profit margins
per unit will be high, because the product often has great value in a user's
application.
Several studies have shown that the performance criteria that serve as a
primary basis for competition change from ill defined and uncertain to well
articulated as a firm travels through the various states of development
(Frischmuth and Allen, 1969). In emerging product areas, there is a
proliferation of product performance dimensions. These frequently cannot be
stated quantitatively, and even the relative importance or ranking of the various
dimensions may be unstable. Thus, because most product innovations will be
market-stimulated, there will be a high degree of uncertainty about their
potential. This can be called target uncertainty.
Although the total amount of research and development (R&D) in a sector
may be large, its focus will be diffuse. This is called technical uncertainty. The
expected value of any R&D investment is reduced by the combined effect of
target uncertainty and technical uncertainty.
Technology to meet needs will come from many sources, including
customers, consultants, and other informal contacts, because fluid units tend to
rely heavily on diverse, external sources of information. However, the critical
input will not be state-of-the-art technology but new insights about needs (von
Hippel, 1977); innovations will originate in units with intimate knowledge of
users and user needs.
As both producers and users of a product gain experience, target
uncertainty lessens and product innovation enters the transitional state. The
usefulness of the new product is increasingly better understood, and it may take
on a variety of new forms to serve other parts of the market. Additional
improvements and innovations incorporating new components and systems
concepts may be required to expand its possible uses and sales. A greater degree
of competition based on product differentiation usually develops, and dominant
product designs may begin to emerge.
At the same time, forces that reduce the rate of product change and
innovation are beginning to build up. As obvious improvements are introduced,
it becomes increasingly difficult to better past performance, users
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 20

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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 21

Fluid Pattern Transitional Specific Pattern

Pattern
Competitive Functional Product variation Cost reduction
emphasis on product
performance
Innovation Information on Opportunities Pressure to reduce
stimulated by users' needs and created by cost and improve
users' technical expanding quality
inputs internal
technical
capability
Predominant type Frequent major Major process Incremental for
of innovation changes in changes product and
products required by process, with
rising volume cumulative
improvement in
productivity and
quality
Product line Diverse, often Includes at least Mostly
including custom one product undifferentiated
designs design stable standard products
enough to have
significant
production
volume
Production Flexible and Becoming more Efficient, capital-
processes inefficient; major rigid, with intensive, and
changes easily changes rigid; cost of
accommodated occurring in change is high
major steps
Equipment General-purpose, Some Special-purpose,
requiring highly subprocesses mostly automatic
skilled labor automated, with labor tasks
creating "islands mainly monitoring
of automation" and control
Materials Inputs are limited Specialized Specialized
to generally materials may materials will be
available materials be demanded demanded; if not
from some available, vertical
suppliers integration will be
extensive
Plant Small-scale, General-purpose Large-scale,
located near user with specialized highly specific to
or source of sections particular products
technology
Organizational Informal and Through liaison Through emphasis
control is entrepreneurial relationships, on structure, goals,
project and task and rules
groups
Figure 1
A dynamic model of innovation. Reprinted with permission from
Abernathy and Utterback (1978), Technology Review, copyright 1978.
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 22

develop loyalties and preferences, and the practicalities of marketing,

distribution, maintenance, advertising, and so forth demand greater
standardization. Innovations leading to better product performance become less
likely unless the improvement is easy for the customer to evaluate and compare,
for firms will attempt to maximize their sales and market share by defining their
needs based on those of the customer.
The reduction in target uncertainty that comes from greater diffusion of
product use allows a correspondingly greater degree of technical uncertainty to
be tolerated. Therefore, larger R&D investments will be justified—for advanced
technology will become a major source of further product innovation. At some
point, before the cost of technological innovation becomes prohibitively high,
and before increasing cost competition erodes margins below levels that can
support large categories of indirect expense, the benefits of R&D probably
reach a maximum.
The emergence of a dominant product design that enforces standardization
marks the beginning of the specific state. Such product design milestones can
be identified in many product lines; sealed refrigeration units for home
refrigerators and freezers, effective can-sealing technology in the food canning
industry, and the standardized diesel locomotives in the locomotive and railroad
industry are but a few examples.
George White (1978) contends that dominant designs can be recognized in
the early stages of their development. He suggests that dominant designs will
usually display several of the following qualifies:

• Technologies that lift fundamental technical constraints on the art

without imposing stringent new constraints.
• Designs that enhance the value of potential innovations in other
elements of a product or process.
• Products that ensure expansion into new markets.
• Products that build on existing operations rather than replacing them.

The dominant new product design signals a significant transformation,

affecting the type of innovation that follows it, the source of information, and
the size, scope, and use of formal research. As the productive unit evolves into
this specific state, the set of competitors often becomes an oligopoly and
competition begins to shift to product price, which means that product design
and process design become more and more closely interdependent as a line of
business develops. Margins are reduced, and production efficiency and
economies of scale become emphasized. Consequently, the requirements for the
market become simpler and more precise. As price competition increases,
production processes become more capital-intensive and may be relocated to
achieve lower costs. This relocation may even shift capacity overseas (Vernon,
1966; Wells, 1972).
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 23

Because investment in existing process equipment is high, and product and

process change axe interdependent, both product and process innovations in the
specific state are usually incremental. Under these conditions, however, both
product and process features are well articulated and easily analyzed, and the
conditions necessary for the application of scientific results and systems
techniques are present. Unfortunately, the payoff required to justify the cost of
change is large, whereas potential benefits are often marginal; innovations
typically will be developed by equipment suppliers for whom the incentives are
greater and adopted by the larger user firms (Abernathy, 1976; Abernathy and
Wayne, 1974). Thus, as the product market shifts from fluid to transitional to
specific, the locus of major product innovation may shift from user to
manufacturer to equipment supplier (see Figure 2).

PROCESS INNOVATIONS
A production process is the system of process equipment, work force, task
specifications, material inputs, work and information flows, and so forth
employed by a unit to produce a product or service. In the fluid state, the
productive unit will typically be small, with limited resources. Order backlogs
may rise rapidly, even though the market is small, reflecting the unit's limited
capacity. The novelty of the product may mean that the unit will be the sole
supplier for a limited period of time.
In this situation, the unit will attempt to expand rapidly in the simplest way
possible. The emphasis will be on highly skilled and flexible labor, and the
process itself will be composed largely of unstandardized and manual
operations, or operations that rely on general-purpose equipment. The
adaptations made to equipment by the firm will be minor, as in a job shop, and
the problems of coordination and control will be similar. Capacity levels will be
poorly defined. Such a system necessarily is inefficient. Greater volume will be
achieved through paralleling existing processes and improving manual
operations. There will be few scale barriers to entry into the business.
As a small purchaser, the unit will usually have little influence over its
suppliers. Raw materials and parts will be used as available; if new materials or
parts are produced for the unit, their quality may vary widely. Variations in
input quality and product design are compensated by the considerable flexibility
in the types of tasks each individual and piece of equipment can perform.
When significant-enough volume is achieved in one or more product lines
to encourage standardization, the production process enters the transitional
state. Major process change then occurs at a rapid rate. Production
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 24

 Fluid Pattern Transitional Pattern Specific Pattern
Competitive emphasis on Functional product performance Production variation Cost reduction
Innovation stimulated by Information on users' needs and Opportunities created by expanding Pressure to reduce cost and improve
users' technical inputs internal technical capability quality
Product line Diverse, often including custom Includes at least one product design Mostly undifferentiated standard
designs stable enough to have significant products
production volume
Performance criteria are Ill-defined and uncertain targets Becoming stable with each product Well-defined and monotonic; cost-
for innovation; many often occupying a somewhat different and quality-related dimensions
qualitative criteria position vis-à-vis criteria predominate
Uncertainty concerns The relevance of outcomes that The balance of market and Primarily technical issues as market
might be achieved; demands are technical factors as appropriate demands are well known
ill defined targets for R & D are clearer
Source of technology is Often a user of the product Often a manufacturer of the product Often a supplier of parts, materials,
etc.
Product use is In a market niche with emphasis Expanding as more market Widespread
on its unique advantages segments are entered
Product price Is high and demand is insensitive Often failing rapidly with rising Low and demand is sensitive to price;
to price; profit margins are high elasticity of demand profit margins are low
Exports are Robust based on the product's Strong but facing competition from Declining under strong competition
unique performance imitators from abroad
Competitors are Few with widely fluctuating Many, but a decline in numbers Few, a classic oligopoly situation in
Technology and Global Industry: Companies and Nations in the World Economy

market shares begins after appearance of a which market shares are stable
dominant design
Unit is vulnerable to others who Can rapidly imitate and improve Can produce more efficiently and Can replace its product with
on its innovations consistently functionally superior or far less
expensive substitutes
Figure 2
INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES

Hypotheses concerning the dynamics of product innovation.

Reprinted with permission from Abernathy and Utterback (1978), Technology Review, copyright 1978.
25
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 26

systems become increasingly difficult to change, mechanistic, and rigid.

Tasks become more specialized and are subjected to more formal operating
controls. Some tasks are automated, and emphasis is placed on a systematic
flow of work. Levels of automation win vary widely with "islands of
automation" linked by manual operations (Bright, 1958). As a result, production
processes in this state will have a segmented quality. Steps to expand capacity
will most frequently include breaking bottlenecks. A larger initial investment
will be required to enter the line of business during the transitional state than in
the fluid state.
Having become a more significant producer and purchaser, the unit will
develop suppliers that depend on its business, which will enable it to influence
the consistency of its inputs. Labor tasks will gradually become more
structured, with emphasis on particular skills. Maintenance, scheduling, and
control will increasingly be handled by specialized labor rather than directly
during production.
The production process reaches the specific state when it becomes highly
developed and integrated around specific product designs, and as investment
becomes correspondingly large. In this state, selective improvement of process
elements becomes increasingly more difficult. Production volume and scale of
plants will be large. The process becomes so well integrated that changes
become extremely costly, because even a minor change may require changes in
related elements of the process and in the product design. Process redesign
typically comes in progressive steps, but it may also be spurred either by the
development of new technology or by a sudden or cumulative shift in the
requirements of the market. If changes are resisted as process technology and
the market continue to evolve, then the stage is set for either economic decay or
a revolutionary, as opposed to evolutionary, change.
A strong influence will be exerted on suppliers to provide consistent
quality and flow of inputs, as these are critical to the unit's productivity and
profits in its now high-volume and low-margin operation. Tasks that cannot be
automated may be segregated from the mainstream and performed in separate
locations or by subcontractors. Consequently, production scheduling and
control, quality control, materials requirements planning and materials
handling, job design, labor relations, and capital investment decisions will vary
with changes in product and process technology.
The discussion above implies that various productivity elements—process
integration, materials and labor inputs, and scale—can be considered as a set of
actively coupled elements. This means that each must change in a balanced way
for product and process change to advance uniformly. When one element is
changing more rapidly than others, or when one or
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more elements are static while others are changing, we speak of start-up
problems or barriers to innovation (Ramstrom and Rhenman, 1969).
Unit production costs often decrease in proportion to the cumulative
volume of production. This phenomenon has been observed, for example, in the
production of items as diverse as light bulbs, integrated circuits, color television
sets, automobiles, and aircraft. A similar phenomenon is common in studies of
individuals' performance of repetitive tasks. Because reductions in unit costs
were first associated with increasing labor skills, the relationship between unit
costs and cumulative production is known as a learning curve or an experience
curve. Indeed, a stable and skilled labor force is apparently a prerequisite for
rapid cost reduction with increases in production. The contention here is that
change in each of the elements noted above, including labor skills, underlies the
experience phenomenon. Further, management-determined changes in product
design and process configuration make possible the required changes in other
elements and thus pace the reduction in cost. These hypotheses are summarized
in Figure 3.

ORGANIZATIONAL STRUCTURE AND INNOVATIVE

CAPACITY
Not only do changes in products and processes occur in the systematic
pattern described above, but organizational requirements may also be expected
to vary according to a similar pattern (see Figure 4). During periods of high
target and technical uncertainty, a productive unit must be focused to make
progress; for a group to be successful in an uncertain environment, individuals
in the organization must act together. This type of organizational structure is
called organic (Bums and Stalker, 1961). Such an organization emphasizes,
among other things, frequent adjustment and redefinition of tasks, less
hierarchy, and more lateral communication. An organic organization is more
appropriate to uncertain environments because of its increased potential for
gathering and processing information for decision making.
The relative power of individuals in the organization will be related to their
assumption of entrepreneurial roles. The rewards for radical product innovation
will often be ownership of a small, new enterprise. The potential wealth
resulting from such innovations will be valued by the entrepreneur to a much
greater degree than his or her present income. Realization of potential rewards
will depend on the survival and growth of the firm, which in turn will depend
largely on the ability of the entrepreneur to generate a superior product and to
capture a share of an emerging market. The innovative capacity of such an
organization will be high.
As transition begins, and individuals and units in the organization be
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Fluid Pattern Transitional Specific Pattern

Pattern
Production Flexible and Becoming more Efficient,
processes inefficient: major rigid, with capital-
changes easily changes intensive, and
accommodated occurring in rigid; cost of
major steps change is high
Equipment General-purpose, Some Special
requiring highly subprocesses purpose, mostly
skilled labor automated, automatic with
creating ''islands labor tasks
of automation'' mainly
monitoring and
control
Process Is slight with Is rapidly Is extreme,
interdependence subprocesses increasing making it
being relatively difficult to
independent of incorporate
one another changes without
disrupting the
rest of the
process
Cost of process Is low Is moderate Is high
change
Materials Inputs arc limited Specialized Specialized
to generally materials may materials will
available materials be demanded be demanded; if
from some not available,
suppliers vertical
integration will
be extensive
Labor Is highly skilled Semiskilled, Is moderately
and paid and can performs well- skilled
perform a variety defined tasks at performing
of tasks low wages largely
maintenance
and control
functions
Degree of vertical slow the unit will Is growing as Is extensive,
integration purchase most of the unit begins and usually
its raw materials to produce many only those units
and many parts of its own having a high
and components critical parts, degree of
components, vertical
and materials integration will
survive
Plant Small-scale, General-purpose Large-scale,
located near user with specialized highly specific
or source of sections to particular
technology products
Figure 3
Hypotheses concerning the dynamics of process innovation. Reprinted
with permission from Abernathy and Utterback (1978), Technology Review,
copyright 1978.
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Fluid Pattern Transitional Specific Pattern

Pattern
Organization Informal and Through liaison Through
control is entrepreneurial relationships, emphasis on
project and task structure, goals,
groups and rules
Organizational Organic with Hierarchical and Mechanistic
structure is frequent lateral with well-
adjustment and relationships are defined tasks
redefinition of tasks increasingly and relationships
defined
Requirements of Are Are increasingly Are those skills
management entrepreneurial the managerial needed to
skills skills needed to maintain
cope with stability and
growing moderate growth
complexity
Innovators are Rewarded for Rewarded for Discouraged
radical product expansion of from pursuing
innovation, often operations and ideas that
via ownership and contributions to threaten the
rapid growth of rapid stability of the
the unit productivity gains unit
Innovative Is high Is moderate Is low due to the
capacity of the disruptive
organization nature of major
innovations
Figure 4
Hypotheses concerning the dynamics of organizational form. Reprinted
with permission from Abernathy and Utterback (1978), Technology Review,
copyright 1978.
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come more sequentially interdependent, coordination and control will

occur to a greater extent through planning, liaison relationships, and project and
task groups. When the task environment is better defined, an appropriate means
of coordination and control will be to define various lateral relationships based
on the dependence of one part of the organization on another (Lawrence and
Lorsch, 1967). Thus, during transition, organizations are often structured
according to products, or regions, each division replicating in some respects the
earlier entrepreneurial form.
The relative power of individuals will begin to shift from those with
entrepreneurial ability to those with management ability, for a different set of
skills will be required for the growth and structuring of the organization. Often
the original entrepreneur or entrepreneurial group will spin off to start another
smaller enterprise.
As a dominant design emerges and production operations expand rapidly
in response to increased demand, the focus of rewards will shift to those who
are able to expand production operations, marketing functions, and so forth.
Ownership of the unit by this time may be well established, and rewards may be
provided in more traditional terms of bonuses, stock options, and other
managerial prerequisites.
These changes will cause moderation of the innovative capacity of an
organization. As a product becomes more standardized and is produced in a
more systematized process, interdependence among organizational subunits
gradually increases, making it more difficult and costly to incorporate radical
innovations.
Once a production process becomes highly developed with respect to a
specified and standardized product, organizational control will be provided
through emphasis on structure, goals, and rules. When the environment is better
known and operations become routinized, it is necessary to provide more rigid
coordination that establishes consistent routines and rules to minimize
inefficiency and costs in operations. This type of structure is known as
mechanistic.
The power and influence of individuals who show administrative ability
will increase in a mechanistic organization. When the technical and market
environment becomes stable—and when growth of a productive unit relies more
on stretching existing products and processes—the ability to hold a steady and
consistent course will be highly valued.
Rewards in a stable situation will be centered on financial results and on
predictable, incremental performance in product and process change that build
on past investments. Ideas that threaten to disrupt the stability of the existing
process will be discouraged, and ideas that extend the life of existing products
and technology will be encouraged and rewarded, probably in a highly
structured manner.
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The innovative capacity of such a productive unit viewed in isolation will

be low. When production processes are highly integrated in a system, and a
high degree of interdependence exists among subprocesses, the disruption and
cost associated with major changes will be a primary concern. Moreover,
influential individuals' perceptions of the gains from improvements that provide
immediate and certain rewards amplified by a high production volume will be
clear, whereas the consequences of changes that are costly, uncertain, or
delayed may be greeted with great skepticism. These hypotheses are
summarized in Figure 4.
These issues raise difficult problems for organizations. In an organization
with a diversity of products in different markets and at different phases in the
dynamic product cycle, there is a serious problem of fitting together the
organizational styles required for each of the stages. A subdivision that may be
the logical functional locus for the introduction of a new product because of
similarity of market may have a hierarchical, bureaucratic organization more
appropriate to a mature old product and therefore be unable to accommodate
itself to the innovation.

TRANSITON FROM RADICAL TO EVOLUTIONARY

INNOVATION
Although we have discussed the three different patterns of innovation as
distinct modes of change, they are not completely rigid and independent. That
is, each pattern has definable characteristics, but the lines between them tend to
blur in real life. Several examples illustrate how movement from one pattern to
another proceeds.
John Tilton's study (1971) of developments in the semiconductor industry
from 1950 through 1968 indicates that the rate of major innovation decreased
and that the type of innovation shifted. Eight of 13 major product innovations
occurred in the first 7 years of that period, during which time the industry was
making less than 5 percent of its total 18-year sales.
Two types of enterprise can be identified in this early period—established
units that came to semiconductors from vested positions in vacuum tube
markets, and new entrants such as Fairchild Semiconductors, IBM Corporation,
and Texas Instruments Inc. The established units responded to competition from
the newcomers by emphasizing process innovations, whereas the newcomers
sought entry and strength through product innovation. The three successful new
entrants just listed were responsible for half of the major product innovations
and only one of the nine process innovations Triton identified in that 18-year
period; however, the three principal established units (divisions of General
Electric, Philco, and RCA) made only one-quarter of the product innovations in
the same period. Here, process innovation did not prove to be an effective
competitive stance; by
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1966, the three established units together held only 18 percent of the market,
whereas the three new units held 42 percent. Since 1968, however, the basis of
competition in the semiconductor industry has changed; as costs and
productivity have become more important, the rate of major product innovation
has decreased, and effective process innovation has become an important factor
in competitive success.
Like the transistor in the electronics industry, the DC-3 stands out as a
major change in the aircraft and airlines industries. Almarin Phillips (1971) has
shown that the DC-3 was a culmination of previous innovations. It was not the
largest, fastest, or longest-range aircraft; it was the most economical, large, fast
plane able to fly long distances. It was also essentially the first commercial
product of an entering firm (the DC-1 and DC-2 were produced by Douglas in
only small numbers).
The DC-3 changed the character of innovation in the aircraft industry. No
major innovations were introduced into commercial aircraft design from 1936
until jet-powered aircraft appeared in the 1950s. Instead, there were many
incremental refinements to the DC-3 concept, which lowered airline operating
costs per passenger-mile an additional 50 percent.
The history of the electric light bulb also shows a series of evolutionary
improvements that started with a few major innovations and ended in a highly
standardized commodity-like product (Bright, 1949). By 1909, the first tungsten
filament and vacuum bulb innovations were in place; from then until 1955 there
came a series of incremental changes that dropped the price of a 60-watt bulb
from $1.60 to $0.20 (even with no inflation adjustment), increased the lumens
output by 175 percent, and reduced the direct labor content from 3 to 0.18
minutes per bulb. The production process evolved from a flexible job-shop
configuration, with more than 11 separate operations and a heavy reliance on
the skills of manual labor, to a single machine attended by a few workers.
Product and process evolved in a similar way in the automobile industry
(Abernathy, 1978). During the 4-year period from 1905 to 1909, the Ford Motor
Company developed, produced, and sold five different engines, ranging from
two to six cylinders. Each engine tested a new concept. They were made in a
factory that was flexibly organized, much as a job shop, relying on trade
craftsmen working with general-purpose machine tools that were not the best
then available. Out of this experience came a dominant design—the Model T—
in 1909, and within 15 years, 2 million engines of this design were produced
each year (about 15 million in all) in a facility then recognized as the most
efficient and highly integrated in the world. During that 15-year period there
were incremental, but not fundamental, innovations in the Ford product.
The shift from radical to evolutionary product innovation is a common
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thread in these examples. It is related to the development of a dominant product

design, and it is accompanied by heightened price competition and increased
emphasis on process innovation. Small-scale units that are flexible and highly
reliant on manual labor and craft skills using general-purpose equipment
develop into units that rely on automated, equipment-intensive, high-volume
processes. Thus, changes in innovative pattern, production process, and scale
and kind of production capability all occur together in a consistent, predictable
way.

DYNAMICS OF A SET OF COMPETING PRODUCTIVE UNITS

Creative synthesis of a new product innovation by one or a few firms may
result in a temporary monopoly, high unit profit margins and prices, and sales
of the innovation in those few market niches where it possesses the greatest
performance advantage over competing products. As volume of production and
demand grows, and as a wider variety of applications is opened for the
innovation, many new firms enter the market with similar products.
The appearance of a dominant design shifts the competitive emphasis to
favor those firms with a greater skill in process innovation and process
integration, and with more highly developed internal technical and engineering
skills. Many firms will be unable to compete effectively and will fail. Others
may possess special resources and thus merge successfully with the ultimately
dominant firms, whereas weaker firms may merge and still fail.
Eventually, the market reaches a point of stability, corresponding to the
specific state, in which there are only a few firms—four or five is a typical
number from the evidence reviewed to date—having standardized or slightly
differentiated products and stable sales and market shares. A few small firms
may remain in the industry, serving specialized market segments, but, as
opposed to the small firms entering special segments early in the industry, they
have little growth potential. Thus, it is important to distinguish between small
surviving firms and small firms that are new entrants, and to keep in mind that
the term "new entrants" includes existing larger firms moving from their
established market or technological base into a new product area.
Mueller and Tilton (1969) were among the first to present this hypothesis
in its entirety. They contend that a new industry is created by the occurrence of
a major process or product innovation and develops technologically as less
radical innovations are introduced. They further argue that the large corporation
seldom provides its people with incentives to introduce a development of
radical importance; thus, these changes tend to be de
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veloped by new entrants without an established stake in a product market

segment. In their words, neither large absolute size nor market power is a
necessary condition for successful competitive development of most major
innovations.
Mueller and Tilton contend that once a major innovation is established,
there will be a rush of firms entering the newly formed industry or adopting a
new process innovation. They hold that during the early period of entry and
experimentation immediately after a major innovation, the science and
technology on which it depends are often only crudely understood, and that this
reduces the advantage of large firms.
However:

As the number of firms entering the industry increases and more and more
R&D is undertaken on the innovation, the scientific and technological frontiers
of the new technology expand rapidly. Research becomes increasingly
specialized and sophisticated and the technology is broken down into its
component parts with individual investigations focusing on improvements in
small elements of the technology [Mueller and Tilton, 1969, p. 576].

This situation clearly works to the advantage of larger firms in the

expanding industry and to the disadvantage of smaller entrants.
Staples, Baker, and Sweeny (1977) have summarized several clear
parallels between the present theory and Mueller and Tilton's hypotheses:

The Utterback and Abernathy model holds implications for organizational

structure, just as Mueller and Tilton's does for the composition of an industry.
A comparison of the two will show a number of similarities. Both describe a
continuum. The stages roughly correspond. Both emphasize the shift of the
basis of competition from performance and technological characteristics to
price and cost considerations. In both, the evolution is accompanied by an
expanding market, increasing importance of production process investment,
and a progression from radical to incremental product and process innovation.
In general, they describe a progression from a state of flux with rapid
technological progress to an ordered situation with cumulative incremental
changes. Although they emphasize different aspects of innovation from
different perspectives, the models are consistent [Staples et al., 1977, p. 12].

Both this work and that of Mueller and Triton contend that as an industry
stabilizes—that is, as technological progress slows down and production
techniques become standardized—barriers to entry increase. The most attractive
market segments will already be occupied. As process integration progresses,
the cost of production equipment rises dramatically. Product prices will fall
concurrently, so that firms with the largest market shares will be the ones to
benefit from further expansion. Product differentiation will usually be
increasingly centered around the technical strengths and R&D organization of
the existing firms. Strong patent positions established by earlier entering firms
become difficult for later entrants to circumvent.
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Finally, an existing distribution network may also be a powerful barrier to

entry, particularly to foreign firms.
Another hallmark of stability is the emergence of a set of captive suppliers
of equipment and components. Although such suppliers can be an initial source
of innovation and growth, they ultimately may become a conservative force,
further stabilizing the competition and change within the product market
segment, and creating yet another barrier to entry.
A final characteristic of the evolution toward stability is a concerted drive
among the surviving firms toward vertical integration from materials production
to sale. This integration may take various forms. Firms producing the product
can reach backward to furnish more of their own components, subassemblies,
and raw materials, or the firms producing components can reach forward to do
more of the assembly and production of final goods for the market. Such
dramatic changes will clearly have ripple effects on firms that buy from or sell
to the evolving set of productive units. It is just at the point of stability in which
firms get locked into narrow positions that they also ultimately increase their
vulnerability. An existing distribution network can suddenly be threatened by a
new technology that requires sharply reduced servicing or maintenance, or by
the entrance of a large product line. An existing patent may expire. Although
Mueller and Tilton contend that industries become stable when patent positions
expire, the present argument is that this is more likely to be a period of invasion
of the industry by a new wave of product and process change—or, in a few
cases, the revitalization of the dominant technology itself.
The development of a set of productive units is expected to begin with a
wave of entry gradually reaching a peak about when the dominant design of the
major product emerges, and then rapidly tapering off. This sequence is followed
by a corresponding wave of firms exiting from the industry. The sum of the two
waves—entries and exits—will yield the total number of participants in the
product market segment at any point. Therefore, the number of participants in
an industry can be represented by a curve that starts with a gentle rise
representing the first few fluid productive units entering the business followed
by a much sharper rise that represents a wave of imitating firms. The point at
which a dominant design is introduced in the industry is followed by a sharp
decline in the total number of participants until the curve of total participants
reaches the stable condition with a few firms sharing the market.
We will now turn to a discussion of the auto industry, which exhibits such
a wave of change.1 We will then turn to the question of successive waves of
entry, and again present specific examples that illustrate the applicability of the
model.
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THE AUTOMOBILE
More than 100 firms entered and participated in the American automobile
industry for a period of 5 years or longer. Figure 5 shows the wave of entry that
began in 1894 and continued through 1950, followed by a wave of exits
beginning in 1923 and peaking only a few years later, although it has continued
until the present day.

Figure 5
Entry and exit of firms in the U.S. automobile industry: 1894-1962.
Data from Fabris (1966).
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As hypothesized, entry began slowly but then accelerated rapidly after

1900, reaching a peak of 75 participants in 1923. In the next 2 years, 23 firms,
nearly a third of the industry, left or merged, and by 1930, 35 firms had exited.
During the ensuing depression, 20 more firms left.2 There was a brief flurry of
entries and then exits immediately after World War II, but as Figure 5 shows,
the number of firms in the industry was relatively stable from 1940 through
1960.
The number and scope of major product innovations are reflected in this
pattern of entries and exits. In 1923, the year with the largest number of firms,
Dodge introduced the all-steel, closed-body automobile. The large number of
exits over the next few years corresponds to the fact that by 1925, 50 percent of
United States production was closed steel-body cars, and by 1926, 80 percent of
all automobiles were of this type. The post-World War II stability in market
shares and number of firms reflects the fact that approximately three-quarters of
the major product innovations occurred before the start of the war.3
Innovations in product accessories and styling concepts were tested in the
low-volume, high-profit luxury automobile. Conversely, incremental
innovations were more commonly introduced in lower-price, high-volume
product lines. General Motors led in both types of innovations, particularly for
major product changes. In certain years, engines show a higher annual
magnitude of changes; these changes, however, occur with less frequency than
those in chassis characteristics; body productive units are more flexible and
continuously changing than engine plants, which tend to change occasionally in
an integrated and systematic way.4

COMPARATIVE ANALYSIS
As a productive unit develops, its reliance increases on outside sources for
production process equipment and components. Firms in the auto industry, for
example, developed an early and increasing reliance on suppliers for many
types of equipment and innovations (Abernathy, 1978, pp. 60-61).
Development of relationships with suppliers, and of a captive set of
suppliers, is a hallmark of all the evolving product market segments cited. For
example, during the 1890s George Eastman was helped greatly by the
availability of high-quality papers and chemicals, some of which had been
developed for the earlier dry-plate photographic market; he was also assisted by
the rapid increase in the number of firms manufacturing cameras. Several such
firms were subcontracted by Kodak to manufacture camera backs and shutters
to Eastman's design. Similarly, during the 1970s the large number of companies
assembling electronic calculators were
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greatly aided by the availability of high-quality components with declining

prices from semiconductor manufacturers. However, in both these examples,
these strengths eventually became weaknesses. Established competitors tried to
bankrupt Kodak by capturing the two or three sources of high-quality
photographic paper, thus drying up his supply. Then, unexplained quality
variations in the celluloid that he purchased combined with other circumstances
to make several months' production of film useless. Finally, financial weakness
and instability among the various firms manufacturing cameras threatened to
make it difficult and expensive for Kodak to provide cameras to customers.
These events pushed Eastman first in the direction of producing its own
photographic paper, then its own chemicals, and finally its own cameras,
camera backs, and shutters (Bright, 1949; Jenkins, 1975).
Advantages also turned to disadvantages in the calculator industry when
rapid reductions in the price of semiconductors caused enormous inventory
losses for firms that were purely assemblers. As the production capacity of
semiconductor manufacturers increased and production costs dropped further,
virtually all the value-added in the calculator occurred in the manufacture of its
components; these firms simply integrated forward to provide the entire
calculator for the user (Majumdar, 1977). Thus, while suppliers may play a
highly creative role as a set of productive units develops, there will also be a
drive among producing firms to capture those elements of supply that create the
greatest uncertainties for them.
However, it should be pointed out that the most innovative producers
always seem to provide some of their own production equipment. Abernathy
(1978) and Fabris (1966) show that General Motors and, especially, Ford have
made continuing process innovations. In the semiconductor industry, Texas
Instruments, in particular, has stressed production process innovation and
integration, and Tilton's data (1971) show a pronounced shift toward process
innovation by new firms as the industry developed and as their market shares
expanded.
In summary, those firms that survive the introduction of a dominant design
appear to be those that integrate vertically or establish the closest supplier
relationships. Sometimes, it is the supplier who integrates forward, rather than
an early manufacturer who integrates backward, that dominates the market. As
Abernathy observed:

The degree of vertical integration is not static as long as major product changes
are taking place. It is rather the equilibrium condition of a continuous effort to
extend integration backward in the face of the constant erosion caused by
product change. As the technology of product design advances so that novel
changes [are] made less necessary, vertical integration can be maintained
without such continuous effort [Abernathy, 1978, pp. 110-111].
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Examining market structure during waves of change indicates that firms

that are highly integrated are the most vulnerable to functional technological
competition, for they have developed stable production processes and sources
of supply and thus have a major commitment to the existing technology
(Utterback and Kim, 1986). They may view the new technology or product as
either highly specialized with a narrower and small market or as an inferior
good, also with narrow market appeal. For example, all the major vacuum tube
firms adopted the transistor for traditional applications of tubes. Gene Strull of
Westinghouse Electric Corporation has been quoted by Braun and MacDonald
(1978) to the effect that probably every major older company began the use of
transistors in the divisions that had been making tubes for the same purposes.
Stroll claims that this practice handicapped the introduction of semiconductors
because it made them look like a replacement for the tube; it was a few years
before people started to look and see what the transistor could do in its own right.
All major mechanical calculator firms were early entrants in the electronic
calculator business. However, they emphasized the complexities of the
electronic calculators, and produced them only for the most difficult and limited
scientific applications, not in broader and simpler lines for use in business
(Majumdar, 1977).
The major mechanical typewriter firms were early entrants in the
manufacture of electric typewriters but did not continue with their innovations
after World War II. The government played a role here in that it directed the
typewriter companies to manufacture various types of arms for the war effort
and specifically enjoined them from making typewriters. Since IBM
Corporation was not in a critical labor supply area, it was allowed to continue
manufacturing electric typewriters, nearly all of which were placed in
government and military offices. This not only allowed IBM to expand its
technical capability and market share, but it also introduced a wide variety of
people to use of the new electric typewriter. When IBM's competitors reentered
the new business after the war, they all did so with their traditional mechanical
designs (Engler, 1965).
Finally, companies producing woven carpets of wool were placed at a
double disadvantage by the innovation of tufted carpeting using synthetic fibers.
Finns producing woven woolen carpets had strong ties with wool suppliers and
controlled, through purchases, nearly the entire wool market. Synthetic
materials not only enabled the new tufting technology to be highly productive,
but they allowed the carpet market to expand dramatically with falling, rather
than rising, marginal costs, an experience that was foreign to the manufacturers
of woven carpets (Reynolds, 1967).
The previous examples have shown how firms enter and leave an industry
in parallel with product innovation in that industry. In the fluid state, while
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product requirements are still ambiguous, there will tend to be a rapid entry of
firms and few failures. As the industry enters the transitional state, and product
requirements become more defined, fewer firms enter and a larger number
either may merge or fail. Finally, as the industry enters the specific state, there
are only a few large firms, each controlling a consistent share of the market, and
possibly a few small firms serving highly specialized segments.

INNOVATION, ORGANIZATIONAL STRUCTURE, AND

INTERNATIONAL TRADE
The literature on technology and international trade has shown that shifts
in innovation and industry structure are tied to shifts in the location of
production and flows of trade. Louis Wells (1972) finds that trade varies with
the product life cycle as follows: Innovation occurs and production begins in the
country with the largest and most demanding market for a product—typically
the United States. Exports quickly begin to serve mid-scale markets—Europe
and Japan. Production then begins in the early export markets with the focus of
exports starting to shift to less well developed markets, such as South America.
Europe and Japan begin exporting to developing countries in competition with
the United States while manufacturing begins in those countries also.
Ultimately, producers in developing nations begin exporting back to Europe,
Japan, and the United States. An essential point of this argument is that once a
product becomes a commodity and the technology stabilizes—that is, when it
enters the specific state—maintaining control of production becomes
increasingly difficult. This is especially so if other countries have great
advantages in factor costs, including materials and energy as well as labor.
Conversely, if technology is rapidly changing, innovation and manufacture are
much more likely to occur close to users. Freeman (1968) has linked this
phenomenon to the export of process equipment. Hekman (1980) has shown
that the rapid advance of textile technology led manufacturers to cluster around
Boston in the 1830s. He further shows that as production technology stabilized,
the industry became widely dispersed in part through the export of now-
standardized textile equipment from Boston.
Linsu Kim (1980) has pursued a similar hypothesis in reverse in the
contemporary and international setting of the Korean electronics industry. He
found that the industry became established in Korea through transfers of
standardized technology to firms having both the strategy and the organization
capable of absorbing it. Later, these firms began to produce variations in
product and process. The learning and adjustment engendered by the firms'
incremental innovations help to create an organization that
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 43

may become ''innovation viable,'' that is, an organization able to succeed in

making product changes in larger steps and to compete on a more equal and
independent footing in export markets.
Nearly all these examples point to the hypothesis that entering early is the
most viable strategy for a firm. If we based our assessment of technological and
market dynamics strictly on U.S. business history, it would be hard to disprove
this hypothesis. For example, carbon-filament incandescent lamps replaced gas
lighting; they themselves were replaced by metal-filament incandescents and
later by fluorescent lighting. The Edison Company and the Swan Lamp
Company were the innovators in carbon-filament lamps, but only an
insurmountable patent position in other aspects of lamp manufacture allowed
Edison to overcome new firms that adopted metal filaments earlier than it did.
Sylvania in the United States was the first to innovate with fluorescent lighting,
and it increased its market share from 5 to 20 percent at General Electric's
expense. Harvested, naturally formed ice for refrigeration was replaced by
machine-made ice and later by mechanical refrigeration; it was not the ice-
harvesting companies that innovated in mechanical means of ice production,
nor was it the companies producing ice and ice boxes who innovated in the area
of electromechanical refrigeration. Finally, in the 20 years from 1889 to 1909,
Eastman Kodak's share of the U.S. photographic market went from 16 percent
to 43 percent at the expense of established makers of dry photographic plates,
because of its innovation of celluloid roll film.
Whereas some investigators of technology and corporate strategy in the
United States have emphasized the value of early entry with an innovation,
Harvey Brooks writes:

The typical pattern of Japanese success has been rapid penetration of a narrow,
but carefully selected segment of a broad, expanding world market in which
superiority in production efficiency, economies of scale, and exploitation of
learning curve effects were particularly important. By expanding more
aggressively than its U.S. competitors and anticipating learning curve
improvements and economies of scale further into the future in its pricing
strategies, Japan has been able to capture an important share of the market for
selected products just behind the current technological frontier. They have then
broadened out from this point in the middle technology spectrum and moved
gradually toward more sophisticated and higher value-added products in the
same or a closely allied market segment. Willingness to plunge in and adopt a
new technology on the basis of its ultimate promise before it was proven to be
cost-effective has been combined with careful and thorough .scanning of
related world technological developments for their possible competitive threat
or promise [Brooks, 1985, p. 330].

The success of Japanese firms in U.S. markets for automobiles and steel
raises a variety of questions about business strategies in technologically
dynamic product markets. Clearly, in the past each wave of radical product
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INNOVATION AND INDUSTRIAL EVOLUTION IN MANUFACTURING INDUSTRIES 44

change has brought with it the entry of new firms—either small, technology-
based enterprises or larger firms carrying their technical skills into the new
product and market areas—and these firms may dominate the restructured
industry. The Japanese example, however, shows that productive units can
pursue widely different strategies as long as the strategy is matched to the state
of evolution of the technology. Clearly, the dynamics of technological change
in relation to corporate strategy and international competition are fruitful areas
for further work. This is especially so in the light of changing organizational
forms and the increasing integration of production across national boundaries,
issues discussed by Doz and Teece in subsequent chapters in this volume.

SUMMARY
In summary, to understand how the development and diffusion of
technology affects national productivity and competitiveness, it is essential that
we understand the linkages of product technologies with manufacturing process,
corporate organization and strategy, and the structure and dynamics of an
industry. Lacking balance and integration among all essential factors means that
by investing heavily in one area, a firm could allow its competitors to exploit
the new product or process technology first.
Focusing on manufacturing (or product development, or finance) alone is
wholly insufficient. Product design for manufacture, change in organization,
and appropriate strategy are also prerequisites for competitive strength. By the
same token, potential for product innovation and competitiveness depends
increasingly on ability to innovate in manufacturing processes. Finally, there
exists a hierarchy of productive units—a product for one is part of the process
for another and therefore affects productivity directly. Productivity at the final
use stage is strongly affected by the vitality of productive units at earlier stages.
Lack of responsive suppliers of equipment and components will seriously
constrain advances in ultimate products and systems. Moreover, it is not clear to
what degree a nation can import process equipment and assume that its long-run
competitive and innovative strengths will not be eroded.
With regard to industry structure, appearance of a dominant design shifts
emphasis to manufacturing for survival. Those who fail to shift will usually not
survive. The dominant design should address world markets and standards to be
most competitive (see Lehnerd in this volume). Similarly, it is a mistake in
competition to automate too soon or too extensively. Doing so may reduce
flexibility in the face of continuing product change and may leave a firm with
heavily capitalized plants that are obsolete the day they come on stream.
Tailored manufacturing approaches that allow
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needed flexibility in product characteristics are often hallmarks of the most

successful and competitive firms.
As a product design stabilizes, diffusion of technology is inevitable
through movement of skills and people as well as advanced equipment.
Architectural rebuilding of industry is constantly required; a vital area for
research is the discovery of means through which large and established
organizations can constantly and creatively renew their businesses. In an
organization with a diversity of products in different markets and at different
phases in the dynamic product cycle shown in Figure 1, there is a serious
problem of fitting together the organizational styles required for each of the
different stages. A subdivision that may be the logical functional locus for the
introduction of a new product because of similarity of market may have a
hierarchical, bureaucratic organization more appropriate to a mature old product
and therefore be unable to accommodate itself to the innovation. This may have
been one of the main reasons why vacuum tube divisions that initially seemed
to be at the forefront of transistor and semiconductor technology (where they
benefited from government support) were unable to become the leaders in the
market for this technology when it moved from the fluid sage to the transitional
sage. Purely entrepreneurial strategies may no longer be sufficient for
successful entry. Rather, creative coalitions blending the strengths of both new
and established firms may be required for success in a more international
competitive arena.

ACKNOWLEDGMENTS
I am especially indebted to the late William J. Abernathy. Our
collaboration led to many of the ideas and findings expressed here. Many others
were originated by him and are explored in the context of the auto industry in
his book The Productivity Dilemma (Baltimore: Johns Hopkins University
Press, 1978). This report is based on work supported by the National Science
Foundation, Division of Policy Research and Analysis under Grant No. PRA
76-82054 to the Center for Policy Alternatives at the Massachusetts Institute of
Technology.
I also owe a special debt to both Harvey Brooks and Bruce Guile. The
original manuscript for this was written in 1982 as part of the above-mentioned
project. Harvey Brooks provided an extensive and challenging commentary on
the manuscript. Many of his questions are addressed in pan here, much
improving the resulting document, but many remain to be addressed. Bruce
Guile helped far beyond any reasonable expectation not only in thoroughly
editing the manuscript but in providing essential suggestions, advice, and
encouragement.
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NOTES

1. Many other examples also could be cited to support these hypotheses. For example, Arthur
Bright's work (1949) on invention and innovation in the electric lamp industry cites detailed
statistics on firms' entrances and exits, and he gives elaborate histories of the major firms—
Westinghouse, the Thompson-Huston Company, and the Edison Company, the latter two of
which later merged to become General Electric. Phillips (1971) and Miller and Sawers (1970)
provide similar data on air frame and aircraft engine manufacturers; these data have been
summarized in another paper by Linsu Kim (1980). Anderson (1953) gives general figures on
the number of participants in different phases of the American ice and refrigeration industry,
and Jenkins (1975), while concentrating on the Eastman Kodak Company, also discusses the
formation, merges, and demise of many other competing firms.
2. The material in this section is based on a dissertation by Richard Fabris entitled "Product
Innovation in the Automobile Industry," written in 1966. Supplementary information on the
origin and diffusion of different major innovations has been obtained from William Abernathy's
book, The Productivity Dilemma, and on market shares and entry from Burton H. Klein's book,
Dynamic Economics.
3. These figures are somewhat understated because Fabris does not count a firm that merged but
continued in a larger conglomerate as leaving the industry—for example, Cadillac and the
Oakland Company (now Pontiac) are counted as surviving independent firms.
4. Fabris studied 32 major product innovations and found that 70 percent occurred before 1935.
Abernathy (1978) includes three additional major innovations as occurring during this period—
the aluminum alloyed piston, the automatic choke, and disc brakes. Two more of Abernathy's
major product innovations—energy absorbing steering assemblies and 12-volt electrical systems
—follow the 1962 termination of Fabris' analysis, so there is about a two-thirds overlap
between the two studies.

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Anderson, O. E., Jr. 1953. Refrigeration in America: A History of a New Technology and Its
Impact. Princeton, N.J.: Princeton University Press.
Braun, E., and S. MacDonald. 1978. Revolution in Miniature: The History and Impact of
Semiconductor Electronics. Cambridge, England: Cambridge University Press.
Bright, A. A., Jr. 1949. Electric Lamp Industry: Technological Change and Economic Development
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Bright, J. R. 1958. Chapter 1 in Automation and Management. Division of Research, Graduate
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Brooks, H. 1985. Technology as a factor in competitiveness. Pp. 328-356 in U.S. Com
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petitiveness in the World Economy, B. R. Scott and G. C. Lodge, eds. Boston, Mass.:
Harvard Business School Press.
Burns, T., and G. M. Stalker. 1961. The Management of Innovation. London: Tavistock.
Engler, G. N. 1965. The Typewriter Industry: The Impact of a Significant Technological Innovation.
Ph.D. dissertation. University of California, Los Angeles.
Fabris, R. 1966. Product Innovation in the Automobile Industry. Ph.D. dissertation. University of
Michigan.
Freeman, C. 1968. Chemical process plant: Innovation and the world market. National Institute
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Frischmuth, J. S., and T. J. Allen. 1969. A model for the description of technical problem solving.
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Hekman, J. S. 1980. The product cycle and New England textiles. Quarterly Journal of Economics
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Hill, C. T., and J. M. Utterback, eds. 1979. Chapter 2 in Technological Innovation for a Dynamic
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Jenkins, R. V. 1975. Images and Enterprise: Technology and the American Photographic Industry,
1839 to 1925. Baltimore, Md.: Johns Hopkins University Press.
Kim, L. 1980. Stages of development of Industrial Technology in a developing country: A model.
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Klein, B. H. 1977. Dynamic Economics. Cambridge, Mass.: Harvard University Press.
Lawrence, P. R., and J. W. Lorsch. 1967. Organization and Environment. Division of Research,
Harvard Business School. Boston: Harvard Business School .
Majumdar, B. A. 1977. Innovations, Product Developments, and Technology Transfers: An
Empirical Study of Dynamic Competitive Advantage, The Case of Electronic Calculators.
Ph.D. dissertation. Case Western Reserve University.
Miller, R. E., and D. Sawers. 1970. The Technical Development of Modern Aviation. New York:
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Mueller, D.C., and J. E. Tilton. 1969. R&D cost as a barrier to entry. Canadian Journal of
Economics 2 (November):576.
Normann, R. 1971. Organizational innovativeness: Product variation and reorientation.
Administrative Science Quarterly 16 (June):203-215.
Phillips, A. 1971. Technology and Market Structure: A Study of the Aircraft Industry. Lexington,
Mass.: Heath Lexington Books.
Ramstrom, D., and E. Rhenman. 1969. A method of describing the development of an engineering
project. IEEE Transactions on Engineering Management EM-16 (May):58-64.
Reynolds, W. A. 1967. Innovation in the U.S. Carpet Industry, 1947-1963. Ph.D. dissertation.
Columbia University.
Rosenbloom, R. S. 1974. Technological innovation in firms and industries: An assessment of the
state of the art. Harvard Business School Working Paper. HBS 74-8 . Boston: Harvard
Business School.
Staples, E. P., N. R. Baker, and D. J. Sweeny. 1977. Market Structure and Technological
Innovation: A Step Towards a Unifying Theory. Final Technical Report. NSF Grant RDA
75-17332, November.
Tilton, J. E. 1971. International Diffusion of Technology: The Case of Semiconductors.
Washington, D.C.: The Brookings Institution.
Utterback, J. M. 1975. Innovation in industry and the diffusion of technology. Science 183:620-626.
Utterback, J. M. 1978. Management of technology. Pp. 137-160 Studies in Operation Management,
Arnoldo Hax, ed. Amsterdam: North Holland.
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Utterback, J. M., and W. J. Abernathy. 1975. A dynamic model of process and product innovation.
Omega 3(6):639-656.
Utterback, J. M., and L. Kim. 1986. Invasion of a stable business by radical innovation. Pp. 113-151
in The Management of Productivity and Technology in Manufacturing. New York:
Plenum Press.
Vernon, R. 1966. International investment and international wade in the product cycle. Quarterly
Journal of Economics 80(2):190-207.
von Hippel, E. 1977. The dominant role of the user in semi-conductor and electronic subassembly
process innovation. IEEE Transactions on Engineering Management EM-24 (May):60-71.
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Mass.: Harvard Business School.
White, G. R. 1978. Management criteria for effective innovation. Technology Review 80(4):14-22.
Technology and Global Industry: Companies and Nations in the World Economy
REVITALIZING THE MANUFACTURE AND DESIGN OF MATURE GLOBAL 49
PRODUCTS

Revitalizing the Manufacture and Design

of Mature Global Products

ALVIN P. LEHNERD

Manufacturing enterprises are evolutionary entities. Over time, their

product portfolios expand through evolutionary and chronological
developments. Products are usually designed and developed one at a time. As a
result, it is the exception when the designs of a manufacturer's products
embrace much compatibility, standardization, or modularization. The norm is
that product portfolios are rarely designed simultaneously; designs take place in
a sequential manner. Additionally, many current products of U.S. manufacturers
were designed and tooled years ago, yet prevailing labor rates, manufacturing
processes, energy costs, availability of materials, and interest rates are often
significantly changed from the time of the original product design and tooling
activities. It is rare that a U.S. manufacturer invests the time and resources
necessary to rationalize production of an entire product line to fit the changing
economic environment and to take advantage of opportunities provided by
technological advance.
Manufacturers usually design for function, then redesign for
manufacturing; thus, two design iterations usually take place. If an enterprise
wishes to maintain or gain market share in global markets, the firms' managers
and technical personnel must learn to combine manufacturing with innovation
in product design. Few enlightened companies take time for a third design
iteration to automate and mechanize production for global leadership in cost
and value.
In many, if not all, instances, design for manufacturing is also constrained
by the existing resources of plant and equipment. In other words, manufacturing
engineers guide the design decisions to match the profiles
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and capabilities of their existing factories and their respective in-house

capabilities. Inplace facilities are frequently barriers to product innovations.
Fixed capital investments in existing capabilities are also barriers to more
advanced lower-cost processes. Organizations commonly ignore what the
production cost could be if their products were not shackled to outdated
manufacturing processes and could also use state-of-the-an materials requiring
new processes and procedures.
An additional issue is that few U.S. domestic manufacturers look at their
product offerings as global opportunities. This domestic myopia— the belief
that the marketplace ends at the U.S. borders—is a problem for U.S. industry,
and the problem will only get worse as the world becomes more economically
integrated.
Finally, corporate planning horizons are too short, and manufacturers
seldom ask themselves what they are doing to ensure their longevity in the
business. Too many managements or boards of directors do not act until
external influences cause significant disruptions and spur the organization into
action.
This chapter presents a case history of a 1970s program at Black & Decker
Corporation to redesign a product line for production automation and leadership
in cost and value. The program was an effort to redesign standard products to
take advantage of opportunities for using new materials and new manufacturing
and design techniques.

BLACK & DECKER

When managers at Black & Decker Corporation observed growing global
competition in the 1960s and 1970s, they decided that a window of opportunity
existed to improve their product lines and manufacturing capability. Moreover,
they decided that if they did not take time to do it right the first time, they
would never have the time or resources to do it over. They recognized that if
they were to be a domestic manufacturer with aspirations to do business
internationally 20 years hence, they would have to change the business in a way
that would ensure that long-range performance. This involved making certain
irrevocable decisions.
The impetus for change came from three sources. First, it was evident that
foreign competition would increase in Black & Decker's product markets and
that this would lead to foreign participation in new, related product markets.
Second, in the 1970s, inflation in costs of labor, material, services, and
capital goods was a serious consideration. Table 1 shows the effect of inflation
in the labor component of product costs. It assumes an 8 percent compounded
inflation rate over five periods from year 1 to year 6. To
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maintain constant labor-cost content in the product, one-third of the labor has to
be removed from the product between period 1 and period 5. In Black &
Decker's assessment, offsetting inflation in labor costs depended on making
better use of labor in adding value through design standardization,
mechanization, automation, better use of material and floor space, and
intelligent capital planning.
TABLE 1 Impact of Wage Inflation on Labor Costs (8 percent compounded inflation)
Year Hourly Wage ($) Labor Minute Value of $3.00
1st 3.00 60.0
2nd 3.24 55.5
3rd 3.50 51.5
4th 3.78 47.6
5th 4.08 44.1
6th 4.41 40.8
The third factor in Black & Decker's decisions was an anticipated
continued public attention to consumer protection and environmental concerns.
In the power tool industry, this attention took the form of requirements for
double insulation of tools. The term "double insulation" refers to the additional
insulation barrier placed in an electrical device to protect the user from
electrical shock if the main insulation system ever fails. In the late 1960s there
was a strong possibility that double insulation of domestic power tools would be
legally required. Black & Decker decided that the threat of required double
insulation provided an opportunity to study the entire product line.
The program begun at Black & Decker in the early 1970s was called
Double Insulation. All consumer power tools were to be redesigned at the same
time and would initially be manufactured in various locations in North America
with standardized pans and components.
Double Insulation was Black & Decker's vehicle to redesign the line and
develop a "family" look, simplify the product offering, reduce manufacturing
costs, automate manufacturing, standardize components, incorporate new
materials, improve product performance, incorporate new product features, and
provide for worldwide product specifications. The program was designed to
incorporate double insulation on 122 basic tools with hundreds of variations. Of
18 tool groups manufactured by Black & Decker, 8 contributed 73 percent of
sales, 71 percent of earnings, and 91 percent of units sold. These groups were
tools and drivers, jig saws, shrub and hedge trimmers, hammers, circular saws,
grinders and polishers, finishing sanders, and edgers.
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Many of Black & Decker's U.S. competitors that had already introduced
products with double insulation had incurred a 15 to 20 percent premium in
material and labor costs in doing so. It was Black & Decker's goal to add double
insulation without increasing the cost of any new tool beyond that of the
existing product. In addition, of course, Black & Decker aimed to avoid dilution
of assets or return on investment.
In this instance, Black & Decker's decision to introduce fundamental
redesign throughout its product line was motivated by the prospect of an
industrywide requirement to incorporate double insulation in power tools. At
other times, competitive product analysis plays .an important role in decisions
to redesign (the Appendix to this chapter describes a competitive product
analysis carried out by the Sunbeam Appliance Company).
An important part of the plan for Double Insulation was the decision that
the resources of the organization would be concentrated on this transition. Black
& Decker would leave only a small portion of its management and engineering
staff to carry out development efforts on new products. The development of
new products was put in abeyance, and the resources usually devoted to
development were focused on the manufacturing processes essential to the
program.
To accomplish the engineering goals, a bridge was needed between design
engineering and manufacturing. That bridge was the placement of advanced
manufacturing engineers in residence at headquarters to work elbow to elbow
with the design engineering groups. These manufacturing

Figure 1
Financial analysis of Double Insulation program.
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engineers were involved with machine development, process development,

value and cost engineering, purchasing engineering, and packaging. In addition
to bringing manufacturing and design together at the engineering level, the
basic structure of the company was changed. Before these changes were made,
the program structure had consisted of a general manager and two vice
presidents— one for manufacturing, and one for engineering and product
development. That organization was changed, and a new position—vice
president of operations—was developed to combine manufacturing, product
development, and advanced manufacturing engineering under one manager.

Figure 2
Investment requirements for Double Insulation program.

A final general point about the Double Insulation program was the large
investment required and the long time horizon needed to reap a return on that
investment. As Figure 1 shows, the break-even point in the program came
nearly 7 years after the program began, and total cost was $17 million. Figure 2
shows the cumulative cost of the program from 1971 through 1975. Capital
expenditures were $5 million. tooling was $5.5 million, and development
engineering and manufacturing technology were $1? million each. It is
important to note that this program is rare from the standpoint that as much
money was spent on manufacturing technology as on development engineering.
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Designing For Manufacture

The transition to Black & Decker's leadership in cost and value was the
result of collaborative effort among design, manufacturing, and manufacturing
engineering functions. The changes in design and production of motors are one
example of this collaborative effort.
The most common component in all power tools is the universal motor.
Figure 3 shows all the components of such motors before redesign. Figure 4
shows the motor configuration both before and after redesign. Motors are now
manufactured automatically, untouched by human hands. The laminations,
placed at the head of the mechanized line, are stacked, welded, insulated,
wound, varnished, terminated, and tested automatically. Table 2 shows, at 1974
volumes of 2,400 pieces per hour, that the new Double Insulation
manufacturing system required 16 operators and that the old design would have
required 108 operators. Material, labor, and overhead cost $0.51 in the old
system and $0.31 in the new. The labor content cost $0.02 in the new system,
down from $0.14 in the old.
Through attention to standardization, the entire range of Black & Decker
power tools could be produced using a line of motors that vary only in stack
length—that is, standardization froze the dimensional geometry of

Figure 3
Electric motor field components.
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PRODUCTS

the motors in the axial profile. All motors can now be produced on the same
machines, and the only difference is stack length and the amount of copper and
steel used. As Figure 5 shows, designs ranged from 60 watts to 650 watts, and
the only dimension that changed was in the axial profile. The only difference in
cost from the low-wattage to the high-wattage motors was the cost of materials
and machine time; labor cost remained the same through the entire wattage
range.

Figure 4
Motor configuration before and after redesign.

TABLE 2 Motor Field Production, Operator Requirements, and Costs at 2,400 Units
per Hour, Old and New Design and Manufacturing Process
Old Design and New Design and
Manufacturing Process Manufacturing Process
Operators to produce 108 16
Cost to insulate $0.51 $0.31
(materials, labor,
overhead)
Labor cost $0. 14 $0.02
Capital to produce $400,000 $1,222,000
Annual savings (labor and materials only): $1,280,000
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Figure 5
Motor stack length, 60 to 650 watts.

Another effect of design for manufacture can be seen in the production

costs for the armature of the motors. As Table 3 shows, four times as many
operators would have been needed to produce armatures under the old system as
under the new system at a constant production volume. The effect on labor costs
was dramatic. The labor cost of the manufacture using the new design was only
$0.025 cents per unit, whereas the cost using the old design was $0.108 per unit.
TABLE 3 Armature Production, Operation Requirements, and Costs at 1,800 Units
per Hour, Old and New Design and Manufacturing Processes
Old Design and New Design and
Manufacturing Process Manufacturing Process
Operators to produce 60 15
Cost to insulate $0.26 $0.11
(materials, labor,
overhead)
Labor cost $0.108 $0.025
Capital to produce $2,340,000 $795,000
Annual savings (labor and materials only): $540,000
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The Results Of Double Insulation

The Double Insulation program worked for Black & Decker. It reduced
production costs, created opportunities for profitable vertical integration,
increased market share, and improved the company's capability for new product
development. Each of these changes is discussed further in the following
sections.

Cost Reductions
Cost reductions due to the Double Insulation program came mostly from
labor savings, and the balance came from reduced factory overhead, material
savings, and savings from standardization of parts and modularization. In 1976
Black & Decker reviewed the program and compared existing equipment and
labor costs with the capital equipment and labor costs that would have been
required for the 1976 volume without the Double Insulation program (see
Table 4). If the company had not carried out this program, estimated 1976
requirements for motor manufacture would have been nearly 600 people
whereas the new system required only 171. That is a labor cost difference—
from $6.4 million down to $1.8 million—of $4.6 million per year. The capital
investment for the new system was higher than simple capital replacement—
$4.6 million instead of $3.0 million—but with labor savings of $4.6 million per
year, the payback on the investment was 4 months.
In its 1974 annual report, Black & Decker published its assessment of
TABLE 4 Comparison of Labor and Capital Requirements for Electric Motor
Production, 1972 and 1976 Volumes, Old and New Designs
1972 Volume 1976 Volume
Workers required
Old design 242 596
New design 86 171
Annual labor cost
Old design $2,700,000 $6,400,000
New design $ 900,000 $1,800,000
Annual labor savings $1,800,000 $4,600,000
Capital costa
Old design $1,300,000 $3,000,000
New design $2,300,000 $4,600,000
Capital cost difference $1,000,000 $1,600,000
Payback 1.25 years 4 months
a Includes floor space at $20/sq. ft.
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the effect of this project on four basic power tools (Figure 6). In current dollars,
Black & Decker's power drills, for example, were $10 cheaper in 1973 than
they were in 1958.

Figure 6
Prices, 1958 and 1973, of four basic hand power tools.

Figure 7 shows substantial reductions in the real cost of Black & Decker's
products. The constant-dollar cost of products A, B, and C dropped by 47, 62,
and 55 percent, respectively. The company was able to produce each product at
an almost constant current dollar cost despite steady inflation in materials and
labor costs. For Black & Decker's pricing position in the marketplace, the
relevant comparison is between the top two lines on each graph, which show the
difference, in current dollars.. between manufacturing costs with and without
Double Insulation.

Increased Vertical Integration

The cost and value leadership permitted unprecedented low prices to the
consumers and thereby expanded Black & Decker's market share and increased
household penetrations of power tools. The expanded volume resulted in
opportunities for cost-effective vertical integrations. Examples include:
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• Use of plastic materials grew from thousands of pounds per year to

millions of pounds per year. Black & Decker's molding facilities were
able to justify railcar bulk shipment of uncolored plastics resulting in a
cost advantage of 5, 10, and sometimes 15 percent per pound. The
coloring of plastic compounds at the molding machine reduced
inventories, provided instant response to color changes, and eliminated
material handling.
• The standardization of gears, and design revisions that allowed the
change to spur gears from bevel gears, permitted the use of gears made
from powdered metal. This change eliminated the need for gear cutting
and bobbing, heat treating, and gauging. These activities all
contributed to high capital cost, high labor cost, and inefficient use of
material in production. The volumes were large enough to permit
vertical integration of fabrication of powdered metal gears.
• Before the Double Insulation program, 29 percent of the total cost of a
drill was in the cost of a purchased chuck. Production volumes, again,
coupled with a modern state-of-art processing system enabled
backward integration into chuck manufacturing at reduced costs of
about 40 to 50 percent.
• Standardization of bearings, switches, cord sets, cartons, fasteners, and
so on resulted in component volumes high enough to justify seeking
sources on world markets for the best price.

The ''inflation offset'' idea proved to be recursive in that low production

cost permitted low sales price, which increased unit sales, fueled vertical
integration, and further reduced costs.

Competitive Performance And Market Share

In the U.S. market, Black & Decker's competitors in consumer power tools
were caught absolutely fiat-looted. Their product designs and manufacturing
processes were costly, and in an attempt to continue to compete they tried to
match Black & Decker prices. This diluted their profitability and collapsed their
ability to redesign to match Black & Decker. In the resulting shakeout in the
market for consumer power tools, Stanley, Skil, Pet, McGraw Edison,
Sunbeam, General Electric, Wen, Thor, Porter Cable, and Rockwell all left the
consumer market. Sears Roebuck and Co. was able to stay in the domestic
consumer market with Black & Decker.
In the European market, consumer power tools were much more expensive
because the tool offerings were different. European tool producers provided a
power driver in the drill configuration, but all other power tools—sander,
circular saw, hedge trimmer—were sold as attachments. The availability of new
low-cost single-purpose power tools enabled the
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Figure 7(a)

Figure 7(b)
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consumer to eliminate the inconvenience and performance compromise of

attachment technology. Black & Decker performed well throughout Europe as
the new tools both greatly expanded Black & Decker's market share and
increased household penetration.

Figure 7(c)
Figure 7
Product cost trends in current dollars with and without Double insulation and
product cost trend with Double Insulation in constant 1967 dollars for
three products, 1967-1980.

Impact On New Product Development

Another benefit of Black & Decker's efforts was a substantially improved
ability in product development. As new product concepts emerged, much of the
work in design and tooling was eliminated because of the standardization of
motors, bearings, switches, gears, cord sets, and fasteners. Design and tooling
engineers working on a new product had only to concern themselves with the
"business end" of the product and to perfect its intended function. New designs
could be developed using components already
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standardized for manufacturability. The product did not have to start with a
blank sheet of paper and be designed from scratch.
As products reached their maturity and had to be dropped, massive write-
offs and scrapping of tools and equipment were avoided because there were few
special-purpose tools or equipment. This flexibility allowed marketers and
managers to pivot quickly and avoid being tied to a dying product because they
could not afford the write-offs.
In short, the pace of new product development and product retirement was
greatly accelerated. Products could be introduced, exploited, and phased out
with minimal expense related specifically to the decision to develop or retire a
product.

SUMMARY AND CONCLUSIONS

In accomplishing the dramatic cost reductions through the Double
Insulation program, the attitudes of the management were extremely important.
Black & Decker management had a target of 15 percent compounded growth
rate, and they wanted to remain independent and to service world markets. To
do these things, the management focused not on marketing or financial
manipulation, but on cost and value leadership in the industry. The
management, as a team, projected how a successful program of this type could
affect the marketplace and had the courage and tenacity to see it through. Black
& Decker was also fortunate in having a large mount of latent talent: Many
ordinary people proved capable of performing extraordinary tasks. With pricing
and promotional strategies, the corporation was able to provide enough growth
with the product improvements to avoid either reductions or expansions of its
labor force.
Black & Decker's experience with the Double Insulation program shows
the potential benefit of aggressively evaluating the design and production of
"mature" manufactured products. Considered in relation to developed global
markets, advances in materials and manufacturing processes provide
opportunities for redesigning products to decrease the cost and increase the
quality of manufactured goods.
Although the success that Black & Decker had with power tools may not
be replicated in other industries, the principle of redesign and retooling for cost
and value leadership in global markets can provide a focus for other
manufacturing firms. It is a valid approach to achieving global competitiveness
in manufacturing. By this means, U.S. firms can design, develop, and
manufacture world-class products in the United States and at the same time
achieve leadership in product value.
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APPENDIX COMPETITOR ANALYSIS BY SUNBEAM

APPLIANCE COMPANY
In 1982 Sunbeam Appliance Company launched a program aimed at
capturing at least 30 percent of the worldwide market share for the steam/ dry
iron in markets they wished to participate in. The first step was to assess global
production capabilities and methods. Sunbeam obtained samples of competitive
products from around the world for analysis of materials and labor content—
estimated in time, not dollars. Components were reviewed and estimates of
production costs were developed for all of the designs. After this material was
pulled together, project management convened a 2-day review for Sunbeam
engineers from Australia, Germany, England, Canada, Mexico, and the United
Sates to talk over what had been uncovered in this global product evaluation.
That analysis revealed some interesting aspects of the design and
manufacture of steam/dry irons around the world. The number of pans used in
the product ranged from a high of 147 parts to a low of 74 pans. The number of
fasteners ranged from 30 to 16, and the number of fastener types in any one
design ranged from 15 to 9. Sunbeam's existing product used 97 pans with 18
fasteners in 10 configurations. Reducing the cost of that design, incorporating
everything learned from composite design, yielded a design which had 73 parts,
13 fasteners, 7 types.

Figure A-1
Relationship of pan count to material and labor cost per iron.
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To gain a significant share of the market, however, it was necessary to

leapfrog existing products and come up with a design with significantly lower
cost and complexity over competitive offerings. Such a design was developed,
with 51 parts and 3 fasteners in 2 configurations. Figure A-1 makes the point
that driving down the part count also drives down cost.
Although reducing the part count entails a considerable effort in design
engineering, effective design and process engineering will drive down labor and
material costs.
The result of that effort was a composite design that would be the best of
all of the products collected with attention to what the product would cost if the
design were used throughout the world and compatibility were maintained. The
new design is substantially cheaper to produce than either of Sunbeam's existing
designs. The product was launched in 1986.
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Capturing Value From Technological

Innovation: Integration, Strategic
Partnering, And Licensing Decisions

DAVID J. TEECE

Why, and under what circumstances, is the recognized technological

progressiveness of a nation not sufficient to capture the benefits stemming from
its capabilities in science and technology? This chapter examines why firms and
nations can lose ground in the commercialization of advanced technologies at a
time when they are the principal sources for major technological innovations of
industrial significance; the capacity for scientific and technological innovation
may be the last rather than the first advantage that a mature economy loses as it
enters its declining phase.
The framework developed here helps identify the factors that determine
who wins from innovation: The firm that is first to market, follower firms, or
firms that have related capabilities that the innovator needs. The follower firms
may or may not be imitators in the narrow sense of the term, although they
sometimes are. The framework helps to explain the share of the profits from
innovation accruing to the innovating firms and nations compared to its
followers and suppliers.

THE PHENOMENON
A classic example of the phenomenon considered in this chapter is the
computerized axial tomographic (CAT) scanner developed by the U.K. firm
Electrical Musical Industries (EMI) Ltd.1 By the early 1970s, EMI

This chapter is a revised version of a previously published paper by David

J. Teece: "Profiting from Technological Innovation," Research Policy. Vol. 15
(1986), No. 6.
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was in a variety of product lines, including phonograph records, movies, and

advanced electronics. EMI had developed high-resolution televisions in the
1930s, pioneered airborne radar during World War II, and developed the United
Kingdom's first all solid-state computers in 1952.
In the late 1960s, the pattern recognition research of Godfrey N.
Hounsfield, an EMI senior research engineer, resulted in his being able to
display a scan of a pig's brain. Subsequent clinical work established that
computerized axial tomography was viable for generating cross-sectional
'Mews" of the human body, the greatest advance in radiology since the
discovery of x rays in 1895.
Although EMI was initially successful with its CAT scanner, within 6
years of its introduction into the United States in 1973, the company had lost
market leadership and by the eighth year had dropped out of the CAT scanner
business. Other companies successfully dominated the market, though they
were late entrants, and are still profiting in the business today.
A further example is that of the Royal Crown Companies, Inc., a small
beverage company that was the first to introduce cola in a can and the first to
introduce diet cola. Both Coca-Cola and Pepsi-Cola followed almost
immediately and deprived Royal Crown of any significant advantage from its
innovation. Bowmar Instrument Corporation, which introduced the

Figure 1
Taxonomy of outcomes from the innovation process
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pocket calculator, was not able to withstand competition from Texas

Instruments, Hewlett-Packard, and others, and went out of business. Xerox
Corporation failed to succeed with its entry into the office computer business,
even though Apple Computer, Inc., succeeded with the Macintosh, which
contained many of Xerox's key product ideas, such as the mouse and icons. The
story of the DeHavilland Comet has some of the same features. The Comet I jet
was introduced into the commercial airline business 2 years or so before Boeing
introduced the 707, but DeHavilland failed to capitalize on its substantial early
advantage. MITS introduced the first personal computer, the Altair, experienced
a burst of sales, then slid quietly into oblivion.
If there are innovators who lose, there must be followers (imitators) who
win. A classic example is IBM Corporation with its PC, a great success from
the time it was introduced in 1981. Neither the architecture nor the components
of the IBM PC were considered advanced when introduced; nor was the way
the technology was packaged a significant departure from the then-current
practice. Yet the IBM PC was fabulously successful and established MS-DOS
as the leading operating system for 16-bit PCs. By the end of 1984, IBM had
shipped more than 500,000 PCs and may have irreversibly eclipsed Apple in the
PC industry.
Figure 1 presents a simplified taxonomy—with examples—of the possible
outcomes from innovation. Quadrant 1 represents positive outcomes for the
innovator. A first-to-market advantage is translated into a sustained competitive
advantage that either creates a new earnings stream or enhances an existing one.
Quadrant 4 and its corollary quadrant 2 are the focus of this paper.

PROFITING FROM INNOVATION: BASIC BUILDING

BLOCKS
To develop a coherent framework within which to explain the distribution
of outcomes illustrated in Figure 1, three fundamental building blocks must be
put in place: the appropriability regime, the dominant design paradigm, and
complementary assets.

Regimes Of Appropriability
A regime of appropriability refers to the environmental factors, excluding
firm and market structure, that govern an innovator's ability to capture the
profits generated by an innovation. The most important dimensions of such a
regime are the nature of the technology and the efficacy of legal mechanisms of
protection.
It has long been known that patents do not work in practice as they do
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in theory. Rarely, if ever, do patents confer perfect appropriability, although

they do afford considerable protection on new chemical products and rather
simple mechanical inventions. Many patents can be "invented around" at
modest costs. They are especially ineffective at protecting process innovations.
Often patents provide little protection, because the legal requirements for
upholding their validity or for proving their infringement are high.
In some industries, particularly where the innovation is embedded in
processes, wade secrets are a viable alternative to patents. Protection of trade
secrets is possible, however, only if a firm can put its product before the public
and still keep the underlying technology secret. Usually only chemical formulas
and industrial-commercial processes (for example, cosmetics and recipes) can
be protected as trade secrets after they are placed on the market.
The degree to which knowledge is tacit or codified also affects ease of
imitation. Codified knowledge is easier to transmit and receive and is therefore
more exposed to industrial espionage and the like. Tacit knowledge by
definition is not articulated, and transfer is hard unless those who possess the
know-how in question can demonstrate it to others (Teece, 1981). Survey
research indicates that methods of appropriability vary markedly across
industries, and probably within industries as well (Levin et al., 1984).
The property rights environment within which a firm operates can thus be
classified according to the nature of the technology and the efficacy of the legal
system to assign and protect intellectual property. Though a gross
simplification, a dichotomy can be drawn between environments in which the
appropriability regime is "tight" (technology is relatively easy to protect) and
"loose" (technology is almost impossible to protect. Examples of the former
include the formula for Coca-Cola syrup; an example of the latter is the
Simplex algorithm in linear programming.

The Dominant Design Paradigm

Two stages are commonly recognized in the evolutionary development of a
given branch of a science: the pre-paradigmatic stage when there is no single,
generally accepted conceptual treatment of the phenomenon in a field of study,
and the paradigmatic stage, which begins when a body of theory appears to
have passed the canons of scientific acceptability. The emergence of a dominant
paradigm signals scientific maturity and the acceptance of agreed-upon
"standards" by which what has been referred to as "normal" scientific research
can proceed. These "standards'' remain in force unless the paradigm is
overturned. Revolutionary science is what
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overturns normal science, as when the Copernican theories of astronomy

overturned those of Ptolemy in the seventeenth century.
Abernathy and Utterback (1978), Dosi (1982), and Utterback (in this
volume) provide treatment of the technological evolution of an industry in ways
that parallel Kuhnian notions of scientific evolution (Kuhn, 1970). In the early
stages of industrial development, product designs are fluid, manufacturing
processes are loosely and adaptively organized, and generalized capital is used
in production. Competition among firms manifests itself in competition among
designs, which are markedly different from each other. This might be called the
pre-paradigmatic stage of an industry.
After considerable trial and error in the marketplace, one design or a
narrow class of designs begins to emerge as the most promising. Such design
must be able to meet a set of user needs in a relatively complete fashion. The
Model T Ford, the IBM System/360, and the Douglas DC-3 are examples of
dominant designs in the automobile, computer, and aircraft industries,
respectively.
Once a dominant design emerges, competition shifts to price and away
from design. Competitive success then shifts to a new set of variables. Scale
and learning become much more important, and specialized capital is deployed
as incumbents seek to lower unit costs through exploiting economies of scale
and learning. Reduced uncertainty over product design provides an opportunity
to amortize specialized long-lived investments.
Innovation is not necessarily halted once the dominant design emerges; as
Clarke (1985) points out, it can occur at a lower level in the design hierarchy.
For instance, a ''v" cylinder configuration emerged in automobile engine blocks
during the 1930s with the Ford V-8 engine. Niches were quickly found for it.
Moreover, once the product design stabilizes, there is likely to be a surge of
process innovation as producers attempt to lower production costs for the new
product (see Figure 2).
The Abernathy-Utterback framework does not characterize all industries. It
seems better suited to mass markets, in which consumer tastes are relatively
homogeneous, than to small niche markets where the absence of scale and
learning economies attaches a much lower penalty to multiple designs. For
these niche markets, generalized equipment will be used in production.
The emergence of a dominant design is a watershed that holds great
significance for the distribution of profits between innovator and follower. The
innovator may have been responsible for the fundamental scientific
breakthroughs as well as the basic design of the new product. However, if
imitation is relatively easy, imitators may enter the fray, modifying the product
in important ways, yet relying on the fundamental designs pioneered by the
innovator. When the game of musical chairs stops and a
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dominant design emerges, the innovator might well end up in a disadvantageous

position relative to a follower. Hence, when imitation is coupled with design
modification before the emergence of a dominant design, followers have a good
chance that their modified product will be anointed as the industry standard,
often to the great disadvantage of the innovator.

Figure 2
Innovation over the product/industry life cycle.

Complementary Assets
Let the unit of analysis be an innovation. An innovation consists of
technical knowledge about how to do something better than the existing state of
the art. Assume that the know-how in question is partly codified and partly
tacit. For such know-how to generate profits, it must be sold or used in the
market.
In almost all cases, the successful commercialization of an innovation
requires that the know-how in question be used in conjunction with other
capabilities or assets. Services such as marketing, competitive manufacturing,
and after-sales support are almost always needed. These services are often
obtained from complementary assets that are specialized. For example, the
commercialization of a new drug is likely to require the dissemination of
information over a specialized information channel. In some cases, as when the
innovation is systemic, the complementary. assets may be other parts of a
system. For instance, computer hardware typically
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requires specialized software, both for the operating system and for
applications. Even when an innovation is autonomous, as with plug-compatible
components, certain complementary capabilities or assets will be needed for
successful commercialization. Figure 3 summarizes this relationship
schematically.
An important distinction is whether the assets required for least-cost
production and distribution are specialized to the innovation. Figure 4 illustrates
differences between complementary assets that are genetic, specialized, and
cospecialized.
Genetic assets are general-purpose assets that need not be tailored to the
innovation in question. Specialized assets are those where there is unilateral
dependence between the innovation and the complementary asset.
Cospecialized assets are those for which there is a bilateral dependence. For
instance, specialized repair facilities were needed to support the introduction of
the rotary engine by Mazda. These assets are cospecialized because of the
mutual dependence of the innovation on the repair facility. Containerization
similarly required the deployment of some cospecialized assets in ocean
shipping and terminals. However, the dependence of truck

Figure 3
Complementary assets needed to commercialize an innovation.
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ing on containerized shipping was less than that of containerized shipping on

trucking, as trucks can convert from containers to flatbeds at low cost. An
example of a generic asset is the manufacturing facilities needed to make
running shoes. Generalized equipment can be employed in the main, exceptions
being the molds for the soles.

Figure 4
Complementary assets: generic, specialized, and cospecialized.

IMPLICATIONS FOR PROFITABILITY

These three concepts can now be related in a way that sheds light on the
imitation process and the distribution of profits between innovator and follower.
We begin by examining tight appropriability regimes.

Tight Appropriability Regimes

In those few instances when the innovator has an ironclad patent or
copyright protection, or when the nature of the product is such that trade
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secrets effectively deny imitators access to the relevant knowledge, the

innovator is almost assured that the innovation can be translated into market
value for some period of time. Even if the innovator does not possess the
desirable endowment of complementary costs, ironclad protection of
intellectual property gives the innovator the time to acquire these assets. If these
assets are genetic, a contractual relationship may well suffice, and the innovator
may simply license the technology. Specialized R&D firms are viable in such
an environment. Universal Oil Products, an R&D firm that developed refining
processes for the petroleum industry, is a case in point. If, however, the
complementary assets are specialized or cospecialized, contractual relationships
are exposed to hazards, because one or both parties will have to commit capital
to certain irreversible investments, which will be valueless if the relationship
between innovator and licensee breaks down. Accordingly, the innovator may
find it prudent to expand by acquiring or developing specialized and
cospecialized assets. Fortunately, the factors that render imitation difficult will
enable the innovator to build or acquire those complementary assets without
competing with imitators for their control.
Competition from imitators is muted in this type of regime, which
sometimes characterizes the petrochemical industry. In this industry, the
protection offered by patents is fairly easily enforced. One factor assisting the
licensee in this regard is that most petrochemical processes are designed around
a variety of catalysts that can be kept proprietary. An agreement not to analyze
the catalyst can be extracted from licensees, affording extra protection.
However, even if such requirements are violated by licensees, the innovator is
still well positioned, as the most important properties of a catalyst are related to
its physical structure, and the process for generating this structure cannot be
deduced from structural analysis alone. Every chemical-reaction technology a
company acquires is thus accompanied by an ongoing dependence on the
innovating company for the catalyst appropriate to the plant design. Failure to
comply with the licensing contract can thus result in a cutoff in the supply of
the catalyst and possibly closure of the facility.
Similarly, if the innovator comes to market in the pre-paradigmatic phase
with a sound product concept but the wrong design, a tight appropriability
regime will afford the innovator the time needed to perform the trials needed to
get the design right. As discussed earlier, the best initial design concepts often
turn out to be hopelessly wrong, but if the innovator is protected by an
impenetrable thicket of patents, or has technology that is difficult to copy, then
the market may well afford the innovator the necessary time to develop the right
design before being eclipsed by imitators.
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Loose Appropriability
Tight appropriability is the exception rather than the rule. Therefore,
innovators must turn to business strategy if they are to keep imitators at bay.
The nature of the competitive process will depend on whether the industry is in
the paradigmatic or pre-paradigmatic phase.

Pre-Paradigmatic Phase
In the pre-paradigmatic phase, the innovator must be careful to let the
basic design "float" until there is sufficient evidence that the design is likely to
become the industry standard. In some industries there may be little opportunity
for product modification. In microelectronics, for example, designs become
locked in when the circuitry is chosen. Product modification is limited to
debugging and modifying software. An innovator must begin the design process
anew if the product does not fit the market wen. In some respects, however, the
selection of designs is dictated by the need to meet compatibility standards so
that new hardware can be used with existing applications software. In one
sense, therefore, the design issue for the microprocessor industry today is
relatively straightforward: deliver greater power and speed while meeting the
computer industry standards of the existing software base. However, from time
to time windows of opportunity emerge for the introduction of entirely new
families of microprocessors that will define a new industry and software
standard. In these instances, basic design parameters are less well defined and
can be permitted to "float" until market acceptance is apparent.
The early history of the automobile industry exemplifies the importance of
selecting the fight design in the pre-paradigm tic stages. None of the early
producers of steam-powered cars survived the early shakeout when the internal
combustion engine in a closed-body automobile emerged as the dominant
design. The steamer, nevertheless, had numerous early virtues, such as
reliability, which the cars with internal combustion engines could not deliver.
The British fiasco with the Comet I is also instructive. DeHavilland had
picked an early design that had both technical and commercial flaws. By
moving into production, significant irreversibilities and loss of reputation
hobbled de Havilland to such a degree that it was unable to convert to the
Boeing design that subsequently emerged as dominant. It was not even able to
occupy second place, which went instead to Douglas.
As a general principle, it appears that innovators in loose appropriability
regimes need to be intimately coupled to the market so that user needs can
affect designs. When multiple parallel and sequential prototyping is
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feasible, it has clear advantages. Generally such an approach is prohibitively

costly. When development costs for a large commercial aircraft exceed a billion
dollars, variations on a theme are all that is possible.
Hence, assessing the probability that an innovator will enter the
paradigmatic phase possessing the dominant design is problematic. The
probabilities increase, the lower the relative cost of prototyping and the more
tightly coupled the firm is to the market. The latter is a function of
organizational design and can be influenced by managerial choices. The former
is embedded in the technology and cannot be influenced, except in minor ways,
by managerial decisions. Consequently, in industries with large costs for
development and prototyping—hence significant irreversibilities—and where
innovation of the product concept is easy, the probability that the innovator will
emerge as a winner at the end of the pre-paradigmatic stage is low.

Paradigmatic Stage
In the pre-paradigmatic phase, complementary assets do not loom large.
Rivalry focuses on trying to identify the design that will be dominant.
Production volumes are low, and there is little to be gained in deploying
specialized assets, as scale economies are unavailable and price is not a
principal competitive factor. As the leading design or designs begin to be
revealed by the market, however, volumes increase and opportunities for
economies of scale induce firms to begin gearing up for mass production by
acquiring specialized tooling and equipment and possibly specialized
distribution as well. Since these investments impose significant irreversibilities,
producers are likely to proceed with caution. Islands of specialized capital will
begin to appear in an industry that otherwise features a sea of general-purpose
manufacturing equipment.
But as the terms of competition begin to change, and prices become
increasingly important, access to complementary assets becomes critical. Since
the core technology is easy to imitate, by assumption, commercial success
swings upon the terms and conditions affecting access to the required
complementary assets.
It is at this point that specialized and cospecialized assets become critically
important. Generalized equipment and skills, almost by definition, are always
available in an industry, and even if they are unavailable, they do not entail
significant irreversibilities. Accordingly, firms have easy access to this type of
capital, and, even if the relevant assets are not available in sufficient quantity,
they can easily be put in place as this involves few risks. Specialized assets, on
the other hand, imply significant irreversibilities and cannot be easily acquired
by contract, as the risks are
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significant for the party making the dedicated investment. The firms that control
the cospecialized assets, such as distribution channels and specialized
manufacturing capacity, are clearly in an advantageous position relative to an
innovator. Indeed, in the rare instances in which incumbent firms possess an
airtight monopoly over specialized assets, and the innovator is in a regime of
loose appropriability, all of the profits from the innovation could conceivably
accrue to those firms, who should be able to get the upper hand.
Even when the innovator does not face competitors or potential
competitors who control key assets, the innovator may still be disadvantaged.
For instance, the technology embedded in cardiac pacemakers was easy to
imitate, so competitive outcomes quickly came to be determined by who had
easiest access to the complementary assets—in this case, specialized marketing.
A similar situation has recently arisen in the United States with respect to
personal computers. As an industry participant recently observed:

There are a huge number of computer manufacturers, companies that make

peripherals (e.g., printers, hard disk drives, floppy disk drives), and software
companies. They are all trying to get marketing distributors became they
cannot afford to call on all of the U.S. companies directly. They need to go
through retail distribution channels, such as Businessland, in order to reach the
marketplace. The problem today, however, is that many of these companies are
not able to get shelf space and thus are having a very difficult time marketing
their products. The point of distribution is where the profit and the power are
in the marketplace today. [Norman, 1986, p. 438]

CHANNEL STRATEGY ISSUES

The preceding analysis indicates how access to complementary assets,
such as manufacturing and distribution, on competitive terms is critical if the
innovator is to avoid handing over most of the profits to imitators, or to the
owners of the complementary assets that are specialized or cospecialized to the
innovation. It is now necessary to delve deeper into the control structure that the
innovator ideally will establish over these critical assets.
There are many possible channels that could be employed. At one extreme
the innovator could integrate into all of the necessary complementary assets, but
complete integration is likely to be unnecessary and also prohibitively
expensive. It is important to recognize that the variety of assets and
competences needed is likely to be quite large, even for only modestly complex
technologies. To produce a personal computer, for instance, a company needs
access to expertise in semiconductor, display, disk drive, networking, and
keyboard technologies, among others. No
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company can keep pace in all of these areas by itself. At the other extreme, the
innovator could try to gain access to these assets through straightforward
contractual relationships (for example, component supply contracts, fabrication
contracts, service contracts). In many instances such contracts may suffice,
although they sometimes expose the innovator to hazards and dependencies that
might otherwise be avoided. Between the fully integrated and full contractual
extremes are many intermediate forms and channels. An analysis of the
properties of the two extreme forms is presented below. A brief synopsis of
mixed modes then follows.

Contractual Modes
The advantages of a contractual solution—whereby the innovator signs a
contract, such as a license, with independent suppliers, manufacturers, or
distributors—are obvious. The innovator will not have to make the up-front
capital expenditures needed to build or buy the assets in question. This reduces
risks as well as cash requirements.
Contracting rather than integrating is likely to be the optimal strategy when
the innovator's appropriability regime is tight and the complementary assets are
available in competitive supply (that is, there is adequate capacity and a choice
of sources).
Both conditions apply in the petrochemical industry, for instance, so an
innovator does not need to be integrated to be successful. Consider, first, the
appropriability regime. As discussed earlier, the protection offered by patents is
fairly easily enforced, particularly for process technology, in the petrochemical
industry. Given the advantageous feedstock prices available to hydrocarbon-
rich petrochemical exporters, and the appropriability regime characteristic of
this industry, there is neither incentive nor advantage in owning the
complementary assets (production facilities), as they are not typically highly
specialized to the innovation. Union Carbide appears to realize this and has
recently adjusted its strategy accordingly. Essentially, Carbide is placing its
existing technology into a new subsidiary, Engineering and Hydrocarbons
Service. The company is engaging in licensing and offers engineering,
construction, and management services to customers who want to take their
feedstocks and integrate them forward into petrochemicals. But Carbide itself
appears to be backing away from an integration strategy.
Chemical and petrochemical product innovations are not as easily
protected as process technology is, which should raise new challenges to
innovating firms in developed nations as they attempt to shift out of commodity
petrochemicals. There are already numerous examples of new products that
made it to the marketplace, filled a customer need, but never
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generated competitive returns to the innovator because of imitation. For

example, in the 1960s the Dow Chemical Company decided to start
manufacturing rigid polyurethene foam. It was quickly imitated, however, by
many small firms that had lower costs.2 The absence of low-cost manufacturing
capability left Dow vulnerable.
Contractual relationships can bring added credibility to the innovator,
especially if the innovator is relatively unknown when the contractual partner is
established and viable. Indeed, arms-length contracting that embodies more
than a simple buy-sell agreement is becoming so common, and is so
multifaceted, that the term strategic partnering has been devised to describe it.
Even large companies such as IBM are now engaging in it. For IBM, partnering
buys access to new technologies, enabling a company to ''learn things we
couldn't have learned without many years of trial and error."3 IBM's
arrangement with Microsoft Corporation for the use of MS-DOS operating
system software on the IBM PC facilitated the timely introduction of IBM's
personal computer into the market.
Smaller, less integrated companies are often eager to sign on with
established companies because of the name recognition and reputation
spillovers. For instance, Cipher Data Products, Inc., contracted with IBM to
develop a low-priced version of IBM's 3480 half-inch streaming cartridge drive,
which is likely to become the industry standard. As Cipher management points
out, "one of the biggest advantages to dealing with IBM is that, once you've
created a product that meets the high quality standards necessary to sell into the
IBM world, you can sell into any arena."4 Similarly, IBM's contract with
Microsoft "meant instant credibility" to Microsoft (McKenna, 1985, p. 94).
It is most important to recognize, however, that strategic (contractual)
partnering, which is currently fashionable, holds certain hazards, particularly for
the innovator, when the innovator is trying to use contracts to acquire
specialized capabilities. First, it may be difficult to induce suppliers to make
costly irreversible commitments that depend for their success on the success of
the innovation. To expect suppliers, manufacturers, and distributors to do so is
to invite them to take risks along with the innovator. The problem this poses for
the innovator is similar to the problems associated with attracting venture
capital. The innovator must persuade its prospective partner that the risk is a
good one. The situation is open to opportunistic abuses on both sides. The
innovator has incentives to overstate the value of the innovation, while the
supplier has incentives to "run with the technology" should the innovation be a
success.
Instances of irreversible capital commitments by both parties nevertheless
exist. Apple's Laserwriter—a laser printer that allows PC users to produce near-
typeset-quality text and art department graphics—is a case
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in point. Apple persuaded Canon, Inc., to participate in the development of the

Laserwriter by providing subsystems from its copiers—but only after Apple
contracted to pay for a certain number of copier engines and cases. In short,
Apple accepted a good deal of the financial risk to induce Canon to assist in the
development and production of the Laserwriter. The arrangement appears to
have been prudent, yet there were clearly hazards for both sides. It is difficult to
write, execute, and enforce complex development contracts, particularly when
the design of the new product is still ''floating." Apple was exposed to the risk
that its coinnovator Canon would fail to deliver, and Canon was exposed to the
risk that the Apple design and marketing effort would not succeed. Still, Apple's
alternatives may have been limited, inasmuch as it did not command the
requisite technology to "go it alone."
In short, the current euphoria over strategic partnering may be partially
misplaced. The advantages are being stressed (for example, McKenna, 1985)
without a balanced presentation of costs and risks. Briefly, there is the risk that
the partner will not perform according to the innovator's perception of what the
contract requires; there is the added danger that the partner may imitate the
innovator's technology and attempt to compete with the innovator. This latter
possibility is particularly acute if the provider of the complementary asset is
uniquely situated with respect to the complementary asset in question and has
the capacity to imitate the technology, which the innovator is unable to protect.
The innovator will then find that it has created a competitor who is better
positioned than the innovator to take advantage of the market opportunity at
hand. Business Week has expressed concerns along these lines in its discussion
of the "hollow corporation."5
It is important to bear in mind, however, that contractual or partnering
strategies in certain cases are ideal. If the innovator's technology is well
protected, and if what the partner has to provide is a "generic" capacity
available from many potential partners, then the innovation will be able to
maintain the upper hand while avoiding the costs of duplicating downstream
capacity. Even if the partner fails to perform, adequate alternatives exist (by
assumption, the partner's capacities are commonly available) so the innovator's
efforts to successfully commercialize the technology ought to proceed profitably.

Integration Modes
Integration, which by definition involves ownership, is distinguished from
pure contractual modes in that it typically facilitates incentive alignment and
tighter organizational control (Williamson, 1985). An innovator who owns
rather than rents the complementary assets needed to com
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mercialize is in a position to capture spillover benefits stemming from increased

demand for the complementary assets caused by the innovation.
Indeed, an innovator might be in the position, at least before the innovation
is announced, to buy up capacity in the complementary assets, possibly to great
subsequent advantage. If futures markets exist, though generally speaking they
do not, taking forward positions in the complementary assets may suffice to
capture much of the spillover.
Even after the innovation is announced, the innovator might still be able to
build or buy complementary capacities at competitive prices if the innovation
has ironclad legal protection (that is, if the innovation is in a tight
appropriability regime). However, if the innovation is not tightly protected and
once out is easy to imitate, then securing control of complementary capacities is
likely to be the key success factor, particularly if those capacities are in fixed
supply—so-called bottlenecks. Distribution and specialized manufacturing
competences often become bottlenecks.
As a practical matter, however, an innovator may not have the time to
acquire or build the complementary assets that ideally would be desirable. This
is particularly true when imitation is easy, so that timing becomes critical.
Additionally, the innovator may not have the financial resources to proceed.
The implications of timing and cash constraints are summarized in Figure 5.
Accordingly, in loose appropriability regimes innovators need to rank
complementary assets according to their importance. If the complementary
assets are critical, ownership is warranted, although if the firm is cash
constrained a minority position may well be a sensible approach.
When imitation is easy, strategic moves to build or buy specialized
complementary assets must occur with due reference to the moves of
competitors. There is no point in attempting to build a specialized asset, for
instance, if one's imitators can do it faster and cheaper.
It should be self-evident that if the innovator is already a large enterprise
with control over many of the relevant complementary assets, integration is not
likely to be the issue it might otherwise be, as the innovating firm will already
control many of the relevant specialized and cospecialized assets. However, in
industries experiencing rapid technological change, it is unusual that a single
company has the full range of expertise needed to bring advanced products to
market in a timely and cost-effective way. Hence, the integration issue is of
concern to both large and small firms.

Integration Versus Contract Strategies: An Analytic Summary

Figure 6 summarizes some of the relevant considerations in the form of a
decision flow chart. It indicates that a profit-seeking innovator faced
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Figure 5
Specialized complementary assets and loose appropriability:
integration calculus.
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with weak protection of intellectual property and the need to access

specialized complementary assets or capabilities is forced to expand through
integration to prevail over imitators. Put differently, innovators who develop
new products that possess poor protection of intellectual property but require
specialized complementary capacities are more likely to parlay their technology
into a commercial advantage rather than see it prevail in the hands of imitators.
Figure 6 makes it apparent that difficult strategic decisions arise when the
appropriability regime is loose and when specialized assets are critical to
profitable commercialization. These situations are common and require that a
thorough assessment of competitors be part of the innovator's strategic
assessment of opportunities and threats. Figure 7 carries this discussion a step
further and considers only situations where commercialization requires certain
specialized capabilities. It shows the appropriate strategies for the innovators
and predicts the expected outcomes for the various players.
Three classes of players are of interest: innovators, imitators, and the
owners of cospecialized assets (for example, distributors). All three can
potentially benefit or lose from the innovation process. The latter can
potentially benefit from the additional business that the innovation may direct in
the asset owner's direction. Should the asset turn out to be a bottleneck with
respect to commercializing the innovation, the owner of the bottleneck facilities
is obviously in a position to extract profits from the innovator or the imitators.
The vertical axis in Figure 7 measures how those who possess the
technology (the innovator or possibly the imitators) are positioned with respect
to those firms that possess required specialized assets. The horizontal axis
measures the "tightness" of the appropriability regime, tight regimes being
evidenced by ironclad legal protection coupled with technology that is difficult
to copy; loose regimes offer little in the way of legal protection, and the essence
of the technology, once released, is transparent to the imitator. Loose regimes
are further subdivided according to how the innovator and imitators are
positioned in relation to each other. This is likely to be a function of factors
such as lead time and prior positioning in the requisite complementary assets.
Figure 7 makes it apparent that even when firms pursue the optimal
strategy, other industry participants may take the jackpot. This possibility is
unlikely when the intellectual property in question is tightly protected. The only
serious threat to the innovator is where a specialized complementary asset is
"locked up," a possibility recognized in cell 4. This can rarely be done without
the cooperation of government. But it frequently occurs, as when a foreign
government closes access to a foreign market,
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Figure 6
Flow chart for integration versus contract design.
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forcing the innovators to license to foreign firms, but with the government
effectively cartelizing the potential licensees. With weak intellectual property
protection, however, it is clear that the innovator will often lose out to imitators
or asset holders, even when the innovator is pursuing the appropriate strategy
(cell 6). Clearly, incorrect strategies can compound problems. For instance, if
innovators integrate when they should contract,

Figure 7
Optimal contract and integration strategies and outcomes for innovators:
specialized asset case.
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a heavy commitment of resources will be incurred for little if any strategic

benefit, thereby exposing the innovator to even greater losses than would
otherwise be the case. On the other hand, if an innovator tries to contract for the
supply of a critical capability when it should build the capability itself, it may
well find it has nurtured an imitator better able to serve the market.

Mixed Modes
The real world rarely provides extreme or pure cases. Decisions to
integrate or license involve trade-offs, compromises, and mixed approaches. It
is not surprising, therefore, that the real world is characterized by mixed modes
of organization, involving judicious blends of integration and contracting.
Sometimes mixed modes represent transitional phases. For instance, because of
the convergence of computer and telecommunication technology, firms in each
industry are discovering that they often lack the technical capabilities needed in
the other. Since the technological interdependence of the two requires
collaboration among those who design different parts of the system, intense
cross-boundary coordination and information flows are needed. For separate
enterprises, agreement must be reached on complex protocol issues among
parties who see their interests differently. Contractual difficulties can be
anticipated, as the selection of common technical protocols among the parties
will often be followed by transaction-specific investments in hardware and
software. There is little doubt that this was the motivation behind IBM's 1983
purchase of 15 percent of the Rolm Corporation, manufacturer of business
communications systems. This position was expanded to 100 percent in 1984.
IBM's stake in Intel Corporation, which began with a 12 percent purchase in
1982, is most probably not a transitional phase leading to 100 percent purchase,
because both companies realized that the two corporate cultures are not
compatible, and IBM may not be as impressed with Intel's technology as it once
was.

The Cat Scanner And The IBM PC: Insights From The
Framework
EMI's failure to reap significant returns from the CAT scanner can be
explained in large measure by reference to the concepts developed above. The
scanner that EMI developed was of a technical sophistication much higher than
would normally be found in a hospital, requiring a high level of training support
and servicing. EMI did not possess these capabilities, could not easily contract
for them, and was slow to realize their importance.
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It most probably could have formed a partnership with a company like

Siemens to gain access to the requisite capabilities. Its failure to do so was a
strategic error compounded by the limited protection afforded by the law for the
intellectual property embodied in the scanner. Although subsequent court
decisions have upheld some of EMI's patent claims, once the product was in the
market it could be reverse engineered and its essential features copied.
Two competitors, General Electric and Technicare, already possessed the
complementary capabilities that the scanner required, and they were also
technologically capable. In addition, both were experienced marketers of
medical equipment and had reputations for quality, reliability, and service. GE
and Technicare were thus able to commit their R&D resources to developing a
competitive scanner and improving on the EMI scanner where they could while
they rushed to market. GE began taking orders in 1976 and soon after made
inroads on EMI's lead. In 1977 concern for rising health care costs caused the
Carter administration to introduce "certificate of need" regulation, which
required approval by the Department of Health, Education, and Welfare for
expenditures on big ticket items like CAT scanners. This severely cut the size of
the available market.
By 1978 EMI had lost the leadership in market share to Technicare, who
was in turn quickly overtaken by GE. In October 1979 Geoffrey Hounsfield of
EMI shared the Nobel Prize for invention of the CAT scanner. Despite this
honor, and the public recognition of EMI's role in bringing this medical
breakthrough to the world, the collapse of its scanner business forced EMI in
the same year into the arms of a rescuer, Thorn Electrical Industries, Ltd. GE
subsequently acquired what was EMI's scanner business from Thom.6 Though
royalties continued to flow to EMI, the company had failed to capture the
largest pan of the profits generated by the innovation it had pioneered and
successfully commercialized.
If EMI illustrates how a company with outstanding technology and an
excellent product can fail to profit from innovation while the imitators succeed,
the story of the IBM PC indicates how a new product representing only a
modest technological advance can yield remarkable returns to the developer.
The IBM PC, introduced in 1981, succeeded despite the fact that its
architecture was ordinary and its components standard. Philip Estridge's design
team in Boca Raton, Florida, decided to use existing technology rather than the
state of the art to produce a solid, reliable microcomputer. With a 1-year
mandate to develop a PC, Estridge's team could do little else.
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However, the IBM PC did use what at the time was a new 16-bit
microprocessor (the Intel 8088) and a new disk operating system (DOS)
adapted for IBM by Microsoft. Other than the microprocessor and the operating
system, the IBM PC incorporated existing microcomputer "standards" and used
off-the-shelf parts from outside vendors. IBM did write its own basic input/
output system (BIOS), which is embedded in a read-only memory chip, but this
was a relatively straightforward programming exercise.
The key to the PC's success was not the technology. It was the set of
complementary assets that IBM either had or quickly assembled around the PC.
To expand the market for PCs, there was a clear need for an expandable,
flexible microcomputer system with extensive applications of software. IBM
could have based its PC system on its own patented hardware and copyrighted
software. Such an approach would cause complementary products to be
cospecialized, forcing IBM to develop peripherals and a comprehensive library
of software in a short time. Instead, IBM adopted what might be called an
induced contractual approach. By adopting an open system architecture, as
Apple had done, and by making technical information about the operating
system publicly available, IBM induced a spectacular output of software by
third-party suppliers. IBM estimated that by mid-1983, at least 3,000 hardware
and software products were available for the PC.7 Put differently, IBM pulled
together the complementary assets, particularly software, required for success
and did not even use contracts, let alone integration. This was despite the fact
that the software developers were creating assets that were in part cospecialized
to the IBM PC, at least in the first instance.
Several special considerations made this approach a reasonable risk for the
software writers. A critical element was IBM's name and corn-raiment to the
project. The reputation behind the letters I, B, M is perhaps the greatest
cospecialized asset the company possesses. The name implied that the product
would be marketed and serviced in the IBM tradition. It guaranteed that PC-
DOS would become an industry standard, so that the software business would
not be solely dependent on IBM, because emulators were sure to enter. It
guaranteed access to retail distribution outlets on competitive terms. The
consequence was that IBM was able to take a product that was at best a modest
technological accomplishment and turn it into a fabulous commercial success.
The case demonstrates the role of complementary assets in determining
outcomes.
Though the success of the IBM PC is ongoing, the appearance of machines
compatible with the IBM PC (IBM compatibles and "clones") has
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somewhat attenuated PC market growth for IBM. The emergence and rapid
acceptance of the IBM PC established a market-based software standard. Given
IBM's reputation and the quality of the product, the emergence of a market
standard was predictable, as was increased price competition as competitors
focused on cost reduction and performance enhancement. The fact that IBM is
no longer the overwhelmingly dominant PC manufacturer—possibly because of
its price umbrella and modest rate of performance improvement—does not
diminish the lesson of the IBM PC program with regard to capturing returns
from innovation. Despite competition from compatibles and clones, IBM's
return on investment must surely have been attractive.

IMPLICATIONS FOR R&D STRATEGY, INDUSTRY

STRUCTURE, AND TRADE POLICY

Allocating R&D Resources

The analysis so far assumes that the firm has developed an innovation for
which a market exists. It indicates the strategies that the firm must follow to
maximize its share of industry profits relative to imitators and other
competitors. There is no guarantee of success even if optimal strategies are
followed.
The innovating firm can improve its total return to R&D, however, by
adjusting its R&D investment portfolio to maximize the probability that the
technological discoveries that emerge will be easy to protect with existing
property law or will require for commercialization cospecialized assets already
within the firm's repertoire of capabilities. Put differently, if an innovating firm
does not target its R&D resources toward new products and processes that it can
commercialize advantageously relative to potential imitators or followers, then
it is unlikely to profit from its investment in R&D. In this sense, a firm's history
—and the assets it already has in place—ought to condition its R&D investment
decisions. Clearly, an innovating firm with considerable assets already in place
is free to strike out in new directions, so long as it is aware of the kinds of
capabilities required to commercialize the innovation. It is therefore clear that
the R&D investment decision cannot be divorced from the strategic analysis of
markets and industries, and the firm's position in them.

Small Firm Versus Large Firm Comparisons

Business commentators frequently remark that many small entrepreneurial
firms that generate new, commercially valuable technology fail at
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the same time that a large multinational firm, even with a less meritorious
record in innovation, will survive and prosper. One explanation of this
phenomenon is now clear. Large firms are more likely to possess the relevant
specialized and cospecialized assets at the time a new product is introduced.
They can therefore do a better job of using their technology, however meager,
to maximum advantage. Small domestic firms are less likely to have the
relevant specialized and cospecialized assets within their boundaries. They must
therefore incur the expense of trying either to build the necessary assets or to
develop coalitions with competitors or with owners of the assets.

Regimes Of Appropriability And Industry Structure

In industries where legal methods of protection are effective, or where new
products are just hard to copy, the strategic necessity for innovating firms to
obtain cospecialized assets would appear to be less compelling than in
industries where legal protection is weak. In cases where legal protection is
weak or nonexistent, the control of cospecialized assets will be needed for long-
run survival.
In this regard, it is instructive to examine the U.S. drug industry (Temin,
1979). In the 1940s, the U.S. Patent Office began to grant patents on certain
natural substances that involved difficult extraction procedures. Thus, in 1948
Merck received a patent on streptomycin, which is a natural substance.
However, it was not the extraction process but the drug itself that received the
patent. Hence, patents were important to the drug industry, but they did not
prevent imitation as, in some cases, just changing one molecule would enable a
company to come up with a similar substance not violating the patent (Temin,
1979, p. 436). Had patents been more inclusive—and this is not to suggest that
they should be—licensing would have been an effective mechanism for Merck
to profit from its innovation. The emergence of close substitutes for patented
drags, coupled with FDA regulation that had the effect of reducing the elasticity
of demand for drugs, placed high rewards on a strategy of product
differentiation. This strategy required extensive marketing, including a sales
force that could directly contact doctors, who were the purchasers of drugs
through their ability to create prescriptions.8 The result was exclusive
production (that is, the earlier industry practice of licensing was dropped) and
forward integration into marketing (the relevant cospecialized asset).
Generally, if legal protection of the innovators' profits is secure, innovating
firms can select their boundaries according to their ability to identify user needs
and respond to those needs through research and development. The weaker the
legal methods of protection, the greater the
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incentive to obtain the relevant cospecialized assets. Hence, as industries in

which legal protection is weak begin to mature, integration into innovation-
specific cospecialized assets will occur. Often this will take the form of
backward, forward, and lateral integration. (Conglomerate integration is not part
of this phenomenon.) For example, IBM's purchase of Rolm can be seen as a
response to the impact of technological change on the identity of the
cospecialized assets relevant to IBM's future growth.

Industry Maturity, New Entry, And History

As technologically progressive industries mature, and a greater proportion
of the relevant cospecialized assets are brought under the corporate umbrellas of
incumbents, new entry becomes more difficult. Moreover, when it does occur it
is more likely to include the early formation of coalitions. Incumbents will own
the cospecialized assets, and new entrants will find it necessary to forge links
with them. Here lies the explanation for the sudden surge in strategic partnering
now occurring internationally, and particularly in the computer and
telecommunications industry. Note that this change should not be interpreted in
anticompetitive terms. Given existing industry structure, coalitions ought to be
seen not as attempts to stifle competition, but as mechanisms for lowering entry
requirements for innovators.
In industries in which a technological change has occurred and required
deployment of specialized or cospecialized assets, a configuration of firm
boundaries that no longer have compelling efficiencies may well have arisen.
Considerations that once dictated integration may no longer hold, yet there may
not be strong forces leading to divestiture. Hence existing firm boundaries in
some industries—especially those where the technological trajectory and
attendant specialized asset requirements have changed—may be fragile. In
short, history is important in understanding the structure of the modern business
enterprise. Existing firm boundaries cannot always be assumed to have an
obvious rationale in relation to today's requirements.

The Importance Of Manufacturing To International

Competitiveness
Practically all forms of technological know-how must be embedded in
goods and services to yield value to the consumer. An important policy issue for
the innovating nation is whether the identity of the firms and nations performing
this function is important.
In a world of tight appropriability and zero transactions cost—the world of
neoclassical theory—it is a matter of indifference whether an innovating firm
has an in-house manufacturing capability, domestic or foreign. The
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firm can engage in' arms-length contracting (patent licensing, know-how

licensing, coproduction, and so on) for the sale of the output of the activity in
which it has a comparative advantage (in this case R&D) and will maximize
returns by specializing in what it does best.
However, in a regime of loose appropriability, and especially where the
requisite manufacturing assets are specialized to the innovation. which is often
the case, participation in manufacturing may be necessary if an innovator is to
appropriate the rents from its innovation. Hence, if an innovator's
manufacturing costs are higher than those of an imitator, the innovator may well
be put in the position of ceding the largest share of profits to the imitator.
In a loose appropriability regime, low-cost imitator-manufacturers could
capture all of the profits from innovation. In a loose appropriability regime
where specialized manufacturing capabilities are necessary to produce new
products, an innovator with a manufacturing disadvantage may find that an
early advantage at the research and development stage has no commercial
value. This is a potentially crippling situation unless the innovator is assisted by
governmental processes. For example, one reason why U.S. manufacturers did
not capture the greatest part of the profits from the development of color TV,
for which RCA was primarily responsible, is that RCA and its U.S. licensees
were not competitive at manufacturing. In this context, concern that the decline
of manufacturing threatens the entire economy appears to be well founded.
A related implication is that as the technology gap closes, the basis of
competition in an industry will shift to the cospecialized assets. This appears to
be what is happening in microprocessors. Intel is no longer out ahead
technologically. As Gordon Moore, CEO of Intel points out, ''Take the top 10
[semiconductor] companies in the world... and it is hard to tell at any time who
is ahead of whom .... It is clear that we have to be pretty damn close to the
Japanese from a manufacturing standpoint to compete.''9 It is not just that
strength in one area is necessary to compensate for weakness in another. As
technology becomes more public and less proprietary through easier imitation,
strength in manufacturing and other areas is necessary to benefit from whatever
technological advantages an innovator may possess.
Put differently, the notion that the United States can adopt a "designer
role" in international commerce while letting independent firms in countries
such as Japan, Korea, Taiwan, or Mexico do the manufacturing is unlikely to be
a successful strategy for the long run. This is because profits will accrue
primarily to the low-cost manufacturers (by providing a larger sales base over
which they can exploit their special skills). Where imitation is easy, and even
where it is not, it is difficult to do business in the market
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for know-how (Teece, 1981). In particular, there are difficulties in pricing an

intangible asset whose true performance features are difficult to predict.
The trend in international business toward what Miles and Snow (1986)
call dynamic networks—characterized by vertical disintegration and contracting-
therefore ought to be viewed with concern. Dynamic networks, or hollow
corporations, may reflect innovative organizational forms not so much as the
disassembly of the modem corporation because of deterioration in
manufacturing and other activities that complement technological innovation.
Dynamic networks-may therefore signal not so much the rejuvenation of
American enterprise as its piecemeal demise.

How Trade And Investment Barriers Affect Innovators'

Profits
In regimes of loose appropriability, governments can move to shift the
distribution of the gains from innovation away from foreign innovators and
toward domestic firms by denying innovators ownership of specialized assets.
The foreign firm, by assumption an innovator, will be left with the option of
selling its intangible assets on the market for know-how if both trade and
investment are foreclosed by government policy. This option may appear better
than the alternative (no remuneration at all from the market in question).
Licensing may then appear profitable, but only because access to the
complementary assets is blocked by government.
Thus, when an innovating firm generating profits needs access to
complementary assets abroad, host governments, by limiting access, can
sometimes milk the innovators for a share of the profits, particularly that
portion that originates from sales in the host country. However, the ability of
host governments to do so depends on the importance of the host country's
assets to the innovator. If the cost and infrastructure characteristics of the host
country are such that it is the world's lowest cost manufacturing site, and if
domestic industry is competitive, then by acting as a monopsonist the
government of the host country ought to be able to adjust the terms of access to
the complementary assets to appropriate a greater share of the profits generated
by the innovation. 10 If, on the other hand, the host country offers no unique
complementary assets except access to its own market, restrictive practices by
the government will only redistribute profits with respect to domestic rather
than worldwide sales.

Implications For The International Distribution Of The

Benefits From Innovation
Thus, it is clear that innovators who do not have access to the relevant
specialized and cospecialized assets may end up ceding profits to imitators
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and other competitors, or to the owners of the specialized or cospecialized

assets. Even when the innovator possesses the specialized assets, they may be
located abroad. Foreign factors of production are thus likely to benefit from
research and development occurring across borders. There is little doubt, for
instance, that the inability of many U.S. multinationals to sustain competitive
manufacturing in the United States results in declining returns to U.S. labor.
Stockholders and top management probably do as well if not better when a
multinational gains access to cospecialized assets in the firm's foreign
subsidiaries. However, if there is unemployment in the factors of production
supporting these assets, then the foreign factors of production will benefit from
innovation originating beyond national borders. This shows how important it is
that innovating nations maintain competence and competitiveness in the assets—
especially manufacturing—that complement technological innovation. It also
shows how important it is that innovating nations enhance the protection
afforded worldwide to intellectual property.
It must be recognized, however, that there are inherent limits to the legal
protection of intellectual property and that business and national strategies are
therefore likely to be critical in determining how the gains from innovation are
shared' worldwide. By making the correct strategic decision, innovating firms
can move to protect the interests of stockholders. But to ensure that domestic
rather than foreign cospecialized assets capture the largest share of the
externalities spilling over to complementary assets, the supporting infrastructure
for those complementary assets must not be allowed to decay. In short, if a
nation has prowess at innovation, then in the absence of ironclad protection for
intellectual property, it must maintain well-developed complementary assets if
it is to capture the spillover benefits from innovation.

CONCLUSION
This chapter has attempted to synthesize from recent research in industrial
organization and strategic management a framework within which to analyze
the distribution of the profits from innovation. The framework indicates that the
boundaries of the firm are an important strategic variable for innovating firms.
The ownership of complementary assets, particularly when they are specialized
or cospecialized, helps establish who wins and who loses from innovation.
Imitators can often outperform innovators if they are better positioned with
respect to critical complementary assets. Hence, public policy aimed at
promoting innovation must focus not only on R&D but also on complementary
assets as well as the underlying infrastructure. If government decides to
stimulate innovation, it is im
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portant to eliminate barriers to the development of complementary assets that

are specialized or cospecialized to innovation. To fail to do so will cause a large
portion of the profits from innovation to flow to imitators and other
competitors. If these firms lie beyond one's national borders, there are obvious
implications for the international distribution of income.
When applied to world markets, results similar to those obtained from the
"new trade theory" are suggested by the framework. In particular, tariffs and
other restrictions on trade can in some cases injure innovating firms while
simultaneously benefiting protected firms when they are imitators. However,
the propositions suggested by the framework vary according to appropriability
regimes, suggesting that economywide conclusions will be elusive. The policy
conclusions for commodity petrochemicals, for instance, are likely to differ
from those for semiconductors.
The approach also suggests that the product life cycle model of
international trade win play itself out differently in different industries and
markets, in part according to appropriability regimes and the nature of the assets
needed to convert a technological success into a commercial one. Whatever its
limitations, the approach establishes that it is not so much the structure of
markets as the structure of firms, particularly the scope of their boundaries,
coupled with national policies on the development of complementary assets,
that determines the distribution of the profits among innovators and imitator-
followers.

ACKNOWLEDGMENTS
I wish to thank Raphael Amit, Harvey Brooks, Chris Chapin, Therese
Flaherty, Richard Gilbert, Bruce Guile, Heather Haveman, Mel Horwitch,
David Hulbert, Carl Jacobson, Michael Porter, Gary Pisano, Richard Rumelt,
Richard Nelson, Raymond Vernon, and Sidney Winter for helpful discussions
relating to the subject matter of this paper. I gratefully acknowledge the
financial support of the National Science Foundation under grant no.
SRS-8410556 to the Center for Research in Management, University of
California, Berkeley. Versions of this paper were presented at a National
Academy of Engineering symposium titled "World Technologies and National
Sovereignty," February 1986; at a conference on innovation at the University of
Venice, March 1986; and at seminars at the Massachusetts Institute of
Technology and Harvard, Yale, and Stanford universities. Helpful comments
received at these conferences and seminars are gratefully acknowledged.

NOTES

1. The EMI story is summarized in Michael Martin, Managing Technological Innovation and
Entrepreneurship (Reston, Va.: Reston Publishing Company, 1984).
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2. Executive Vice President, Union Carbide, Robert D. Kennedy, quoted in Chemical Week.
3. Comment attributed to Peter Olson III, IBM's director of business development, as reported
in "The Strategy Behind IBM's Strategic Alliances," Electronic Business, October I, 1985, p.
126.
4. Comment attributed to Norman Farquhar, Cipher's vice president for strategic development,
as reported in Electronic Business, October I, 1985, p. 128.
5. See Business Week, March 3, 1986, pp. 57-59. Business Week uses the term "hollow
corporation" to describe a firm that lacks in-house manufacturing capability.
6. See "GE Gobbles a Rival in CT Scanners," Business Week, May 19, 1980.
7. F. Gens and C. Christiansen, "Could 1,000,000 IBM PC Users Be Wrong," Byte, November
1983, p. 88.
8. In the period before FDA regulation, all drugs other than narcotics were available without
prescriptions. Since the user could purchase drugs directly, sales were price sensitive. Once
prescriptions were required, this price sensitivity collapsed; doctors not only do not have to pay
for the drugs, but in most cases they are unaware of the prices of the drugs they are prescribing.
9. "Institutionalizing the Revolution," Forbes, June 16, 1986, p. 35.
10. If the host country market structure is monopolistic, private actors might be able to achieve
the same benefit. Government can force collusion of domestic enterprises to their mutual benefit.

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Clarke, K. B. 1985. The interaction of design hierarchies and market concepts in technological
evolution. Research Policy 14:235-251.
Dosi, G. 1982. Technological paradigms and technological trajectories. Research Policy 1 I
(3):147-162.
Kuhn, T. 1970. The Structure of Scientific Revolutions, 2nd ed. Chicago: University of Chicago
Press.
Levin, R., A. Klevorick, N. Nelson, and S. Winter. 1984. Survey research on R&D appropriability
and technological opportunity. Yale University. Unpublished manuscript.
McKenna, R. 1985. Market positioning in high technology. California Management Review
XXVII:3(Spring):82-108
Miles, R. E., and C. C. Snow. 1986. Network organizations: New concepts for new forms.
California Management Review XXVIII:3(Spring):62-73.
Norman, D. A. 1986. Impact of entrepreneurship and innovations on the distribution of personal
computers. Pp.437-439 in R. Landau and N. Rosenberg, eds., The Positive Sum Strategy.
Washington, D.C.: National Academy Press.
Teece, D. J. 1981. The market for know how and the efficient international transfer of technology.
Annals of the American Academy of Political and Social Science 458(November):81-96
Temin, P. 1979. Technology, regulation, and market structure in the modem pharmaceutical
industry. The Bell Journal of Economics 10(2):429-446.
Williamson, O. E. 1985. Economic Institutions of Capitalism. New York: The Free Press.
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INTERNATIONAL INDUSTRIES: FRAGMENTATION VERSUS GLOBALIZATION 96

International Industries: Fragmentation

Versus Globalization

YVES DOZ

Since World War II, growth in international trade has exceeded world
economic growth by a substantial margin, and national economies have become
increasingly dependent on world trade. Up to 50 percent of the gross national
product (GNP) of small European countries is traded internationally, whereas
only about 25 percent of GNP in larger European countries and 10 to 15 percent
of GNP in the comparatively isolated large economies of the United States and
Japan is traded internationally. Markets for many industrial goods have become
increasingly homogeneous. Simultaneously, foreign investment has grown
rapidly, both in developed and in developing countries.1 Not only has the total
stock of capital grown rapidly, but, more significantly, there has been growth in
the number of subsidiaries of multinational companies (MNCs); growth in the
number of countries in which specific firms were active; and increasing
diversity in the products manufactured and sold abroad through subsidiaries of
MNCs (Vernon and Davidson, 1979).
As both international trade and investment grew rapidly, international
competition became more intense, and many national industries became global
industries. Similarity of markets in different countries and intense global
competition drove international competitors to coordinate their market and
competitive strategies between countries more actively. The relevant scope of
strategy thus shifted from discrete national markets to global markets, and
coordinated worldwide competitive actions between the various subsidiaries of
MNCs became more important.
As national competition shifted to global competition, foreign invest
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INTERNATIONAL INDUSTRIES: FRAGMENTATION VERSUS GLOBALIZATION 97

merit also shifted. Protectionism in the 1930s, the trauma of World War II, and
national reconstruction policies led the early multinational investors to fragment
their operations into discrete market-servicing, self-sufficient investments with
little interdependence between operations in separate countries. The developing
countries' import substitution policies had similar effects. With freer trade and
more intense competition, both the possibility of, and the need for, sourcing
investments in manufacturing arose: International corporations started to
specialize and rationalize their plants to exploit national comparative
advantages. Even where economic and technical conditions prohibited such
specialization—for example, for cement, glass, or industrial gases—competitive
actions became coordinated across subsidiaries as the companies realized they
were competing in a very concentrated global oligopoly. As a result, portfolio
foreign investments, where only intangible assets are leveraged, gave way to
strategically coordinated integrated operations worldwide, exploiting
comparative advantages of different countries for various types of activities.
Labor-intensive activities were sited in locations where labor costs were low
and from which the world markets were served. Such advantages were most
often exploited by owned subsidiaries—through "internalization"—rather than
through subcontracting or licensing.2 This, in ram, led to the development of
intrafirm international trade. Such trade may be intraindustry (e.g., the
processing of semiconductors overseas for reimport into the United States) or
intrafirm but interindustry (e.g., General Electric "offsetting" the sale of jet
engines to the Canadian Armed Forces with exports of consumer goods from
Canada).
With some significant exceptions—usually government imposed—the
trend toward industry globalization and toward MNC integration has affected
most countries and most internationally traded goods. The proportion of
internationally traded goods in the GNP of countries also increased
substantially, so that by 1980 internationally traded goods with substantial trade
levels comprised more than 80 percent of the industrial sectors in Western
Europe (Orléan, 1986). This trend was particularly strong between 1968 and
1978.
Since the late 1970s, however, three sets of factors have come to limit such
globalization. First, the technology no longer always drives toward
globalization: New manufacturing techniques may reverse the trend toward
"world-scale" plants and allow differentiation and segmentation with smaller
cost penalties. Second, protectionism is on the rise and limits the strategic
freedom of global competitors. Protectionism applies not only to trade in goods,
but also increasingly to trade in knowledge, technology in particular. Third, the
organizational and strategic capabilities of global competitors often lag the
competitive opportunities available
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to them, and many firms are less than fully successful in exploiting their
opportunities.
The impact of the three sets of limiting factors mentioned above deserves
more attention. This chapter reflects this interest, beginning with a selective
review of the abundant, if still fragmentary, evidence on the trends toward
market homogenization, industry globalization and firm integration, and the
underlying forces that drive them. These issues are discussed at three
complementary levels of aggregation: the international economic relations
framework; individual industries and their competitive dynamics; and the
logistics, organizational structures, and management processes of individual
firms. Finally, the recent evolution of the three sets of moderating factors—
technologies, government policies leading to growing protectionism, and the
limited organizational capabilities of firms—and what their effect may be on
the fragmentation or globalization of international industries are analyzed.

GLOBALIZATION OF INDUSTRIES

Enabling Conditions
Globalization is rooted in several key enabling conditions: the
homogenization of markets, the decreasing costs of transport and
communication, decreasing trade barriers, and the competitive pressures from
new competitors. First, national markets have become increasingly similar in
taste as income distributions in industrialized nations have equalized. The result
has been the development of relatively homogeneous market segments that
cross borders (Levitt, 1983). Though national markets may have been more
similar in the past than was generally recognized (Helleiner, 1981), the media
(mainly television), international travel, and the action of active multinational
marketers have contributed to the homogenization of markets across national
boundaries. Furthermore, global market segments appear in industries as
different as automobiles (to the advantage of BMW or AMC's "Jeep") and beer
(to the advantage of Heineken and a few others). Higher disposable incomes
also encouraged the development of a market for fashionable "world products"
in a number of countries, be these products such as British raincoats, Italian
sweaters, Swiss watches (Rolex or Swatch), French wines, or Japanese
consumer electronics.
Lower communication and transportation costs—the second enabling
condition—also made serving these homogeneous markets from centralized
locations economical, even for relatively bulky products such as cars. Real-time
low-cost communication also made the coordination of a com
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plex worldwide logistics system feasible. The globalization of manufacturing in

certain industries where products are complex and differentiated might not have
happened without the drastic reductions in transportation and
telecommunication costs between 1950 and 1980.
That wade barriers were removed between the 1950s and the 1980s is well
known and needs no detailed analysis here. The removal of these barriers
provided a third enabling condition for the globalization of industries. Only in
some industries where government-controlled customers predominate, and
where national defense considerations are relevant, did wade barriers stay in
place (Doz, 1986). Specific trade agreements (e.g., the Lomé convention), as
wen as the extension of credit to developing countries, allowed these countries
to participate in this move toward free wade, initiated by traditional
industrialized countries. The recognition that across-the-board import
substitution measures usually fail, and the successful example of the newly
industrialized countries (NICs), also provided an incentive for developing
countries to participate actively in the world economy.
A fourth enabling condition, usually at the level of individual firms, was
the existence of the organizational infrastructure for globalization. In the
mid-1960s, when trade liberalization was initiated and national markets started
to converge visibly, many MNCs were already in place, with their infrastructure
of sales subsidiaries and foreign plants. This gave them the capability both to
gather data worldwide and to respond quickly—at least in theory—to
globalization trends. Global information networks and means of global market
reach were already in place, decreasing the cost of transition from national to
global competition for the major competitors. Experience in handling foreign
manufacture, new product introduction, and technology transfer facilitated a
prompt response to industry globalization by MNCs (Vernon, 1979). Where
such networks and means did not exist, helping hands could be found. Initially,
for example, Japanese exporters relied on Japanese wading companies,
importing countries' mass merchandisers (e.g., Sears in the United States), mass
buyers (e.g., TV rental companies in the United Kingdom), and original
equipment manufacturer (OEM) Customers (e.g., for computer peripherals).
This allowed the new competitors to skip both the market intelligence tasks
(Sears, for instance, specified the TV sets it wanted) and the initial market
access cost and delay[ More complex, more fragmented, less transparent, and
less willing distribution structures would have been a formidable barrier to
globalization and, where present, remain a source of asymmetry in globalization
(witness the painful efforts of many European and American firms to establish a
significant market presence in Japan).
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Driving Forces For Sourcing And Marketing Globalization

The enabling conditions summarized above were necessary, though not
sufficient, for industry globalization to take place. They had to be exploited by
firms trying to gain a permanent competitive advantage. The intense
competition created by these firms was in most cases the main driving force for
integration and globalization to actually take place. Intense competition itself
depended on the opportunity for substantial gains through globalization, the
existence or the creation of destabilizing conditions, and the presence of
competitors with the strategic intent and capabilities to exploit destabilizing
conditions to their advantage.
Growing economies of scale in R&D and in production provided the most
frequent opportunity for increased profits through globalization. Changes in
product and process technology have increased the minimum efficient size of
production in a variety of industries, such as cars, chemicals, consumer
electronics, semiconductors, and machinery. Combined with the emergence of
smaller differentiated global segments, this is a powerful incentive to pool
demand from a variety of national markets and · serve such demand from large,
optimally sited specialized plants. New product development costs have also
risen considerably in a range of industries, the best-known of which are aircraft,
telephone switching, cars, and semiconductors. These higher costs have created
a strong incentive for industries to serve the world market to spread R&D costs
over a larger production. There is a further incentive to serve the world market
quickly to minimize the financing cost of the initial investment and the
competitive risk of technological obsolescence (Hamel and Prahalad, 1985).
In some capital goods industries, such as papermaking machinery,
electrical equipment, and railroad equipment, the cyclicality of domestic
demand and the uncertainty of future domestic orders have led to chronic
overcapacity and to the need for national firms to diversify their customer base
by selling abroad. Intense competition, though, is the key driving force. In
Europe, following the European Economic Community's (EEC) lowering of
trade barriers, little change toward a more efficient industry structure took place
unless triggered and stimulated by intense competition (Owen, 1983).
The emergence of a period of intense competition was facilitated by
technological or market discontinuities that destabilized the existing market and
industry structures. Increases in energy costs, for example, destabilized the
structure of such industries as automobiles and papermaking machinery, making
it possible for new global competitors to emerge. Shifts from electromechanical
to electronic technologies in industries ranging from watches to digital
switching systems and avionics have similarly allowed
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new competitors to establish themselves and occasionally to fender a whole

industry obsolete (e.g., the mechanical Swiss watch industry). Wide fluctuations
in exchange rates have occasionally had significant effects, helping new
competitors to penetrate mature industries, even in the absence of new
technology or changing economies of scale. In 1983 and 1984, for example, the
overvaluation of the U.S. dollar helped Komatsu gain overseas customers at the
expense of Caterpillar (Bartlett, 1985).
Ambitious competitors, with a vision of how to turn situations to their
advantage, were also needed to make competition more intense. These
competitors, such as Komatsu, have the long-term strategic intent to dominate
their industry, and they are able to exploit opportunities as they arise. While the
new competitors have usually been Japanese, they are also occasionally
European (e.g., Leroy Somer in small electric motors) or American (e.g., Otis in
the small-elevator industry). Confronted with intense competition from new
competitors intent on exploiting economies of scale, new product and process
technology, and other destabilizing factors such as exchange rate fluctuations,
established competitors have typically reacted in two complementary ways: (1)
reducing costs through the exploitation of economies of scale or through
economies of location; and (2) gaining worldwide market access through their
own efforts or through networks of partnerships and coalitions.3 First, many
companies attempted to reduce costs by exploiting potential economies of large
scale, typically by integrating and rationalizing production in a region (e.g.,
Philips rationalizing its television tube and receiver plants in Europe and Ford
doing the same with cars). Companies also searched for lower factor costs and
other locational advantages (e.g., the moves offshore in the U.S. electronics
industry in the late 1960s and 1970s, or the relocation of the aluminum smelting
industry). Demands for cost competitiveness led to sourcing globalization. This
practice was sometimes encouraged by governments, either through factor
subsidization (small open countries such as Ireland or Singapore) or by the
imposition of export performance requirements in exchange for access to local
markets, typically in large ''promising'' countries such as Spain, Brazil, and
recently India (Guysinger et al., 1984).
Managing costs is not enough, however, as companies have also come to
recognize the value of worldwide market access (Hamel and Prahalad, 1985).
Such access is becoming critical not only as a response to rising R&D costs but
also as a way of providing potential for competitive retaliation. Goodyear
responded to Michelin's inroads into the U.S. tire market by competing more
actively in Europe, where Michelin was dominant, thus depriving Michelin of
the cash flow it needed to continue its investments to gain market share in the
United States. A fight confined
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to the U.S. market would have been more costly for Goodyear than for
Michelin. Similarly, IBM fights Japanese computer manufacturers not so much
in the United States, where it would hurt itself, as in Japan, where IBM hurts its
Japanese competitors most at the least cost to itself (New Scientist, 1985). U.S.
makers of consumer electronics had no such option and fell almost defenseless
to the Japanese and to Philips.4
Where firms were not yet global enough and could not establish market
presence quickly (either because of government restrictions, or because
distribution channels are hard to penetrate, or both), strategic partnerships and
coalitions developed in industries that were becoming global. The primary
motive of most partnerships and coalitions is to shore up market presence and
technological competence to establish quickly a defensible position in a global
industry. While these do provide a viable option, the sharing of strategic control
over competitive actions by several partners usually results in tensions as soon
as the external technological and market conditions evolve or the relative
strategic importance of the joint activities to the various partners changes. This.
is probably the single largest cause of mortality in collaborative agreements.
Even when the collaboration endures, conflicting priorities may result in delays
that blunt its competitiveness (e.g., the 2-year delay in the launch of the A-320
airplane by Airbus Industries and the continuing tensions between the main
partners on future product policy and on acceptable financial performance).

Empirical Evidence
Although anecdotal evidence of industry globalization and MNC
integration abounds, systematic measurable data on their extent remain scarce
and fragmentary. Some industries are well documented (e.g., automobiles,
textiles, electronic components, aerospace) through numerous industry studies,
but most others are much less well analyzed.5 Aggregate statistics using proxies
such as intrafirm trade also suggest that integration of operations within MNCs
is important, with 20 to 30 percent of the international trade of countries such as
the United States, the United Kingdom, and Sweden being intrafirm trade.
Intrafirm trade seems to be more prevalent in R&D-intensive industries, with
high wages and large plants, which is consistent with the driving forces
hypothesized above (Dunning and Pearce, 1985; Lall, 1978; United Nations
Center on Transnational Corporations, 1983). Yet, even the most detailed
studies are fraught with problems in the availability and interpretation of data
(Hood and Young, 1980). There is a convergence between findings from studies
that start with trade statistics (e.g., based on the U.S. Department of Commerce
Annual Survey of U.S. corporations), those that start with a survey of
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large samples of fir (e.g., Dunning and Pearce, 1985), and those that start with
an analysis of the strategic behavior of firms (e.g., Hood and Young, 1980). The
more anecdotal evidence from individual "case" studies and from industry-
specific studies also points in the same direction.
Industry studies also provide evidence that even in industries that are
traditionally nationally fragmented, pressures for integration and globalization
are being felt. In the furniture industry, for instance, companies such as IKEA
or Habitat-Mothercare are exploiting economies of scale in purchasing,
subcontracting, advertising, and brand image, shifting the bottom end of the
furniture market away from a fragmented national structure to an integrated
multinational one. Similar moves are made at the top end of this market with
international designers' brands and with global distributors, such as Roche-
Bobois. Even where national prestige, national defense, and strategic
independence have traditionally weighed more heavily than competitiveness in
industrial choices, original patterns of globalization and integration develop. By
and large, European integration in aerospace is making progress under tight
supervision from governments. The failure to agree on a single design for a
future fighter plane may ultimately be beneficial in offering two complementary
products and maintaining spirited competition for export orders: Britain, Italy,
Germany, and Spain joined forces and will compete against France and smaller
countries. Similarly, the European microelectronics industry is evolving out of a
stalemate. We see cooperation between large firms that traditionally were
competitors as in the joint development of "megachips" by Philips and Siemens,
and we see new ventures occasionally being funded by old firms, as when
European Silicon Structures is financed by a group of large European electronic
industry firms to make semi-custom chips economically in Europe. Although
these collaborative ventures may not operate under the best possible conditions,
and their cost of coordination is high, they at least overcome the worst aspects
of fragmentation.6
Besides the turnaround in many governments in favor of government-
sponsored transnational cooperation, it is also important to note that pressure
groups that might have tried to block globalization and integration by and large
have failed. Although in the early 1970s it seemed plausible that unions would
gain a strong say in MNC management, they have now been ruled out as a
severe barrier to globalization and integration. This is the result of a
combination of factors, namely, the change of attitude in Europe (both the effect
of the unemployment crisis and also of an ideological shift away from statism
and socialism), the failure of unions to lock MNCs into transnational
bargaining, the lack of support provided by governments (e.g., the inability to
get the Vredeling proposal off the ground), and the divisive aspects of MNC
integration itself on international
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labor cooperation. Where unions succeeded in gaining a say, as they did with
the German codetermination laws, their representatives quickly aligned their
positions on those of management.
Economically weak but politically strong national industrial companies
could also be barriers to globalization, but by and large they fell to competitive
pressures in Europe. Only in a few partly competitive but largely government-
controlled sectors, such as electrical equipment for railroads, do the old industry
structures survive largely unchanged. Even in some of these industries, there are
encouraging signs of possible rationalization, such as the investments by
Compagnie Générale d'Electricité into Ateliers de Constructions Electriques de
Charleroi. Computer manufacturers are victims of probably the worst stalemate
along these lines in Europe. Britain, Germany, and France each have their
"national champion," hopelessly small for global competitiveness, and unable to
renew its product line without much outside help—usually Japanese. Yet each
of these national champions is well enough ensconced in its national political
and economic environment to survive, to prevent its merger into a transnational
alliance, and to block the development of new, more entrepreneurial national or
international competitors. First-class customers desert European suppliers—
mainly to IBM—despite the switching costs involved, and the technical
capability of European computer companies is withered by their Japanese
partners, who provide them with components, critical subsystems, and
peripherals. The continuation of this stalemate threatens the European computer
industry with extinction. In Europe, though, this is more the exception than the
role, and in most industries—aerospace, chemicals and plastics,
pharmaceuticals, and even now automobiles—are taking on the challenge of
global competition with a fair measure of success.

Research And Development

Unlike marketing and manufacturing, research and development have not
been significantly affected by globalization and have remained principally
home-country activities. In a world of sequential market development, where
new products and new processes were first developed and put to use on the
domestic market or in the home plants, home-country R&D made good sense.
As foreign markets developed to resemble the domestic markets, or as foreign
plants were built, new products and technologies were transferred abroad once
they had been proved domestically. Foreign R&D was mainly devoted to the
adaptation of transferred products and processes to local conditions such as
taste, product features, norms and standards, and climate (Fischer and Behrman,
1979; Hirschey and
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Caves, 1981). The role of foreign subsidiaries was not to innovate on their own
but to absorb and apply technology developed in the parent company's
laboratories. Technology was in fact global from the start, but research was
centrally performed and leveraged internationally through product life cycle
phenomena or through transfers to foreign subsidiaries. Even a group such as
Brown Boveri, which epitomized the nationally responsive—and fragmented—
MNC, leveraged its Swiss-developed technology in its foreign operations (Doz,
1978).
In a more complex world, where the United States no longer clearly leads
in product innovation, nor Europe in process innovation, centralized R&D is
less effective. First, the leading users—those who can contribute their
experience to the success of an innovation—are no longer necessarily available
in the domestic market. Although this is truest for MNCs in small countries
(e.g., Holland, Sweden, Switzerland, Korea), it is also applicable to U.S. or
Japanese companies. Leading markets for medical electronics, for example,
may be in the United States and in Japan and Sweden for factory automation, in
France for nuclear engineering, and in Britain for consumer electronics. Second,
key scientists, like the leading 'users, are potentially more dispersed
geographically than they have ever been. Some European pharmaceuticals or
electronics firms find it easier to locate laboratories for new technologies such
as genetic engineering or microchips in the United States than in Europe.
Conversely, India may offer the potential for a large number of inexpensive
software specialists and Italy for creative ones. Several U.S. electronics
companies, such as Control Data, Motorola, and Texas Instruments, are setting
up software R&D centers in India and Italy. Exploiting a larger pool of talent
and avoiding the cost of expatriation are strong motives to locate R&D in
various countries. Third, locating R&D in host countries may also help placate
their governments' desires for more higher skilled jobs (see Branscomb in this
volume).7 It may also make the firm eligible for national R&D subsidies or
access to national collaborative projects. Finally, the mobility and transfer of
knowledge within MNCs is neither easy nor costless (Teece, 1977).
Despite these trends, the forces favoring centralization of R&D remain
strong. First, as markets become increasingly homogeneous, the need for
specific local product adaptation or for autonomous product development is
lessened. Second, the benefits of close proximity of researchers are strong.
Although estimates of the distance beyond which easy informal communication
between scientists breaks down range from a few yards to a 1-day plane
commute, observers agree that the scattering of related research activities is
detrimental to their effectiveness (Allen, 1977). Third, there are often
economies of scope in R&D, particularly where technologies
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are interdependent, which make the scattering of R&D laboratories costly since
they cannot be made self-contained. Fourth, considerations of political risk
seem to have limited the willingness of major firms to be dependent in their
home markets on technologies developed abroad.
It is thus no great surprise to observe that, with a few notable exceptions,
the performance of the R&D function in firms has neither been globalized nor
integrated to any extent comparable to that of manufacturing and marketing.
The results of R&D are global, not the performance of the R&D tasks. With a
few significant exceptions, R&D remained centralized, at least in the
technology-intensive sectors. Foreign R&D labs do mostly product
development and adaptation to local conditions, or sometimes basic research,
but seldom have broad research mandates, except in some of the most mature
MNCs (e.g., IBM, Dow Chemical Company, and Ciba Geigy). Further, few
firms seem to have developed systematic processes for the coordination of
R&D activities across regions of the world, again with a few notable
exceptions, such as IBM.
Yet, as the home market can no longer be equated with the lead market,
centrally performed R&D needs to be responsive to the needs of distant
potential users. This may be easy to achieve for engineered commodities, such
as consumer durables, photocopiers, and typewriters, but it is more difficult
where needs can be defined only in close conjunction with users rather than
through market research (von Hippel, 1982). Whereas Japanese successes have
been confined mainly to engineered commodities, European exporters and
MNCs cover a wider spectrum of products. Large European companies have
particularly difficult problems with their U.S. subsidiaries. Their products are
often developed with too much of a "technology-push" by central labs whose
scientists and managers may have gained a sense for European needs but are
insensitive to U.S. needs. In some cases, they seem to be following what they
think is the "right" path from a technological rather than market standpoint
without considering the lead users' needs. As a result, it is not uncommon for
U.S. subsidiaries of European groups to avoid marketing products developed in
Europe, thus ensuring that their volumes will be too low to break even. Instead,
they develop new products at great cost, take a license from a competitor, or
buy the products directly on an OEM basis.
The issue is not who is right or wrong between the U.S. subsidiary and
headquarters, but the fact that a European group facing such a situation gains
little competitive advantage from being in the United States at all. The converse
example, of insensitivity by U.S.-based companies to non-U.S. market needs in
their product development, is better known and more easily explicable, given
the historical dominance—in the operation of most U.S. MNCs—of the U.S.
market over smaller fragmented national
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markets. Faced with the dilemma between economies of centralization and the
market access advantages of R&D dispersion, MNCs have occasionally done
both; some U.S. MNCs have maintained central laboratories but located the
primary labs for a set of products in the lead market away from headquarters.
In summary, R&D activities have not changed as dramatically over time as
manufacturing and marketing: Their activities have remained largely centralized
—most often in the home country—and their output leveraged through transfer
to foreign subsidiaries or through embodiment in exported products (Hirschey
and Caves, 1981). For most MNCs, the arguments for centralization seem to
have outweighed those favoring geographical fragmentation.

Summary Observations
Although it has to remain impressionistic, since detailed data are lacking,
the analysis of the balance between forces of global homogenization and
integration and forces of fragmentation clearly shows the balance tilting toward
globalization. The removal of trade barriers, and the growing similarity of
national markets mated the potential for globalization of markets and
competition. The development of MNCs, or of global networks allying
independent firms, and the technology of cheap effective transportation and
communication provided the practical means necessary for the integration of
supply. These conditions were necessary, though not sufficient. Intense
competition in most industries was the driving force necessary for integration
and globalization. During the same period, actors who might have stalled
globalization either did not act or acted ineffectively.
Thus, homogenization of markets has increased, industries have
globalized, and firms have responded by geographic integration of their
activities. Such integration took place (1) for sourcing—usually driven by
manufacturing cost-reduction opportunities stemming from growing economies
of scale and from economies of location; (2) for marketing—usually driven by a
mix of economies of scale in distribution and manufacturing; and (3) by the
competitive leverage brought by market scope. Coalitions and partnerships of
all kinds provide an attractive low-cost alternative to single-firm manufacturing
and market access investments. They do not, however, provide the strategic
freedom and control available through a company's own investments.
Research and development activities have typically remained in the home
country. However, as more and more products are developed for world markets,
usually for simultaneous rather than sequential introduction, the
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need for a better integration of foreign subsidiaries and domestic labs has
arisen. Evidence from specific product innovation studies in the United States
and in Europe tends to suggest that this need for integration is not well met.
Conversely, there is little to suggest that MNCs successfully apply innovations
that originate in one subsidiary outside of that subsidiary.
The next section discusses three sets of factors that suggest the trends
toward homogenization, globalization, and integration may slow down or even
reverse themselves in the coming decade. Some of the underlying conditions or
driving forces will have run their course, and new limits may appear.

LIMITS TO GLOBALIZATION

Manufacturing Technology
The evolution of manufacturing technology—in particular the increase in
economies of scale in manufacture—has been one of the key conditions in favor
of market globalization and MNC integration in a number of industries. Several
factors may now slow down this trend. First, new technology has been so
successful at reducing manufacturing unit costs that these costs now account for
only a small proportion of total delivered costs. Further reduction of
manufacturing cost will be of lesser impact than in the past, as other elements of
cost play a much greater role, namely overheads, R&D recovery, and
distribution.
Second, economies of scale may no longer increase in the same way as in
the past. Some new technologies may abruptly decrease economies of scale.
New multipurpose smaller processors in the chemical industry are an example
of this type of technology. Even in the absence of genuinely new technology
that would reduce economies of scale, the advantage of manufacturing systems
—from the well-known materials and resource planning systems to the
embryonic "factory-of-the-future" concepts—are based on cost reduction from
better managing the manufacturing system rather than from increasing the plant
size or the length of the production run. Better manufacturing processes allow
more flexibility in production. For instance, multiple car models can be
produced in varying proportions on the same assembly line with relatively little
cost penalty. This could allow car manufacturers to move back from large
single-model factories serving multicountry markets to multimodel factories
serving single-country markets. Although there may still be some cost penalty
to setting up a flexible factory rather than a narrowly focused one, at least the
tradeoff between increasing flexibility and decreasing costs can be explicitly
considered.
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The impact of flexible manufacturing on the trade-off between integration

and fragmentation of manufacturing is still unclear, however. Greater flexibility
allows producers to cater to shifts in consumer preference—as their
discretionary income increases—from cheap standardized goods toward
customized products. Flexible manufacturing systems may allow both product
customization—at least so long as such customization can be achieved through
featurization around a common core—and low cost. These systems may shift
the basis for cost advantage from scale to scope and thus make it possible for an
integrated manufacturer to serve differentiated worldwide needs.
Third, the "just-in-time" manufacturing concept works best with the
colocation of various facilities into an integrated system. This polarizes
globalization and integration to the extremes: either a series of small "local-for-
local" plants, each by and large self-sufficient, or, at the opposite extreme, a
single integrated source for everything (e.g., Toyota City, or to a lesser extent,
Boeing around Seattle, or Caterpillar around Peoria). A widely dispersed
integrated manufacturing network (such as Ford of Europe), where plants are
distant and supply each other with components and subassemblies, is least
amenable to just-in-time manufacturing management. Buffer inventories must
be kept to allow for transportation delays, localized strikes and disruptions, and
slowdowns in custom clearance. This would suggest that the initial patterns of
integration within MNCs, particularly in Europe, may not endure. Either the
advantages of colocation and flexibility will be such that we will witness a
return to largely local plants, or the advantages of focus and specialization will
continue to exceed those of flexibility, and the advantages of collocation will
lead to even further centralization of manufacturing.
Fourth, the trends toward vertical deintegration may allow more creative
combinations between independent firms at different stages in a value-added
strum. This would allow producers to continue to draw benefits from economies
of scale for components and to gain flexibility for end products. Large-scale
component manufacturing can be delegated to independent suppliers serving
multiple smaller-scale assemblers, for instance. This may lead to different
balances between integration and fragmentation at various stages of the value-
added chain in the same industry.
Most industries and firms are not yet affected by all of these trends, but
economies of scale in production are unlikely to be the opportunity they were in
the 1960s and 1970s. As a result, economies of scale will no longer be a driving
force toward globalization and integration. Choices for MNC managers will be
more complex than just building up the largest plants with the aim of regaining
competitiveness. Most companies are
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likely to end up with a mix of plants of various sizes and locations, and with
various degrees of focus or flexibility.
Economies of location are also likely to become less important. With a few
exceptions—such as aluminum—economies of location derive mainly from
labor cost advantages. Several observations can be made. Not only has
manufacturing cost decreased in relation to delivered cost for a whole range of
industrial products, but also labor costs will decrease in relation to
manufacturing costs with any shift toward more capital-intensive technologies.
Stable or increasing real wages in Europe, despite the recent recessions, have
accelerated the substitution of capital for labor. Even with relatively low wages,
the product quality provided by automation in consumer electronics, for
instance, may lead to rapidly decreasing labor content and to the repatriation
and automation of plants previously dispersed from developed countries.
Locations with low labor costs also tend to catch up with locations with
higher costs if only because skilled labor is scarce and the general wage
structure moves up. Location advantages based on cheap labor are thus often
temporary. Although labor may remain cheap in countries where political risks,
government policies, or financial problems deter foreign investors—and thus
limit the competition for labor—countries such as Singapore, Korea, and
Taiwan, which have been hosts to massive foreign investments, have often seen
their real-term wage rates increase significantly. In some industries—such as
garment production—firms may shift their manufacturing locations in a search
for cheaper labor. Where developed countries' firms subcontract to local
producers—a prevalent practice for garments—shopping around for cheaper
subcontractors is easy; when the foreign MNC sets up its own sourcing plants,
however, closing down and relocating elsewhere is a much more costly and
difficult process.
Differences in the cost of capital between countries also tend to decrease as
the world's capital market becomes more integrated and as MNCs cross-finance
themselves on multiple markets and arbitrage between them. Although domestic
firms may still benefit from favorable institutional arrangements, e.g., the
institutional structure of Japanese capitalism, or from specific government
assistance, e.g., European exporters, these advantages are limited, not always
accessible to MNC subsidiaries, and not often sufficient to justify location.8
Finally, exploiting economies of location also entails certain risks, for
instance, exchange risks. If the mix of manufacturing locations differs
significantly from that of selling locations, the firm is exposed to currency risks.
Whereas this can play in their favor occasionally (e.g., the hefty margins made
by European companies exporting to the United States in 1984-1985), it can
also play the other way around as in the plight of U.S.
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exporters. Various hedging approaches can be adopted,. but they usually either
run counter to the search for economies of location, or they result in the creation
of abundant ''buffer'' excess capacity. Instability of the exchange rate only
increases the difficulties and costs of these approaches.

Protectionism
Since 1975 protectionist pressures on the U.S. Congress have increased
largely as a result of the globalization process. Outright protectionist bills have
been avoided only by successive administrations' careful negotiation of selected
"voluntary" protection. Examples include the "Orderly Marketing Agreements"
for TV sets and the "trigger prices" for steel or other commodities. Proposals
such as the Burke-Hartke Act, which would have considerably limited the
opportunity for U.S. firms to import goods made by their overseas subsidiaries,
have been turned down, but at an increasing political price. The overvaluation
of the dollar in 1983-1985, and the huge U.S. trade deficit only made matters
worse. In the fall of 1985, only the shift in the U.S. position toward an active
intervention policy to devalue the dollar staved off strong protectionist measures.
Europe, while making only slow progress toward a true free internal
market, has resorted to protectionism toward a variety of industries, particularly
those threatened by Japanese imports. Government purchasing policies that
favor national suppliers also endure and close whole industries to foreign
suppliers. Whether the Japanese market is closed or just hard to enter is an old
debate, but it is clear that market access to Japan in critical industries is
extremely difficult.
What is important here is not so much the exact extent of protectionism,
but that recent evolutions do not allow managers to make a safe assumption
about freer trade. The risk of a widespread return to protectionism puts a
damper on globalization strategies that imply high levels of trade and adds fuel
to strategies that return to traditional foreign investment as a way of overcoming
trade barriers. Indeed, the purpose of many of the Japanese investments in
Western Europe and in the United States is to overcome trade barriers, or at
least to serve as "insurance" against new trade barriers, should they be
implemented.
Among the less-obvious aspects of protectionism that may hamper MNC
integration strategies are the issues of data flow across borders. Several
countries have argued that data should be likened to raw material and processed
locally rather than internationally. The issues are manifold and vary from
country to country. Among the most prominent are (1) the importance of local
data processing for stimulating the national demand for electronic data
processing hardware and services and for telecom
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munication services; (2) the disadvantage of local firms and governments in

relation to MNCs and their access to global market information; and (3) the
threat of more centralization of decision making in MNCs, a process directly
related to integration strategies. Canada has clearly articulated concerns about
transborder data flows. Brazil and France have followed suit, with somewhat
different concerns and priorities. Although policies on data flow are often lent
moral legitimacy by being amalgamated with a series of regulations to protect
the privacy of individuals, economic and political considerations drive the
development of such policies. Countries. do compete for the location of data
processing centers by MNCs, and they also compete for international data
transmission and value-added services. A few countries, including the United
States and Britain, have taken an aggressive commercial position by lowering
packet-switching charges, for example, and others try to regulate data flows.
Although the current impact of data flow regulations is limited, it is a concern
for at least some firms.9 In addition, regulation of data flows may also be a way
to ensure that critical knowledge exists within the country. One widespread
concern, for instance, is that some U.S. suppliers of computers keep debugging
software at home, where it can only be accessed by telephone lines from
Europe. Should denial measures be taken by the U.S. government, whatever the
reasons (as was done in 1982 in the Dresser case), such critical software might
no longer be available.10
More broadly, protectionism in technology has become a major issue. In
the 1980s the U.S. government, as well as several U.S. firms, became worried
about the transfer of technology to Japan and to the USSR. This concern arose
as the extent and success of efforts by Japanese firms and the Soviet
government to appropriate Western technologies became clear. With regard to
Japan, the issue is competition, particularly in industries such as
semiconductors. In this industry, in particular, manufacturing equipment is
critical to success, and the U.S. industry became concerned that process
technology was transferred too easily to Japan. The concern was heightened as
Japan came to be seen in the United States as an "unfair" competitor. Similar
concerns have been voiced in other industries, such as aerospace and
computers, as evidenced by IBM's actions against Mitsubishi and Hitachi.
With regard to the USSR, the issue is twofold: first, to deny the USSR
access to the core technologies of military systems, a priority widely shared in
the West; and second, to limit the USSR's access to technologies that may allow
faster economic growth and thus make large military expenditures more
affordable to the Soviets. The second point is a matter of debate between U.S.
government hard-liners and more liberal circles in the United States and among
European governments. The issue gained
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prominence with the discovery, probably by French counterespionage in early

1982, of the magnitude of the Soviet effort to spy on the West, and of the
success of that effort.11 Later updates, based on captured Soviet documents,
kept the issue salient. Also giving prominence to the issue were several
instances of discreet reexport of classified U.S. equipment via Sweden and
Austria and several cases of industrial espionage in major West European and
American companies, including MBB, Dassault, and Hughes. Although studies
suggest that the Soviets are not able to absorb and finance the use of the new
technology they obtain from the West, legally or otherwise, the Reagan
administration took it to heart to stem the flow of technology to the Soviet bloc
(Bornstein, 1985).
The Export Administration Amendment Act of July 1985 extends the list
of goods subject to U.S. export licenses to "dual-use" equipment, civilian in
principle, but using technologies or components with potential military use. The
U.S. policy of reexport control also considerably limits the mobility of
components to be incorporated into systems assembled in another country, and
sold in yet another. European integrated MNCs, such as Philips, suffer great
logistic complications from this new set of laws (Dekker, 1985). This leads
them to substitute, where possible, non-U.S. for U.S. components and
subsystems. Although such substitution is a boost to some European industries,
it leads to an inefficient duplication of effort between the United States and
Europe.
Protectionism in technology—be it through limiting the transfer of data or
through restrictions on exports of goods possibly related to the manufacture of
defense-related equipment—makes it difficult for technology-intensive MNCs
to adopt integration strategies, since the various pans of the company need to be
technologically autonomous. It also makes it difficult for U.S. firms to
cooperate with foreign partners on joint R&D and casts doubt on the ability of
European firms to use technology they would have acquired through
collaborative efforts with the United States or with U.S. government support.
Although Japanese firms are more strongly encouraged than their European
counterparts to participate in U.S. defense projects, the same issues arise
between the United States and Japan as between the United States and Europe.
Conversely, IBM's or Texas Instruments' access to the results of joint Japanese
research projects is a difficult issue.
These concerns have prompted Europe into action, first with the European
Strategic Program for Research and Development in Information Technology
(ESPRIT) and with specialized projects, such as Research in Advanced
Communications in Europe (RACE) and more recently with a program called
EUREKA. ESPRIT's relative success was a surprise, but by the end of 1985
about 195 projects shared 1.4 billion European Currency
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Units, and many of them looked promising. EUREKA, launched as a civilian

equivalent to the U.S. Strategic Defense Initiative, is still embryonic and
funding is uncertain. Despite widespread skepticism, it may take hold and lead
to interesting projects. This direct subsidy approach addresses only one facet of
European competitiveness, however, and maybe not the most important:
European firms show inferiority not in the development of new technology but
in its exploitation. Technology may not be the critical issue. Market structure
and management are. Although much attention in Europe is focused on making
Europe a true "common" market, remarkably little attention is devoted to
managerial limits to the successful exploitation of global technological and
competitive opportunities.

Organizational Capabilities
The various elements discussed above suggest that large international
competitors will face a world of neither fragmentation nor global integration,
but a mixture of both, with many shades of gray and complex patterns of
international operations that are unlikely to fall neatly into any category. Thus,
there will be many trade-offs between industry fragmentation and globalization
and strategies of integration and subsidiary autonomy, and they will vary by
function, country, and business. Differences between industries, between
segments within the same industry, and even between stages in the value-added
chain are going to be important. This will introduce considerable variety in the
situations faced by MNCs. Further, strategies will vary from free and
competitive to negotiated and collaborative through complex networks of
collaborative agreements, coalitions and joint ventures among firms, and
occasionally between them and governments (Doz, 1986).
Not all global competitors are able, organizationally, to cope with such
diversity. Most started as national companies (e.g., most Japanese competitors)
or with fragmented organizational structures loosely "federated" by
headquarters. Such fragmented structures, leaving a lot of autonomy to
individual subsidiaries in various countries, fit well with the fragmented
environment faced by MNCs prior to the 1970s.
The initial transition from autonomous subsidiaries to coordinated
international strategies and integrated manufacturing and marketing networks
has been a traumatic experience for many companies. The process has been
slow (typically 3 to 7 years), painful, and not always successful (Doz and
Prahalad, 1981; Prahalad and Doz, 1981). For a while in the mid-1970s, matrix
organizations were seen as the answer to complex tradeoffs between integration
and fragmentation. Though a matrix organization
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may achieve such trade-offs, it achieves them well only 'if a number of
conditions are met.
First, a matrix organization is not merely a different form of organization.
Rather, it is a different mode of making decisions and ensuring that relevant
data and perspectives are brought to bear on the choices, that trade-offs are
made explicit, and that well-considered decisions are reached. This requires
both a well-developed management system infrastructure, the involvement of
top management, and much attention to the quality of the executive process.
Observations of many companies suggest that not all are able to meet these
conditions. Hence the widespread disillusionment with matrix organizations
(Prahalad and Doz, 1987).
Although the "ideal" MNC organization is easy to spell out in principle, it
is difficult to put in place and make work. Yet, as discussed in the earlier
sections, the conflicting demands for flexibility and responsiveness, on the one
hand, and for global competitiveness and integration, on the other, call for
complex trade-offs. Such conflicting demands thus further limit the capabilities
of firms to succeed in global industries.
Moreover, in many industries, speed and interdependence in action
become increasingly critical. Product cycles are shorter, and the maintenance of
competitive advantage requires coordinated policies across product lines and
business units, both for technology development and for market access (Hamel
and Prahalad, 1985). The growing number and variety of collaborative
arrangements also make it more difficult for companies to maintain
conventional configurations of strategic control, as can be more easily done
with fully owned operations (Doz, 1986). As a result, a gap develops between
the demands put on companies by global competition and the capability of their
organizations and management to meet them.

CONCLUSION
The three sets of factors outlined above—manufacturing technology,
protectionism, and organizational capabilities—may limit the growth of
integrated multinational companies and tilt the balance again toward
fragmentation. Collaborative agreements and strategic partnerships may
increasingly represent an alternative to direct investment for gaining market
access, achieving volume production, or leveraging technology. These may
deeply modify the nature of global competition and international industries by
creating a series of intermediate positions between national and global
competitors.
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INTERNATIONAL INDUSTRIES: FRAGMENTATION VERSUS GLOBALIZATION 116

NOTES

1. For summary data, see Dunning and Pearce, 1985; Stopford, 1983; Vernon, 1977; Franko,
1976. See also, for U.S. multinationals, U.S. Bureau of Economic Analysis, 1986.
2. For a summary of the in—on argument, see Casson, 1979; Rugman, 1981; Dunning, 1979.
Many authors draw on Hymer, 1976.
3. For a general argument on the dynamics of global competition, illustrated with the example
of color television sets, see Hamel and Prahalad, 1985.
4. See Hamel and Prahalad, 1985, for a summary argument. For a more detailed analysis, see
Millstein, 1983.
5. For a series of industrial studies, see Zysman and Tyson, 1983; Hochmuth and Davidson,
1985.
6. For an early analysis of these problems in collaborative ventures, see Hochmuth, 1974.
7. The argument cuts both ways, though, as it may be argued that local scientists or technicians
employed by MNCs develop knowledge, the economic benefits from which may well accrue to
another country where the MNC operates, whereas local firms would have a greater propensity
to export innovative goods and processes, thus creating more value for the country.
8. For a more detailed discussion of the limits to the competitive advantage that can be obtained
from multinational resource deployment, see Doz and Prahalad, 1986.
9. For a summary analysis, see Kane, 1985, and United Nations Center on Transnational
Corporations, 1982.
10. For a detailed discussion of the Dresser case, see Bettis, 1984.
11. Although not publicly available, the various CIA reports to the U.S. Congress did much to
increase the political salience of the transfer of technology to the Soviet Union.

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Dunning, J. H., and R. D. Pearce. 1985. The World's Largest Industrial Enterprises, 1962-1983.
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Hamel, G., and C. K. Prahalad. 1985. Do you really have a global strategy? Harvard Business
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Helleiner, G. K. 1981. Intra Firm Trade and the Developing Countries. New York: St. Martin's Press.
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Hood, N., and S. Young. 1980. European Development Strategies of U.S.-Owned Manufacturing
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Kane, M. J. 1985. A Study of the Impact of Transborder Data Flow: Regulation on Large U.S.-
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Levitt, T. 1983. The Globalization of Markets. Havard Business Review (May-June):92-102.
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New Scientist. 1985. IBM begins its Japanese assault. (17 October):22-23.
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Prahalad, C. K., and Y. Doz. 1981. An approach to strategic control in multinational companies.
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Prahalad, C. K., and Y. Doz. 1982 (forthcoming). The Multinationals' Mission. New York: The Free
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Stopford, J. M. 1983. The World Directory of Multinational Enterprises, 1982-83. London:
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U.S. Bureau of Economic Analysis. 1986. U.S. Direct Investment Abroad: 1982 Benchmark &
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Vernon, R. 1977. Storm Over the Multinationals. Cambridge, Mass.: Harvard University Press.
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Vernon, R., and W. H. Davidson. 1979. Foreign Production of Technology-Intensive Products by
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Cornell University Press.
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 119

The Impacts Of Technology In The

Services Sector

JAMES BRIAN QUINN

In recent years much attention has been appropriately focused on the

structural changes technology has wrought upon manufacturing, particularly in
the United States. But technology has created even more dramatic changes in
the services sector, which now accounts for some 68 percent of U.S. GNP and
71 percent of U.S. employment. The shift toward services has been a long-term
trend, not only in the United States but in all major industrialized countries (see
Figures 1 and 2). This chapter addresses a variety of issues relating to
technological change and services:

• What are the major causes and implications of the shift toward a
services economy?
• How has technology restructured the services sector and how does this
restructuring affect U.S. trade and competitiveness?
• Can a services economy generate a continuously higher standard of
living?
• How might a services economy and services technologies affect
national sovereignty and the nation's posture in the world?

WHAT IS THE SERVICES SECTOR?

Many engineers and executives mistakenly perceive the services sector as
"making hamburgers" or "shining shoes." Such simplifications belie the
complexity, power, technological sophistication, and continuing growth
potentials of services in a modem economy. Although there is not complete
consensus on a definition for the services sector, it is generally considered
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 120

Figure 1
Employment in industrial sectors as percentage of total labor force.
From Quinn (1983).

Figure 2
Percentage of employment in service industries, five nations, selected years,
1960 to 1982. From Quinn (1986).
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 121

to embrace all those Standard Industrial Classification categories in which

(1) the primary output is not a product or a construction, (2) value is added
principally by other means (such as convenience, amusement, feelings of well-
being, improved knowledge, security, health, comfort, location availability, or
flexibility) that cannot be inventoried, and (3) outputs are essentially consumed
when produced (Collier, 1983; Mark, 1982).
''Services'' cannot be viewed as a single sector easily isolated from all
others. Table 1 suggests its scale, diversity, and economic impact.
If one defines an industry as a group of enterprises whose outputs are
largely substitutable for each other, there is no such thing as a single services
sector. The sector is at least as heterogeneous as manufacturing; one should
think of it as a grouping of diverse industries, just as manufacturing is. This
context makes it easier (1) to understand some of the more important
relationships between technology and specific services industries, and (2) to
dispel some of the myths about the services sector.

MYTHS ABOUT THE SERVICES SECTOR

The first myth about services is that they are somehow less important on a
"human needs scale" (Maslow, 1954, chapters 5 and 8) than products. Hence (so
the argument goes), services cannot provide the same value added or economic
stability as a production economy. In elemental societies, the first value added
is created by the mere presence or adequacy of a product, for example,
producing food for sustenance, housing for basic shelter, or clothing for
protection from the elements.1 But as soon as there is even a localized self-
sufficiency or surplus in a single product, added value is created by distribution
of the product—a services activity. In fact, the added production is worthless
without the distribution.
In such primitive societies other "services," such as health care, education,
trading, entertainment, religion, creative designs, and nonfunctional art works,
quickly become more highly valued than basic products, whose production soon
becomes the work of the poor. Similarly, in modem societies most of a
product's added value is due to service functions: better design, convenience in
use, packaging, distribution, marketing presentation, post-purchase
serviceability, and so on. And many of the most highly valued (high-priced)
activities in the economy are services such as architecture, art, health care,
entertainment, travel, banking, investment, personal security, or education.
Initial analyses indicate that measured value added in the services sector is
at least as high as in manufacturing (see Figure 3). Services also appear less
cyclical than manufacturing. In the last two decades, services employment has
advanced an average of 2.1 percent during economic con
TABLE 1 Components of United States Gross National Product
Services Current $ Billions 1972 $ Billions
1970 1975 1980 1983 1984 1970 1975 1980 1983 1984
Total GNP 993 1,549 2,632 3,305 3,663 1,086 1,234 1,475 1,535 1,639
Agriculture, forestry, fisheries 29 53 77 73 91 34 37 40 39 45
Manufacturing 252 358 582 685 776 261 290 351 354 391
Transportation 39 55 99 115 130 43 46 52 47 $0
Communication 24 40 67 92 103 26 36 52 59 63
Wholesale trade 68 117 190 229 265 72 88 104 114 130
Retail trade 98 149 238 307 337 104 122 142 152 165
Finance, insurance, real estate 142 216 399 543 598 155 188 236 254 265
Other service industries 114 186 342 478 529 127 148 189 207 219 THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR
Technology and Global Industry: Companies and Nations in the World Economy

122
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 123

tractions and 4.8 percent during expansions. Employment in the goods-

producing sector declined an average 8.3 percent in recessions and increased an
average 3.8 percent in expansions (Office of the U.S. Trade Representative,
1983, p. 21) (see Figure 4). This means that people will give up many product
purchases (indicating lower marginal utility for those products) before they will
sacrifice desired services like education, telephones, banking, health care,
police, or fire protection.
A second myth is that service industries are much more labor-intensive and
less technologically based than manufacturing. Stephen Roach of Morgan
Stanley & Company, Inc., has shown that capital stock per services worker has
been rising since the mid-1960s and now surpasses that for manufacturing
workers (Roach, 1985). Kutcher and Mark's data—grouping 145 industries on
the basis of capital stock per worker and labor hours per unit of output—show
wide variations in labor intensity in both the manufacturing and services
sectors. Some service industries—notably rail and pipeline transportation,
broadcasting, communications, public utilities, air transport—are among the
most capital-intensive of all industries. Nearly half of the 30 most capital-
intensive industries were services. But,

Figure 3
PIMS index of value added. Derived from industry survey and calculations
from PIMS (Profit Impact of Management Strategy) 1985 data base,
Strategic Planning Institute, Cambridge, Massachusetts.
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 124

surprisingly, few service industries were found in the three lowest capital-
intensity deciles (Kutcher and Mark, 1983). Profit Impact of Management
Strategy (PIMS) data from the Strategic Planning Institute, Cambridge,
Massachusetts, also show that aggregate capital intensities in services are
comparable to those in manufacturing (see Figure 5).

Figure 4
Recession resistance of the services sector.

Many service industries are very technology-intensive today. One thinks

first of communications, information services, health care, airlines, and public
utilities. But the banking, education, financial services, entertainment, car
rental, message delivery, and retailing industries have also become technology-
intensive (Office of Technology Assessment, 1984). For example, retail
discounting (largely by major chain retail operations)
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 125

represented 48 percent of all retail general merchandise sold to the public in

1984, and the top five merchandise chains had more than $70 billion in total
sales in 1985.2 These and the large food-retailing chains require extraordinarily
sophisticated computer, communications, product control, credit, and cash-
management systems to compete successfully. The services sector is a major
market for high technology—one study indicating that 80 percent of the
computing, communications, and related information technologies equipment
sold in 1982 went to the services sector (Kirkland, 1985). In Britain 70 percent
of all computer systems sold in 1984 went to the services sector (The
Economist, July 6, 1985).

Figure 5
PIMS indices of capital intensity. PIMS 1985 data base, Strategic
Planning Institute, Cambridge, Massachusetts.

A third myth about the services sector is that it is much too small-scale and
diffuse either to buy major technological systems or to do research on its own.
Again, initial analysis of the PIMS data suggest this is not true. Although
detailed Herfindahl indexes are not available, concentration and mechanization
in the services sector (see Figures 6 and 7) appear to be about as high as in
manufacturing.3 Thus, the sector has the potential not only to purchase
technology but also to contribute to its conception, design, and development.
We have not included government agencies or municipalities in our statistics,
but they clearly have similar capabilities. A fourth myth is the fear that a
services economy cannot continue to
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Figure 6
PIMS indices of concentration. PIMS 1985 data base, Strategic
Planning Institute, Cambridge, Massachusetts.

Figure 7
PIMS indices of mechanization. Index of mechanization calculated
as [Gross Book Value of Plant and Equipment]/[(Value Added/Net
Sales) x (Net Sales + Change in Inventory/Percent Plant Utilization)].
From PIMS 1955 data base, Strategic Planning Institute,
Cambridge, Massachusetts.
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 127

create an ever higher level of per capita income. Part of this fear is the
belief that services do not lend themselves to productivity increases through
technology infusions. Our analysis suggests that the overwhelming proportion
of productivity increases in both manufacturing and services have derived from
capital and technological infusions. Between 1975 and 1982 there was a 97
percent increase in new technology investment per service worker (Office of the
U.S. Trade Representative, 1983, p. 24). Some service industries have
undergone significant improvements in productivity over the last two decades.
In others, such improvements have not been very impressive (see Table 2).
TABLE 2 Productivity Increases in the Services Sector
Percent Average Annual Improvement
1960-1983 1970-1983
Telephone/communications 6.1 6.8
Air transportation 5.8 4.5
Railroad (revenue traffic) 5.1 4.8
Gas, electrical utilities 2.7 1.0a
Commercial bang — 0.9b
Hotels/motels 1.6 0.8
a1981 data,
b1982 data,
SOURCE: Bureau of Labor Statistic, Office of Productivity and Technology.

At the margin, services and manufacturing seem about equally attractive to

capital (see Figure 8). Consequently, one would expect a continuing willingness
to invest in services for productivity improvements and competitive advantage
whenever services eau offer adequate returns. Because less attention has been
given to automating services than to manufacturing, many opportunities to
improve productivity still exist, and office automation is high on both
producers' and users' lists of priorities (Collier, 1983).
Services can create real growth in per capita income as long as any of three
conditions obtain: (1) the product sectors can produce enough output at
continuously lower relative costs to release purchasing power for other desired
(services) uses, (2) it is possible to increase productivity in existing services, or
(3) entrepreneurs can conceive of new services having higher marginal value to
buyers than existing services or products. Within wide limits, the services
economy is a natural outgrowth of productivity increases in the goods-
producing sector. Whereas agriculture once demanded some 70 percent of all
employment in the United States, less than 4 percent of the work force now
produces much more food per capita—including 50 percent more of the major
grains than the country can eat (see Figure 1).
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Figure 8
PIMS indices of investment efficiency. From PIMS 1985 data base,
Strategic Planning Institute, Cambridge, Massachusetts.

A similar productivity phenomenon is now at work in manufacturing. With

a decrease in the number of hours of work needed to produce or buy a basic
automobile, radio, or washing machine, the percentage of the economy able to
be devoted to other things naturally goes up. Since the average person can eat
only so many pounds of food or use so many cars, washing machines, or
appliances, the marginal utility of other things rises, and in recent years these
things have often been services. As the perceived value (relative utility) of these
activities increases, a given expenditure on services will create greater value at
the margin and wealth is enhanced. For decades, the services sector has
provided the U.S. engine for growth (see Table 3).
Once survival needs are met, the relative value (or utility) of all other
objects, concepts, or services is solely a creation of the human mind. Pearls,
gourmet foods, more comfortable furniture, vacations, phonograph records,
parks, high-powered cars, or travel have value only because people create this
value in their minds. Thus, there is no intrinsic limit to the wealth a services
economy can create, other than the limits of human imagination in finding or
placing higher values on new services. Such limits seem remote at the moment.
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TABLE 3 Services Growth

Sector Compound Annual Growth (percent)
1960-1984 1980-1984
Goods-producing 2.8 2.4
Agriculture, forestry, fisheries 1.4 3.1
Construction 0.7 1.2
Manufacturing 3.5 2.6
Mining 2.1 1.0
Services-producing 4.0 3.6
Communication 7.1 4.7
Telephone, telegraph 7.6 4.7
Radio, television 2.9 6.2
Finance, insurance, real estate 4.0 2.9
Banking 3.8 1.7
Insurance 3.0 0.2
Securities, commodities brokers 4.6 16.9
Real estate 4.2 3.3
Public utilities 3.9 1.9
Services 4.1 2.4
Amusements, recreation 3.4 4.9
Auto repair 4.2 1.5
Business services 6.8 7.2
Health services 5.2 3.6
Legal services 4.6 6.4
Personal services 0.4 1.9
Transportation 2.1 -1.0
Wholesale, retail trade 3.9 4.7

SOURCE: New York Times (October 27, 1985).

THE LIMITS OF CURRENT DATA

To help show how technology affects the generation of wealth through the
services sector and the structure and competitiveness of a modem economy, this
paper draws upon information collected from four data bases: the Bureau of
Labor Statistics, the U.S. Department of Commerce, the Standard & Poors
Corporation's Compustat Tapes, and the PIMS data base. Aggregate data for the
services sector are compared against aggregate GNP and manufacturing sector
data and are analyzed for each major services sector to reveal certain key
variables and make appropriate comparisons among the sectors. This chapter
also draws upon information obtained from
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knowledgeable technology-using concerns and from experts in five sample

service industries: financial services, communications, public transportation
(airlines and rental cars), health care and delivery, and retailing.
The information from these various sources makes clear that, although
current data are replete with definitional problems and artifacts, the impact of
technology on the services sector is powerful, misunderstood, and crucial to the
future development of the United States and other advanced economies. This
topic is worthy of much further study. This chapter, therefore, is not intended as
a research report, but rather to help provide some initial insights on this
complex issue.

Some Data Anomalies

Data anomalies abound. Most serious are those in defining what is
included in measures of "the services sector." Specialized services (like product
design or development, market research, accounting or data analyses) are
captured as "manufacturing" costs if performed within manufacturing concerns,
but as "services" if provided externally. Internal salesmen are reflected in
manufacturing employment, but external sales representatives and wholesalers
are services. If a farmer harvests his own grain, the costs become production
costs; if the farmer hires a professional combine operator, the activity is a
service. Home cooking and clothes washing are not measured as services
activities, but restaurants and automatic laundries are. The oil that provides a
home's heat is a product sale; but electricity for the same purpose may come
from a "services sector" utility. And so on.
Productivity measurements pose a special problem (Mark, 1982). Although
it is easy to count the number of autos or washing machines produced, how
does one measure the output of a bank, insurance company, legal firm, or
consultant in order to make productivity measurements? The output of a
government agency is often measured only by the agency's cost (New York
Times, October 27, 1985). One medical procedure may require fewer resources
than another, but the (unmeasured) pain and morbidity it entails could be much
higher. Many people may actually place more value on noncurative treatments
or hope-creating reassurances (such as laetril or counseling) than a statistically
beneficial procedure (such as chemotherapy). And so on again.
Defining the services component of international trade movements is even
more complicated. If a loan officer in the British subsidiary of a U.S. bank
relies heavily on analyses or expertise developed in New York for a deal he
consummates in London, is this an export, a return on investment abroad, or just
a local sale of services? Similarly, in manu
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facturing it is often impossible to say how much of a company's overseas profit

is due to the company's products versus the embodied technology, training,
systems, or services support the company provides indirectly to host country
users from its U.S. base. How a cost or benefit is classified often depends on
how the company is organized and the purpose of the measurement itself.
Such definitional problems are magnified by the ease with which services
can be concealed in transfer pricing, cost allocation, or tax avoidance choices.
Finally, trade in services is seriously distorted by the not too subtle trade
barriers individual countries have placed on such trade, through their regulatory
or monopolistic (banking, insurance, travel, postal, telegraph, and so on) home
market restrictions (Sellers, 1985; The Economist, July 6, 1985). These will be
attacked seriously for the first time in the next round of the Multinational Trade
Negotiations.

Product Versus Service Interchangeability

Another artifact is the distinction (and preference) often attributed to
production of products as opposed to services. This viewpoint ignores the
truism that products and services are often interchangeable over a broad
spectrum. Theodore Levitt, editor of the Harvard Business Review, has said, ''A
man doesn't buy a ¼-inch drill, he buys the expectation of a ¼-inch hole.'' A
customer rarely cares whether a computer manufacturer accomplishes a
function by a hardware circuit or internal software. Cable network services
replace home antenna sales and provide more of what the customer is really
buying, increased quality in reception and choice in programs. Computer-aided
design and manufacturing software substitutes for added production machinery.
Conversely, tree shakers and automatic harvesters substitute for teams of
migrant pickers. Disposals and compactors lower garbage disposal costs. Home
hair sprays replace beauticians. Gourmet processed foods and microwave ovens
substitute for restaurants. And so on.
All of these substitutions create productivity and value-added increases
that are just as real as the substitution of a machine for a factory worker or a
new vacuum cleaner for a carpet sweeper. One set should not be denigrated and
the other praised.

CHANGES IN INDUSTRY STRUCTURE

Recognizing these anomalies in the data, what useful observations or
hypotheses can we make concerning the impact of technology on the services
sector? What are some of the resulting effects on the overall
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 132

structure of economic and competitive activities? Many potential effects are not
yet realized because major technology introductions in several key services
areas are relatively recent. Other effects are difficult to separate from those
caused by the simultaneous deregulation of such important activities as airlines,
communications, financial services, or common carrier services.
Two classes of technology affect service industries: industry-specific
technologies (such as aeronautics for airlines or internal-imaging technologies
for health care diagnostics) and generic technologies (such as communication,
information-handling, data-storage, or transportation technologies) available to
all sectors. Their effects on the service industries and overall economic
competition differ somewhat. But their main impact is to allow significant
changes in (1) economies of scale, (2) economies of scope, (3) output
complexity, (4) functional competition, (5) international competitiveness, and
(6) distribution of wealth. Such impacts occur virtually everywhere in the
economy. Introductions of technology have created entirely new competitive
situations for the service industries, their suppliers, and their customers
domestically and internationally. They have changed the nature of
manufacturing competition, and they have posed new technological,
management, and policy opportunities and threats throughout the world.

Economies Of Scale
Many service industries reported new economies of scale made possible by
recently introduced technologies. The first-order effect in most cases was a new
competitive structure characterized by both increased concentration and
increased fragmentation (niching or segmentation). To obtain the full
economies of scale available, large services companies merged into giant
companies (Standard & Poor's Industry Survey, December 13, 1984). This
phenomenon offers some interesting international trade policy opportunities.
Since many services are inexpensive to transport internationally, nations or
enterprises that achieve economies of scale early should enjoy some initial trade
advantages externally and some entry barriers to their home markets. And
countries whose economic policies permit such scale should benefit.
In the United States, new consortia have formed to provide new services
no existing entity could handle alone. Many intermediate-size companies,
unable to afford the new technologies, sold out to their larger brethren (see
Table 4). Concentration measures in banking, transportation, financial services,
and (less so) retailing all show increases from 1975 to 1985 (see Table 5). The
communications industry was so affected by the AT&T
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breakup as to make comparisons meaningless. After an initial concentration

toward larger hospitals and delivery units, Diagnostic Related Groups and other
economic considerations have begun to stimulate decentralization in certain
aspects of health care. In all these industries, however, many smaller enterprises
also identified local niches or specialized services and concentrated successfully
on these. The result seems to parallel the classic "V"-shaped return pattern that
Booz Allen & Hamilton, Inc., has reported for other industries, with higher
returns accruing both to a few large entities and to those who specialize. For
example:
• In the mid-1960s and early 1970s, automation of the securities-trading
process changed the entire structure of that industry. Under the old market
system, shares traded had to be physically delivered from the seller's agent to
the buyer's. As daily volumes hit 10-12 million shares, only the big banks could
hire and manage enough people to keep track of and clear their securities trades
each day. Smaller firms began to fail because they could not control or process
their securities. Finally, Wall Street firms joined together to form the Central
Certificate Services (later the Deposit Trust Company) to immobilize virtually
all the securities certificates under one roof. Then, rather than moving shares, a
single set of accounting entries could control ownership. After 5-6 years the
system became all electronic, and smaller broken could tie into the depository.
Now more than 175 million private and 175 million government transactions
are handled yearly by automated clearinghouses (Office of Technology
Assessment, 1984, p. 101).
Later a group of New York banks formed the Clearinghouse for
International Payments System (CHIPS), which handles transfers worth $60
trillion annually with same-day settlements (American Bankers Association,
1984). Trades can be made instantly by investment bankers all over the world,
broadening and decentralizing the market vastly, despite the procedures
required by the centralization clearinghouse. And specialized networks like
Nasdaq, Intex, and Instinet now serve smaller, segmented, or localized markets
(The Economist, July 6, 1985).
• Because of the reimbursement system then in use, the first effect of
capital-intensive technologies in medical care was to centralize treatment into
the hospitals. Small practitioners and hospitals did not have the patient volumes
to afford the elaborate diagnostic, treatment, surgical, and recovery equipment
that was being developed. This concentration allowed highly specialized
medical practices to form around the hospitals and created even more
specialized regional referral centers
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TABLE 4 Merger Transactions

Number of Transactions (rank)
Four-Year $ Millions
Paid (rank)
Industry 1984 Cumulative Industry 1984
Classification of Classification of
Seller Seller
Banking and 251 ( 1) 1,343 Oil and gas $42,981.8 ( 1)
finance
Wholesale and 143 ( 2) 498 Food processing 7,094.8 ( 2)
distribution
Miscellaneous 138 ( 3) 506 Conglomerate 6,982.9 ( 3)
Services
Retail 130 ( 4) 393 Retail 6,673.2 ( 4)
Computer 118 ( 5) 399 Banking and 5,846.3 ( 5)
software, finance
supplies, and
services
Oil and gas 102 ( 6) 369 Computer 3,766.4 ( 6)
software,
supplies and
services
Industrial and 93 ( 7) 379 Packaging and 3,089.4 ( 7)
farm equipment containers
and machinery
Brokerage, 86 ( 8) 251 Insurance 3,005.9 ( 8)
investment and
management
consulting
services
Health services 86 ( 8) 244 Printing and 2,863.9 ( 9)
publishing
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Number of Transactions (rank)

Four-Year $ Millions
Paid (rank)
Industry 1984 Cumulative Industry 1984
Classification of Classification of
Seller Seller
Broadcasting 83 (10) 237 Chemicals, paints, 2,629.9 (10)
and coatings
Chemicals, 79 (11) 251 Leisure and 2,580.7 (11)
paints, and entertainment
coatings
Instruments and 71 (12) 237 Energy services 2,546.2 (12)
photographic
equipment
Printing and 67 (13) 225 Miscellaneous 2,323.9 (13)
publishing services
Electronics 67 (13) 271 Timber and forest 2,297.2 (14)
products
Insurance 66 (15) 303 Electrical 1,978.4 (15)
equipment
Drugs, medical 61 (16) 260 Broadcasting 1,917.9 (16)
supplies, and
equipment
Food processing 58 (17) 253 Health services 1,687.9 (17)
Office equipment :55 (18) 167 Wholesale and 1,651.8 (18)
and computer distribution
hardware
Electrical 50 (19) 196 ladusUal and farm 1,635.6 (19)
equipment machinery and
equipment
Primary metal 43 (20) 141 Brokerage, 1,460.3 (20)
processing investment, and
management
consulting services

SOURCE: Grimm (1984), pp. 40-41.

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to handle particularly difficult cases. The first-order effects were that many
smaller hospitals suffered, closed down, or joined cooperative networks with
the larger centers.
TABLE 5 Concentration Measures in Five Service Industries, 1975 and 1985
1975 1985
Commercial banking
Total assets $525 billion $1,018 billion
4 firm measure 0.36 0.42
8 firm measure 0.52 0.63
Life insurance
Total assets $213 billion $526 billion
4 firm measure 0.47 0.43
8 firm measure 0.63 0.60
Diversified financial services
Total assets $127 billion $603 billion
4 firm measure 0.29 0.40
8 firm measure 0.44 0.60
Retail sales
Total sales $112 billion $297 billion
4 firm measure 0.31 0.32
8 firm measure 0.49 0.48
Transportation
Total operating revenue $36 billion $107 billion
4 firm measure 0.25 0.30
8 firm measure 0.42 0.51

NOTE: Concentration measures represent the proportion of assets, sales, or operating revenues
accounted for by the largest 4 or 8 companies in the industry. Totals represent summation of assets,
sales, or operating revenues for the largest 50 companies in the industry. Some totals are estimated.
SOURCE: Compiled from Fortune Service 500 data, Fortune, July 1975, and Fortune, June 10, 1985.

However, as uncontrolled costs soared (the average cost of an inpatient

stay rose from $729 in 1972 to $2,898 in 1984) and patient care became more
impersonal, new distribution systems emerged (U.S. Department of Commerce,
1985). Now medical services are integrating both vertically (home care, primary
care, and specialty care) and horizontally (pediatrics, obstetrics, dermatology,
internal medicine) into complex systems (such as health maintenance
organizations [HMOs]) linked by electronic technologies. HMOs have grown in
number from 39 in 1971 to 326 today and now serve more than 13.6 million
people, compared with 3.1 million in 1971. The number of ambulatory surgical
centers exploded from 400 in 1982 to 1,200 in 1985; and home health care was
offered by 42 percent of U.S. hospitals
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in 1984, a 17 percent increase over 1983 (DeYoung, 1985). Management of

these complex service systems has become such a critical factor that large
private companies have found it profitable to apply their skills to hospitals and
integrated health care management. To obtain specific economies, insurance
companies have integrated forward into health care management, and some
hospitals have begun to offer insurance (Business and Health, 1986a,b).

Economies Of Scope
The introduction of new technologies has often created a powerful second-
order effect—economies of scope—the capacity to provide entirely new service
products through the same service network. This was especially true when the
driving technology was electronic communications or information handling.
When properly installed, such technologies often allowed their users to
undertake a much wider set of customer, data, or services activities without
significant cost increases—or even with cost benefits through allocating
equipment, development, or software costs over a richer base of applications. In
addition, new technologies frequently offered increased strategic potentials
through timing advantages in introducing new products or fast response
capabilities in dealing with competitors' moves. Such strategic flexibility can be
the most significant payoff for companies in the services sector.
• In the mid-1960s, when the insurance industry was stable and heavily
regulated, insurance companies automated their back-room activities to obtain
dramatic gains in productivity in handling premium billings and collections.4 As
wildly fluctuating interest rates hit the industry in the mid-1970s, companies
had to change their products rapidly to attract premiums and to offset the effects
of customers borrowing against their policies at low interest rates. Only those
companies that had flexibly designed computer and control systems could
deploy their products rapidly enough to obtain a competitive edge. Persistence
rates (losses or changes in policies over a 5-year period) jumped from around 5
percent to 30-40 percent. Insurance companies used to bring out new rate books
every 3-5 years. Now both rates and products were presented in the electronics
technologies. Industry executives said they could have neither conceived of the
variety of new products needed nor explained and introduced them through
their agents in a timely way without effective electronic and software systems.
Smaller companies could not afford the huge initial costs of needed
technologies and sold out or merged with larger companies who could benefit
from their distribution networks. A flexibly automated back room became a key
element in survival and competitive success.
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Again, smaller or local groups had to create new relationships with those
who had requisite technical capabilities in order to obtain new products in a
timely fashion. Or they had to concentrate on localized or specialized services
the larger company could not yet reproduce. The flexible potentials of
telecommunications have led to an unprecedented series of national and
international coalitions among large and small companies. Because of the need
for compatibility among telecommunications systems, the formation of these
coalitions perhaps led to (1) more rapid technology dissemination than ever
before and (2) the obliteration of many potential national comparative
advantages in these technologies. The worldwide affiliations of IBM and AT&T
offer major examples (see Figure 9).
Two other industries suggest the basic restructurings caused by technology
in the service industries:
• Recognizing that the capability for sales of financial services is now
embodied in the electronic display system, Sears, K mart, and J. C. Penney have
experimented in the $1.6 trillion retail financial services

Figure 9
When worlds collide. Reprinted with permission from The Economist, June 29,
1985.
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market. Starting with its access to 40 million customers annually through its
credit records, Sears now offers insurance (Allstate Insurance Co.), investment
(Dean Witter Financial Services, Inc.), and full real estate services to customers
in many locations (Gardiner, 1985). Through its savings bank, credit card, and
automatic teller machines (ATMs), it is now extending other financial services
to its most remote branches. Although the nation's 45,000 ATMs (U.S.
Department of Commerce, 1985) already offer highly decentralized access to
financial services, more than half are hooked into one of seven national
networks such as Citishare or Cirrus (United States Banker, August 1985, p.
10). Many observers expect home banking services and electronic funds
transfers (EFTs) to extend these services even further. Whereas only 31 percent
of transactions are made through EFT today, Arthur D. Little estimates this
represents 90 percent of the total value of all transactions. McKinsey & Co. has
forecast a three-tiered future banking structure in which about 10 commercial
banks and a few other financial institutions will operate on a national level
(Cooper and Fraser, 1984, p. 216). A few new entrants will use technology to
bring specialized services (such as clearing centers or discount brokerage) to the
middle tier, and the regionals and local banks will scramble to find coalitions or
service highly specialized local needs.
• In rental cars, the large companies in conjunction with airlines can lock
up the general or business traveler with instantaneous guaranteed reservations
virtually anywhere. All have international subsidiaries or affiliates connected
electronically. But niched operators have proliferated under their pricing
umbrella. Automatic telephone answering devices allow both the super elegant
and the Rent-A-Wreck extremes to serve local markets with office-in-the-home
scales of operations. Alamo and Agency rental companies have segmented
target groups with specific needs.

Output Complexity
Technology in services permits complexity. Engineering specialists,
molecular biologists, or epidemiologists can analyze and resolve more complex
problems using computer models and data base networks than ever before. The
effects are so great that in some research areas, Joshua Lederberg, president of
the Rockefeller University, suggests the technology is moving from
"information search to knowledge search," that is, computer technologies can
identify relationships and pose new hypotheses as well as merely analyze and
test dam. For example, computerized an
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alytical models can suggest entirely new structures for complex proteins, and
gene machines can manufacture them within hours for testing against potential
antigen or biological insults. Entertainment and educational media can achieve
effects never before attainable. Law firms can accomplish more complex
searches of legal background, prepare more intricate contracts, and negotiate
and document the resulting settlements more thoroughly in hours than they
previously could in weeks. The velocity of transactions in monetary exchanges
and in commercial activities has increased so greatly that firms cannot compete
without well-developed electronic support systems. These shorter transaction
times have led in turn to potential economic volatilities that can threaten the
capacity of even great companies or nations to control their economic destinies.
The complexities that service technologies allow have created some
bizarre twists integrating world economies in unexpected ways.
• Once the financial houses could process documents efficiently, they
began to look for ways to market effectively and to sell products off their
technology bases. Among other things, a proliferation of products for pension
funds appeared, including master trusts, securities lending, and international
custody. GTE Corporation now has 40 different firms managing its pension
fund worldwide, yet these investments can be monitored, handled, and settled
through a master trust anywhere in the world every day of the week—
impossible without electronics technologies. With this capacity, large pension
funds (like the $17 billion fund of General Motors Corporation) can make or
lose enormous amounts of money on small changes in stock prices or interest
rates.
Because these funds can trade large blocks quickly, the volume of trades
has increased by orders of magnitude in the last decade. Daily volumes traded
on the New York Stock Exchange grew from 10-12 million shares in the early
1970s to more than 102 million in 1984, with more than half of the trades
involving 10,000 or more shares (Wall Street Journal, April 22, 1985, p. 1).
Since the pension funds with large holdings of common stocks could trade
profitably on small point spreads, the secondary consequence of this new
technology has been tremendous pressure on short-term profit and stock price
performance. This pressure has plagued all U.S. companies—manufacturing or
otherwise—trying to increase productivity through long-term investments in
technology. As financial markets further internationalize, this pressure may
extend equally to all nations' publicly held companies.
The technologies that allow manufacturers to produce a higher variety and
quality of products at ever-lower costs also open entirely new market
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niches requiring sophisticated new marketing and services practices never

needed before. But computer-related technologies now permit retail
establishments to deal with this greater range of offerings at a lower cost and
under better control than ever before. Again, technology creates a higher service
value (or utility, hence real growth) for consumers by matching their more
complex tastes and localized needs more explicitly—and usually at lower cost.
For example:
• Computer technology allows rental car companies to analyze their costs
for each type of customer. Because these costs vary enormously, the result has
been an elaborate set of rate structures by city, length of rental, day of week,
season, holiday pattern, and so on. Interestingly, if customers cannot figure
prices accurately, they concentrate more on services rendered, allowing higher
margins to those who can satisfy their needs. Computerized airline reservation
systems allow similar complexity, but they also permit unique service values to
customers, such as: specialized meals, wheelchairs, committed seat
assignments, luggage verification, and even customer counseling for nervous or
new flyers. Bar-code scanners in retailing allow retailers instant feedback on
their sales and inventory movements—and hence the capacity for much more
complex inventory and cost management systems (Chain Store Age Executive,
January 1985, p. 3). Some are now selling this information back to market
research firms who use it to help manufacturers fine-tune their strategies.
Sophisticated information systems are allowing major chains to branch out and
manage a portfolio of retail drug, supermarket, home center, and small specialty
chains with much higher value added potentials (Chain Store Age Executive,
March 1985, pp. 25-27).
Unfortunately, to use the full sophistication of modem technologies, data
about individuals' health, wealth, and activities axe stored in many accessible
places. And disastrous data errors, frauds, or system failures are possible. To
protect individuals and institutions in this environment will require further
sophisticated developments in technologies, institutional attitudes, professional
standards, and national and international regulations. The President's Office of
Telecommunications Policy has suggested some of the likely key issues for
public policy (National Science Foundation, 1975; Rule, 1975).
• Medical technologies perhaps provide the best example supporting the
complexity argument. They can now diagnose, attack, and resolve most of the
common infectious diseases and surgical problems of the past, switching the
medical care system's attention toward the prevention and cure of much more
complex diseases and morbidity patterns. Mortality rates have shifted markedly
(see Table 6). But as
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technology improved, so did people's expectations and use of the system.

Whereas medicine offered few nonsurgical ''cures'' (other than arsenic for
syphilis and quinine for malaria) until the antibiotic revolution of the 1930s, by
the late 1960s patients began to expect cures as a routine matter. They began to
use the system for a much wider and more complex set of purposes and began
to sue if their expectations were not met, regardless of the probabilistic or
medical realities. Medical technologies in many cases became so powerful that
life, according to some definitions, could be sustained almost indefinitely. This
has, of course, led to still another level of technical, legal, and ethical
complexities.
TABLE 6 Causes of Death per 100,000 in the United States
1900 1978
Influenza/pneumonia 202 27
Tuberculosis 194 1
Gastroenteritis 142 0
Nephritis 81 0
Diptheria 40 0
Cardiovascular 137 443
Malignancies 64 182

SOURCE: National Center for Health Statistics (1980).

Functional Or Cross Competition

With such diversity has come the breakdown of traditional industry
demarcations and significantly increased functional or cross competition. These
changes are most obvious in financial services.
• Disintermediation occurred because consumers found they could
communicate effectively directly with the market and no longer cared what—if
any—intermediary came between them and their investments. Banks, insurance
companies, brokerage houses all began to offer a similar range of financial
products and services (see Table 7).
Soon retailers and manufacturers (such as GM and Ford) used their credit
bases to present comparable offerings. The distinction between financing and
product sales rapidly disintegrated—note the success of 2.9 percent financing
campaigns for automobiles. General Motors Acceptance Corporation's $54
billion in assets and $1 billion in profits (more than the corporation's total
profits in 1983) make it the nation's largest single holder of consumer debt
(Gardiner, 1985, p. 9) and suggests the potential impact of such activities on
manufacturing firms. In addition, financial services became another way to
attract customers
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into retail stores—for example, Sears' use of Allstate and Dean Witter on the
one hand and First Nationwide Financial Corporation's joint venture with K
mart Corporation to deliver its services on the other.
• Communications, electronics, and printing technologies have allowed
national and international newspapers to attack the advertising base of
magazines and television networks. Communications technology has enabled
airlines, rental car companies, and hotel chains to join together to offer
complete vacation packages that were once solely the purview of travel agents
and tour groups. Courier services have essentially integrated private airlines and
ground services to compete selectively with telephone, facsimile, telegraph, and
mail services. Through their electronically managed "wholesale clubs," retailers
have integrated backward into wholesaling and into some manufacturing.
One upshot of these changes is more rapid introduction and delivery of
products or services with worldwide-scale economies and quality into the most
remote markets of the United States and other advanced countries. In such
countries, virtually all competition now has international dimensions. A second
result is that consumers' attempts to enjoy both "one-stop" shopping and
competitive prices create new possibilities for inventory and distribution
economies. Major manufacturers can integrate completely from "just-in-time"
suppliers to the shopping mall—as GM seems to intend with its Saturn
automobile project. Although potential gains appear high, with such integration
comes increased risks—notably GM's $5 billion
TABLE 7 Financial Services Offered by Depository and Nondepository Institutions
Banks S&L's Insurers Retailers Securities
Checking a.b b b b b

Saving a.b a.b b b b

Time deposits a.b a.b b b b

Installment loans a.b b b b b

Business loans a.b b b b b

Mortgage loans b a.b b b b

Credit cards b b b a.b b

Insurance a.b b b

Stocks, bonds b b a.b

Mutual funds b b a.b

Real estate b b b

Interstate facilities b b b

a1960.
b1982.
SOURCE: Koch and Steinhauser (1982).
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 144

investment in Saturn—if a mistake is made. Conversely, if competitors miss

this strategic opportunity, they could suffer major losses.
So pervasive are communications and electronics technologies that a key
element in competitive strategy for even "product-oriented" companies such as
Exxon or GM is information management. Their profits can be made or broken
by how well they develop and deploy knowledge about supply costs, new
technologies, exchange rates, changing regulations, swap potentials, political or
market sensitivities, and so on anywhere in the world. In the aggregate, more
money may be made in the goods sector through information and services than
"production" activities. The U.S. Trade Representative's Office in its U.S.
National Study of Trade in Services (1983, p. 13) cites an estimate that about
three-fourths (or 25 of the 33 percent) of the total value added in the "goods
sector" is created by services activities within the sector.5 If this level of
contribution is correct, one can expect to see information managers and similar
services technologists increasingly rising to the top of major producing
organizations—as they already have in oil companies, banks, and the retail
trades. The cross substitution between production and services will become ever
more apparent.

International Competitiveness
Perhaps the most perplexing, yet crucial, impact of services technologies
will be on international trade. Within the definitional limits cited, The
Economist (October 12, 1985) estimates only 18 percent of world trade to be in
services as opposed to 49 percent in manufactures and 33 percent
TABLE 8 World Comparisons
Average Annual Compound Value in 1980
Growth Rate, 1970-1980 ($U.S. billions)a
(percent)
Services exportsb 18.7 350
Merchandise exports 20.4 1,650
Foreign investment incomec 22.4 225
World production 14.2 9,389
a Converted from SDRs and nominal values in national currencies at current exchange rates to U.S.

dollars. World is defined as IMF member countries reporting data for both 1970 and 1980.
b services exports exclude official transactions and investment earnings.
c Foreign investment income includes private direct investment income and portfolio income but

excludes official transactions.

SOURCE: Derived from various issues of Balance of Payments Statistics, International Monetary
Fund, and International Financial Statistics, International Monetary Fund.
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 145

in other goods support activities. Admitting that the $100 billion statistical
discrepancy in world trade balances is probably due to a substantial under-
estimation of services trade, the U.S. Trade Representative's Office estimates
$350 billion in world services trade in 1980 as opposed to $1,650 billion in
merchandise trade (see Table 8). Yet even these figures are misleading because
so many of today's sophisticated products could not be sold abroad without
supporting services to finance, maintain, and upgrade them in the marketplace.
TABLE 9 Ten Largest Services Exporters 1980 (billions of U.S. $)
Country Value of Value Services Services Services
Services Foreign Balance Exports Exports
Exportsa Investments — GDP —
Incomeb (%) Merch.
Exp. (%)
United States 34.9 70.2 6.0 1.4 15.6
United 34.2 17.1 9.8 6.5 30.9
Kingdom
France 33.0 18.4 5.5 5. 1 30.7
Germany 31.9 8.5 - 17.9 3.9 17.2
Italy 22.4 5.3 6.2 5.7 0.2
Japan 18.9 7.2 - 13.4 1.8 14.9
Netherlands 17.7 10.0 0.2 10.5 26.2
Belgium 14.5 17.6 0.5 12.1 26.3
Spain 11.7 0.2 6.3 5.6 56.9
Austria 10.8 2.5 5.1 14.0 62.6
aServices exports exclude official transaction and investment earnings.
b Foreign investment income includes private direct investment income and portfolio income but
excludes official transactions.
SOURCE: Derived from various issues of Balance of Payments Statistics, International Monetary Fu
nd, and International Financial Statistics, International Monetary Fund.

Worldwide services exports in 1980 were only about 3.7 percent of gross
domestic product, and those of the United States were only 1.4 percent, but
worldwide services trade was growing at a 19 percent rate versus merchandise's
20 percent (Office of the U.S. Trade Representative, 1983, p. 13). Both rates
were much greater than world production's 14 percent growth. Twenty-four
countries accounted for 87 percent of services exports in 1980, and the United
States led with $34.9 billion (see Table 9).
Technologies related to services have vastly restructured the international
marketplace in other important ways. Communications technologies, of course,
permit manufacturers to coordinate their design, sourcing, distribution, and
manufacturing activities worldwide to minimize costs. But economies of scale
in services affect manufacturers' Scale economies in other ways as well.
• Containerization and new on-board storage techniques (such as li
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 146

queried natural gas) facilitate and lower the cost of trade for such things as
expensive high-technology goods, volatile chemicals, and coal. This trade in
turn has led to major ($250 billion in 1981) construction and engineering
projects in both buyer and seller countries that require more traded services and
the development of technical support (services) industries in both exporting and
importing countries. Cheaper and more flexible transportation systems also
have lessened geographic constraints on production and further encouraged
transfers of skills, technology, and knowledge among countries (Office of the
U.S. Trade Representative, 1983, p. 16).
• Large-scale investor arrangements now allow direct access to the
Eurobond market where large "blue chip" companies can buy Eurobonds
directly (often at lower interest rates than U.S. treasury bonds) and can place
other securities directly with large investors or on a "bought deal" basis, thus
lowering their capital costs relative to smaller companies. The extent of these
transactions has become significant. By 1985 the market for Eurobonds
denominated in dollars was $38.4 billion, and the commercial paper market was
more than $230 billion (The Economist, March 16, 1985). An international
"swaps" market of more than $20 billion had also developed (Credit Suisse-
First Boston Bank, 1983) enabling two sophisticated companies to borrow in
the domestic markets that were most favorable to their needs (interest levels or
rate stability), then swap their interest obligations, splitting possible interest
savings.
World capital markets have become so integrated that it is difficult for any
single nation's producers to achieve a capital cost advantage over other
international competitors. Local banks or large companies can trade directly in
virtually any money market in the world, as clearances are made
instantaneously by electronics. At present there is continuous trading on some
major market during all but 6 hours each day. Soon trading will be a 24-hour-
per-day phenomenon. The business in foreign exchange transactions is already
$6 trillion annually, and it is expanding. Under these conditions, the extent to
which sovereign nations can intervene effectively to control their monetary
systems (and hence inflation rates) in order to manage their economies through
traditional means is not clear. This may be the most significant single impact of
technology in the services sector.
• In 1985 computerized quotations and satellites had global financial
markets; more than 500 companies were listed on at least one stock exchange
outside their home countries. Innovations in one market were rapidly reflected
in others. The European "bought deal" procedure led the U.S. Securities and
Exchange Commission to issue SEC Rule
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 147

415 allowing companies to preregister issues and sell them off-the-shelf as

needs or market conditions warranted. The negotiated rates of U.S. brokers are
slowly being forced onto the exchanges of other countries. The United States
has relaxed requirements of its bond markets to make them more competitive
with Eurobonds; and foreign exchanges (notably, London and Tokyo) have
opened their memberships to foreign brokers. In investment banking, "bought
deal" procedures have shrunk spreads and concentrated underwriting to the few
firms that have the capital bases, distribution outlets, and trading systems to
handle them. In 1984, two-thirds of all such new issues were handled by only
five firms in the United States (The Economist, March 16, 1985).
One initial impact of improved data, production control, and
communications technologies has been to allow—or force—manufacturing
outside of industrialized (or wealthy) countries to move toward developing
areas where costs of labor or materials have been lower. With advanced
electronic technologies, overseas facilities could be controlled or managed with
whatever degree of centralized coordination competition demanded. Although
this use of technology has distributed manufacturing more widely, the longer-
term effects of decentralized production are less clear. The diversity of
specialized customer tastes that can be accommodated by flexible
manufacturing systems and better communications technology may soon create
higher competitive premiums for those who stay physically closer to the
marketplace and can respond more rapidly to customers' needs for services.
• Saturn's planned 8-day cycle from order to delivery of an options-loaded
vehicle may make it difficult for foreign producers to compete. The same may
be true of just-in-time inventoried products throughout the U.S. production
system. Japanese auto companies manufacturing in the United States are now
bringing their suppliers here for just this reason. Interestingly, manufacturing
may actually return to large advanced economies because of the "services" need
to satisfy a highly diffuse marketplace rapidly and flexibly.
A crucial question is whether, without domestically controlled
manufacturing and R&D, a country can have a healthy technological
community. In the past, manufacturing enterprises have been the locus of most
R&D both for their own consumption and for performance of government R&D
contracts (see Figure 10). If U.S. companies' manufacturing plants were located
overseas, U.S. R&D could support them for a while. But it is difficult to
maintain manufacturing R&D capabilities without the close interaction and
feedback a local plant offers.
As other nations' enterprises achieve world-scale economies with their
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 148

own domestic plants in maturing markets, it may be nearly impossible for U.S.
concerns to stay abreast in manufacturing without domestic plants. Many
competitors are sadly aware of how important user proximity (domestic plants
and markets) has been for Japanese productivity. Although users of services can
provide a significant driving force for product technologies, simultaneous
development of product and manufacturing capabilities has become so
important that lacking the latter could be the fatal flaw in a services economy.
Both wealth and (more important) intellect could leak away to other
"producing" countries.

Figure 10
PIMS indices of research intensity. From PIMS 1985 data
base, Strategic Planning Institute, Cambridge, Massachusetts.

Nevertheless, services themselves are also a critical cost dimension of a

nation's competitiveness in international production. Internal transportation,
communications, financing, health care, distribution, and other services can
lower the real cost of manufactures. Efficiencies in these sectors also improve
the real wealth of laborers for any given wage level; that is, workers can buy
more goods and services per dollar earned. For example, the Japanese have
been superb in certain mass-manufacturing
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 149

fields, but their productivity (in GNP per person) has consistently lagged behind
that of the United States, largely because of a less-productive services sector
(see Table 10).
As an economy moves ever closer to a total services base, a most
important question emerges: What does the nation trade to obtain the
manufactures and raw materials it needs from external sources? Although U.S.
manufacturing and agricultural exports have suffered notable relative declines
in recent years, the United States has had a strong positive net balance of trade
in services and income from investments abroad, excluding payments for
investments in the United States (see Table 11). Some have questioned whether
traditional arguments of comparative advantage will be relevant in world
services trade, especially in financial or information-based services where
everyone can buy the same hardware (and often the same software) and connect
into the same networks (Deardorff and Jones, 1985). This problem is
compounded in the technology because the developers of much of the
technology used in services trade are suppliers (often manufacturers) whose
incentives are to sell and introduce their technologies as widely and quickly as
possible worldwide.
With rapidly advancing generic technologies such as electronics and
communications driving the services industries, it will be difficult to establish
or maintain a national competitive advantage in any given services industry.
Nations' trade and economic policies may have to focus more on improving
education infrastructures and removing barriers to fast and flexible deployment
of technologies and less on traditional investment-oriented industrial policies
(Grossman and Shapiro, 1985). For example, The Economist (November 29,
1985) asserts that by early deregulation of
TABLE 10 Comparative Services Productivity, United States and Japan (dollar
output per hour)
Japan U.S. U.S./Japan
1970 1980 1970 1980 1980
Private domestic business 3.59 6.01 9.40 10.06 1.67
Agriculture 1.37 2.38 16.53 18.36 7.71
Selected services
Transportation and 3.86 5.66 9.29 13.14 2.32
communication
Electricity, gas, water 14.01 19.74 21.98 25.38 1.29
Trade 2.88 4.53 6.88 7.92 1.75
Finance and insurance 6.69 12.03 8.21 8.20 .68
Business services 3.39 3.60 7.69 7.59 2.11
Manufacturing 3.91 8.00 7.92 10.17 1.27

SOURCE: UNIPUB (1984).

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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 150

communications markets, the United States gained a lead in both use and
production of communications technologies that Europe's more regulated
sectors may never close. On the other hand, there is little room for
complacency. Many countries and companies have proved that their skills in
managing services enterprises are formidable indeed. The United States must
work hard not to dissipate its lead in communications as it did in manufacturing.
Ominously, however, many of the same causes of lost position are beginning to
appear in this sector, namely, a short-term orientation, inattention to quality,
and overemphasis on scale economies as opposed to customers' concerns.
TABLE 11 United States Net Trade Balancea (billions of current dollars)
Category 1965 1970 1975 1980 1981 1982 1983 1984
Net goods 8.3 5.6 22.8 9.0 13.2 0.1 -31.9 -90.1
and services
balance
Merchandise 5.0 2.6 8.9 -25.5 -28.0 -36.4 -62.0 -108.3
balance
Services 0.2 0.2 1.8 6.3 8.3 7.4 4.8 0.8
balance
Net 5.3 6.2 12.8 30.4 34.1 29.1 25.4 19.1
investment
income
a Excludes military transactions.

SOURCE: U.S. International Transactions 1960-1984, Washington, D.C.: U.S. Department of

Commerce, Bureau of Economic Analysis.

The trade balance in merchandise has been negative in 11 of the last 24

years. In more than half of these, however, services (including investment
returns) have put the current account in the black. But even adding $10 billion
for the U.S. 10 percent share of understated world services trade (Office of the
U.S. Trade Representative, 1983, p. 108), long-term prospects do not look
encouraging for U.S. trade balances unless manufacturing returns to the United
States and the strong U.S. dollar weakens. Table 12 gives a detailed breakdown
of U.S. services trade.
Many experts believe that the net effect of services trade is even more
seriously understated by definitional and reporting biases. For example:
• As their major customers increasingly sought international raw materials,
supply sources, economies of operating scale, or markets, both U.S. and foreign
banks followed their customers overseas in the 1970s. By the early 1980s,
30-40 percent of all U.S. bank profits came from international operations, with
many of the money center banks exceeding 50 percent (The Economist, March
16, 1985).
The International Trade Commission cited an estimate that in 1982
TABLE 12 U.S. Detailed Services Trade Transactions (millions of dollars)
1978 1979 1980 1981 1982 1983 1984a Change, 1983-1984
Service transactions, net 23,625 32,241 34,487 41,129 35,327 28,143 16,986 - 11,157
Receipts 77,940 102,323 118,216 138,636 138,250 131,944 142,010 10,066
Payments - 54,315 - 70,082 - 83,729 - 97,507 - 102,923 - 103,801 - 125,024 - 21,223
Military transactions, netb 621 - 1,778 - 2,237 - 1,115 195 515 - 1,635 - 2,150
Travel and passenger fares, net - 2,585 - 2,000 - 825 58 - 1,599 - 5,064 - 7,830 - 2,766
Other transportation, net - 988 - 935 - 172 86 591 480 - 976 - 1,456
Fees and royalties, net 5,215 5,352 6,360 6,560 6,938 7,402 7,577 175
Investmeal income, net 20,565 31,218 30,443 34,052 27,803 23,508 18,115 - 5,393
Direct, net 21,247 31,826 28,488 25,496 18,140 14,023 12,351 - 1,672
Other private, net 6,149 8,173 11,905 21,629 23,641 22,310 20,425 - 1,885
U.S. government, net - 6,831 - 8,781 - 9,950 - 13,073 - 13,978 - 12,825 - 14,661 - 1,836
Other private and U.S. government, net 798 383 917 1,488 1,401 1,302 1,734 432
Contractor operations, net 1,348 1,054 1,591 2,027 2,398 1,790 2,109 319
Reinsurance, net - 532 - 617 - 624 - 606 - 590 - 506 - 553 - 47
Communications, net - 65 - 143 - 317 - 466 - 758 - 724 - 721 3
U.S. government, net - 925 - 1,198 - 1,332 - 1,366 - 1,705 - 1,563 - 1,528 35
Other, net 972 1,287 1,599 1,900 2,057 2,306 2,427 121
aPreliminary.
bConsists of goods and services transferred under military sales contracts less imports of goods and services by U.S. defense agencies.
THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR

SOURCE: Survey of Current Business, March 1985, Table G.

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151
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nearly 25 percent of U.S. merchandise exports went to U.S. services

businesses overseas. Some services, such as drilling, minerals exploration, civil
engineering, banking, communications, or transportation, can be readily
exported or are necessary purchases an outsider must make to trade in the
economy. Certain technologies can be exported through licensing agreements.
However, most such agreements pertain to manufacturing or product
technologies. Without significant production inside the parent country (for
example, the United States), a nation's ability to generate international services
revenues through royalties or technology payments may be seriously impaired.
How serious this impairment could be is unknown. Many experts believe that,
unless manufacturing reverts to advanced countries through mechanisms like
those suggested, increasingly services-oriented economies of advanced
countries could lead to a serious and continuing weakening in their world trade
positions, their strategic capabilities, and the value of their currency in world
trade. What the net effect might be as all affluent countries move toward
services economies needs serious research.

Growth And Distribution Of Wealth

What are the effects of a services economy on distribution of growth and
wealth, domestically and internationally? How does technology affect the
process? For nonsupervisory workers, weekly average wages in manufacturing
are about $373, whereas wages in services are about $250. This gap is
overstated because more than 20 percent of all services workers are employed
part-time (less than 30 hours per week); part-time workers constitute less than 5
percent of all manufacturing employees. Hourly wages in specific industries
and current trends paint a more encouraging picture for services. Although
average hourly wages per worker are higher in manufacturing than in some
major services industries, notably retailing, other services activities enjoy
higher average hourly wages than manufacturing, and the gap is closing in
financial and other services (see Table 13).
Job opportunities in the United States have, of course, been growing most
rapidly in the services sector for years. But recent job growth has been
dramatic. From 1948 to 1978, manufacturing jobs grew by 3.6 million, but only
600,000 of these employees were in production jobs. More recently, 642,000
jobs were lost in manufacturing from February 1981 to February 1985, but
services employment grew by 3.1 million. Since more affluent people spend a
higher percentage of their income on services, this trend is likely to continue for
the near future. The Bureau of Labor Statistics (BLS) also estimates that about
half of all new manufacturing jobs created between 1969 and 1979 were white
collar. Neal Rosenthal of BLS's Division of Occupational Outlook estimates
that the
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 153

shift to services employment in the last decade has actually decreased the
percentage of workers holding low-paying jobs (Kirkland, 1985). BLS forecasts
to 1990 suggest that low-paying services jobs will keep pace with, but not
exceed, total growth in employment. But some service areas with high-paying
jobs (such as computer services and investment banking) are expected to have
high growth (see Figure 11). More than 60 percent of U.S. employment is now
in the information industries, and virtually all of the 20 highest-growth
occupations in the 1980s, as forecast by BLS, are in information handling. The
Fishman-Davidson Center (University of Pennsylvania) showed that those
states with the highest proportions of services employment also had the highest
real income averages (see Figure 12). However, which is the cause and which is
the effect is not clear.
TABLE 13 Average Hourly Wages per Worker
1983 ($) 1984 ($) 1983-1984 Growth Rates
(%)
Average nonagricultural 8.02 8.33 3.9
Manufacturing 8.83 9.18 3.9
Durable 9.38 9.74 3.6
Nondurable 8.08 8.37 3.6
Transportation and utilities 10.80 11.11 3.2
Wholesale trades 8.54 8.96 4.7
Retail 5.74 5.88 2.6
Finance, insurance, real estate 7.29 7.62 4.5
Other services 7.30 7.64 4.3

SOURCE: Survey of Current Business, June 1985, Table S12.

Although some observers have suspected that the shift from manufacturing
to services was a prime cause of the productivity slowdown in the United States
in the 1970s, Kutcher and Mark (1983) found that such changes accounted for
less than 0.1 percent of the change in productivity growth from 1959 to 1979. A
real culprit, however, was the shift from high to low productivity goods-
producing industries, accounting for up to 0.6 percent of the slowdown per year.
Since many services jobs must be close to the point at which the services are
used, services employment tends to become more geographically dispersed,
following people's preferences for suburban and rural living. The quality of
employment thus improves on two scales. Many physically difficult or
hazardous jobs in production disappear in favor of ''white collar'' jobs in
services, and the location of jobs is generally more pleasant and convenient.
Services allow more part-time jobs for multiple-income families, and there is
evidence that the family income for those employed in services may thus be
higher than for those in manufacturing.
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 154

Figure 11
Projected job growth by 1995. From Bureau of Labor Statistics.

SOME ULTIMATE QUESTIONS

This discussion may lead to several ultimate questions about services
economies. Can a services economy remain wealthier in the long run than more
manufacturing-oriented economies? How fax can an economy move toward a
services base before it can no longer maintain its relative wealth? Can a services
economy support the R&D necessary to maintain intellectual leadership and a
high level of productivity growth?

Can Services Allow Greater Wealth?

As productivity increases in various manufacturing sectors, a large country
such as the United States can reach self-sufficiency in a wide variety of
products, employing only a small percentage of its population in manufacturing
—just as less than 4 percent of the U.S. population now in agriculture produces
a surfeit of food. Once reasonable self-sufficiency is obtained in a modest range
of production, the definition of "wealthier" becomes more subjective. It depends
on the relative value placed on different goods or
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 155

services by the society. A more stable, safer, healthier society with fewer goods
could be considered wealthier than one with more goods.
Although some observers claim that services industries are inherently
incapable of creating "wealth" that can be transferred to future generations,
even this argument fails. Better education, art, literature, health care, cultural
capabilities, convenience in transportation, communication capabilities,
recreational availability, and personal security can be transferred to future
generations. These services have been the true measures of wealth throughout
history. Thus, services societies can easily be wealthier than production-
oriented economies—especially if the latter must pay a high premium in
environmental degradation. In fact, some observers believe a services-driven
economy may represent the most advanced level of economic development.

Figure 12
Average state real per capita income by percent of total private nonfarm
employment in services in states. From Fishman-Davidson Center (1985).
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 156

What Is The Basis Of World Power?

We often equate manufacturing power with economic wealth and world
power. We forget that in the past the wealthy and great nations tended to be the
trading nations, the educated nations, and the money centers of the world.
Commerce, not manufacturing, led to wealth and power. Has the world changed
fundamentally in the last 100 years? Perhaps so. Military power recently seems
to depend on production power. But today selected intellectual and research
capabilities in high technologies may be more important militarily than massive
production potential, especially if a war is short. Nevertheless, it seems unlikely
that a large modem country could maintain its strategic viability without world
competitive aerospace, steel, chemicals, transportation, electronics,
communications, and related support industries.
Some of these industries may need significant government support to be
strong enough to meet the needs of defense, but fortunately most do sell
extensively to the services sector. This sector could, if properly stimulated,
provide the basic technological demands to maintain an important level of
defense preparedness. Industries such as airlines, communications, information
systems, financial services, and rental cars already hold such potential. Careful
analysis is needed to explore the strategic issues raised by an economy
increasingly oriented toward services.

OVERALL IMPACTS TECHNOLOGY IN SERVICES

Technological advance is rapidly revolutionizing modem economies
through services and presenting entirely new opportunities and challenges for
corporate and national policymakers. The old "room and pop store" and "hand
laundry" analogies are anachronistic. Technology has created services industries
of a scale, sophistication, complexity, and value-added potential to match those
of any manufacturing industry. In fact, services and manufacturing are
inextricably intertwined. Services industries are among the most important
customers and suppliers for manufacturing. They buy many of manufacturing's
highest-technology products and they provide important inputs for
manufacturers, offering the latter opportunities to have lower cost than foreign
competitors in critical areas. Services substitute so broadly and directly for
manufacturing functions that no manufacturer's strategy is complete without a
thorough consideration of how services (or services technologies) can
contribute to the company's productivity, value added, growth, flexibility, and
output quality.
In international trade, services create strong relationships between a
foreign company and its host countries. Most of the benefits of services
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 157

industries—the "product" as well as jobs and facilities—accrue to the host

country, thus developing a strong mutuality of interests between parent
companies and host countries. At present some U.S. services companies enjoy
economies of scale and scope their international competitors cannot equal—
except in banking and communications. And the deregulated U.S. marketplace
provides them a unique stimulus for innovation. If U.S. services companies
move aggressively to develop their own proprietary technology systems, they
can maintain a 1- to 2-year competitive edge in most services areas. Any
slowdown or delay in such innovations will be sure to attract competitive
incursions in the U.S. and world services markets—as has already occurred
with Japanese banking, tourist, hotel, and airline expansions and significant
European acquisitions in U.S. distribution and tourist trade activities.
National sovereignty may be challenged in new and significant ways by
the emergence of modem technologies in the services sector. An individual
country will undoubtedly find it harder to control some of its most important
resources; for example, information, monetary flows, and intellectual property.
Interdependence and diffusion in these areas, however, could lead to greater
world stability and less disparity among nations. As capital and information
increasingly flow electronically across borders, a real question exists whether
traditional comparative advantages are possible, in the long run, and if not
whether the very basis for trade decreases. If nations or corporations cannot
capture the benefits of their research, will they continue to perform it? Or will
they be forced to even more frantic efforts to maintain at least a short-term edge
that makes profits possible?
The long-term structural shift to services raises intellectual questions and
important policy issues but, while there are certainly some problems, it seems
inappropriate to be afraid of a greater services economy—or to deride it. A
greater fear should be that nations misunderstand the services sector,
underdevelop or mismanage it, and overlook its great opportunities while
shoring up manufacturing industries at great national and corporate costs.

ACKNOWLEDGMENTS
The author gratefully acknowledges the generous contributions of Bell and
Howell Company, Bankers Trust, and the Royal Bank of Canada in supporting
the research for this chapter.

NOTES

1. Note that even here the product (clothing) has value only in relation to the service
(protection) it provides its possessor.
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THE IMPACTS OF TECHNOLOGY IN THE SERVICES SECTOR 158

2. Annual reports, Sears Roebuck and Co., and J. C. Penney, K mart, WALmart, and Zayre
Corporations.
3. This conclusion is based on the PIMS data, which are self-reported by relatively large
companies, and like other data bases on service industries have some inherent definitional
problems.
4. London banks, for example, reported handling 128 percent more clearings in 1982 than in
1973 with only a 33 percent increase in personnel (The Economist, July 6, 1985).
5. Studies of productivity in manufacturing also indicate that a typical product is worked on
during only about 8-10 percent of its production cycle; some 90 percent of its cycle is
consumed in movement, waiting, inspection, and other support activities.

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COPING WITH TECHNOLOGICAL CHANGE: U.S. PROBLEMS AND PROSPECTS 160

Coping With Technological Change: U.S.

Problems And Prospects

RAYMOND VERNON
The consequences of technological change on economic activity are
extraordinarily diverse, and any effort to single out a "dominant" consequence
that will overwhelm all the others is certain to fail. But to think seriously about
public policy responses requires making guesses about the nature of future
problems, distinguishing the exceptional from the commonplace, and
differentiating the dominant from the trivial. This chapter will begin, therefore,
by examining a set of broad generalizations about the economic consequences
of technological change over the last four or five decades, generalizations that
reach beyond the available facts in some respects to create a basis for
policymaking.

BASIC SHIFTS
One development that deeply concerns policymakers is an apparent secular
decline in the relative world position of U.S. industry, a decline that is usually
attributed to a fall in U.S. industrial competitiveness in world markets. The idea
of a decline in the "competitiveness" of any given sector in a national economy
is not easy to define and document. It is not yet clear whether or not we
understand the nature of the structural changes that have been going on in the
U.S. economy during the past 20 years or so.1
Consider, for instance, the changing role of manufacturing in the U.S.
economy. Some data point to the conclusion that the manufacturing sector of
the U.S. economy has declined in relation to the U.S. economy as a
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COPING WITH TECHNOLOGICAL CHANGE: U.S. PROBLEMS AND PROSPECTS 161

whole. For example, some shrinkage in the relative share of the U.S. labor force
devoted to manufacturing occurred during the late 1970s and in the 1980s.2
Over the longer term, the contribution of the manufacturing sector to the
country's GNP, when measured in current dollars, fell from 28 percent in 1960
to 21 percent in 1983. But during the same period, the manufacturing sector's
contribution, when measured in constant dollars, hovered around 23 percent
without a clear trend (Economic Report of the President, 1985, p. 244). Data
that purport to measure national output in "constant prices" over a period as
long as two decades are inescapably vulnerable. Yet, those data suggest that the
apparent relative decline in manufacturing was due to a relative fall in the prices
of manufactures rather than to a fall in real output. If that suggestion were based
on more robust figures, it would put a wholly different complexion on the
seeming decline in U.S. manufacturing over the past two decades.
Those who believe that U.S. industry is losing in competitiveness also
point to a decline in the importance of U.S. merchandise exports relative to the
exports of all developed economies, a trend that has included such important
sectors as chemicals, machinery, and automobiles (Lipsey, 1984, p. 70; United
Nations, 1983, pp. 1046, 1048). Are these developments consistent with the
idea of a decline in the competitiveness of U.S. manufactures?
Since 1945 the number of producers and consumers on the world scene has
undergone an extraordinary increase. Outstanding among this new contingent of
producers and consumers have been the Japanese people and the populations of
the various newly industrialized countries—notably, Korea, Taiwan, Hong
Kong, Mexico, Brazil, and even India. And soon China will be joining the list.
The emergence of these new producers and consumers in world markets
has depended on various factors, including some extraordinary improvements in
the technology of transportation and communication—improvements that have
greatly reduced the costs to these late-industrializing countries of assimilating
information from foreign countries and of moving goods and people across
great distances. Once the information barrier was overcome, the comparative
advantage of these countries shifted in favor of manufacturing activities, a shift
that in the first instance was based largely on their wage structure in industry.
The same technological changes in communication and transportation have
contributed to the spread of U.S.-based multinational enterprises over the past
four decades. Technological advances have reduced the cost of search for new
locations on the part of multinational enterprises. And as multinational
enterprises have gained experience at such locations, their responses to
subsequent opportunities have been quicker and more assured.
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COPING WITH TECHNOLOGICAL CHANGE: U.S. PROBLEMS AND PROSPECTS 162

To be sure, some multinational enterprises have drawn back from various

foreign locations in recent years, reacting to political threats or poor profits or
both.3 But, over the long run, U.S.-based enterprises have been drawing on
foreign facilities with increasing alacrity as their experience with such facilities
has broadened and deepened. For instance, a systematic study of the behavior of
57 manufacturing enterprises in the period from 1945 to 1975 dramatically
illustrates the ratcheting effect of past experience on the disposition of those
enterprises to set up additional facilities in foreign countries. In the decade after
World War II, U.S.-based multinational enterprises that were entering on the
manufacture of a new product typically allowed a considerable number of years
to pass before setting up a manufacturing facility for the new product in a
foreign location. By the 1970s, however, that lag was typically much shorter;
and the greater the foreign experience of the firm, the more dramatic the
shortening of the lag (Vernon and Davidson, 1979, pp. 37-62).
The reactions of multinational enterprises to the revolutionary
improvements in communication in recent decades have taken other forms as
well. Such improvements have allowed enterprises to manage their various
subsidiaries as related units in a unified system rather than as isolated
freestanding investments. And the unitary approach has encouraged some
multinational enterprises to plan their financing, production, and marketing
activities on a global scale, thereby increasing the complementarities and
interconnections among the various affiliates that made up the enterprise
(Casson and Norman, 1983, p. 63; Porter, 1985, pp. 410-414; Teece, 1983).
The impact of technology on the location of economic activity, however,
has not been confined to multinational enterprises. With a relative decline in the
costs of communication, the costs of transferring technology between
independent parties can be presumed to have gone down, whereas the speed of
such transfer has probably increased substantially. That development has been
particularly important because of a concurrent development during these same
decades—namely, an increase in the number of sources from which the
technology required in any given product line could be drawn. Various studies
demonstrate that as industries have matured, the number of firms engaged in the
industry has tended to grow, as has the number of suppliers of equipment to
such industries.4 As a consequence, newcomers aspiring to enter the industry
are in a position to shop around among a larger number of firms that might be
able to provide the necessary technology.
The increase in the number of firms engaged in these technological
transfers, whether as donors or recipients, has also been due in part to the efforts
of various governments to support national champions—firms that
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could represent their countries as entrants in some given product line. In the
industrialized countries of Europe and in Japan, these national champions have
typically been found in the technologically advanced sectors, such as
biotechnology industries, computers, or commercial aircraft. In the newly
industrializing countries, such as Brazil or Korea, governmental support has
been thrown to the more mature industries, such as chemicals and metal
fabricating.
To launch this new generation of national champions has not always been
easy; when governments have been successful, their success has usually been
attributable to various policies, including a willingness to invest heavily in
education and in the assimilation of foreign technologies. In many cases, the
ability of the national champions to compete in technologically sophisticated
lines of manufacture has also been helped by the import protection their
governments provided in their home markets, as well as by the selective
provision of various means of support.5
Many observers in the United States attribute the relative decline of U.S.
industry during the past few decades to the unwillingness or inability of the
United States to engage in policies of a similar kind (Diebold, 1983, pp.
644-654; Lodge, 1984, pp. 3-31; Magaziner and Reich, 1982, p. 326; Thurow,
1980, pp. 191-214). In reply, foreign commentators have contended that the
R&D programs of the United States have been so large as to dwarf the support
provided by other countries.6 Others have noted that the U.S. government has
made extensive use of import restrictions during the past decade or so, matching
or exceeding the import restrictions of the Europeans and Japan.7
It may be that the largest part of the new competition faced in recent
decades by the United States was almost inescapable. A necessary condition
contributing to that development was the technological improvements in
communication and transportation, a force that dramatically reduced the costs to
foreigners of acquiring technical skills and technological information. With
these new opportunities universally available, some countries, such as Japan,
Korea, and Brazil, exploited the new situation more effectively than others. But
a substantial global rise in competition, especially in the more mature product
lines, could not have been avoided.
To be sure, the entry of a wave of new industrial producers—many of them
protected in their home markets and bolstered by subsidy—created significant
problems. In some industries, the more efficient production facilities of the
newcomers made existing facilities in the United States redundant; this was a
major factor in Japan's early reentry into the world steel market, for instance, as
wen as the later entry of the newly industrializing countries not only in the steel
market but also in many lighter product lines. Because many of the industries
that were involved were
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highly capital-intensive and characterized by substantial economies of scale, the

appearance of the new entrants commonly produced a state of overcapacity, as
in the ease of steel, basic chemicals, and petroleum refining.
Some observers have attributed the relative decline in the share of U.S.
manufacturing industries to other factors as well. None of these, in my opinion,
is as important as the decline in the costs of acquiring technology and the
concurrent starting up of industrialization programs in so many countries. One
common contention, for instance, is that the capabilities and attitudes of U.S.
managers have changed in recent years, reducing the capacity of U.S. firms to
produce competitive products. Managerial attitudes and other cultural factors
are no doubt relevant in a diagnosis of national business behavior; obviously,
the values of British or German or Nigerian businessmen have something to do
with their performance. But one should recall that throughout most of the 1950s
and 1960s, observers were typically extolling the special virtues of American
entrepreneurship, including its attention to profit and its swift responses to
changes in the environment.8 Ten years later, some of these same characteristics
were being condemned, charged with bringing about a decline in U.S. business
(Abernathy and Hayes, 1980; Thurow, 1980, pp. 3-25). This rapid shift in
perception raises questions about its credibility.
Moreover, the global position of U.S.-based multinational enterprises,
including their foreign affiliates, offers a different impression of U.S.
managerial performance than does the output data for the United States alone; if
the global exports of U.S.-based enterprises are taken as a guide, no competitive
slippage occurred between 1966 and 1977 (Lipsey and Kravis, 1985). The
apparent ability of these multinational networks to cling to their share of world
export markets casts added doubt on the hypothesis that a deterioration in the
quality of management explains the shrinkage in the U.S. position.
A more serious contention with respect to the role of U.S. management in
the asserted decline of U.S. industry is the view that U.S. management practices
—epitomized by the Ford assembly line and time-and-motion studies of the
1920—have become obsolete, outdistanced by the more flexible management
techniques of other countries, notably Japan (Reich, 1983, chapter 4).
Undoubtedly, certain factors in the Japanese environment have contributed to
strikingly high levels of productivity in some sectors of that economy (Brooks,
1985; Roy, 1982). The problem, however, is one of diagnosis. What is the
critical variable? Is it the high levels of literacy of Japanese workers; the
lifetime employment practices of the large firms; the recruitment and promotion
practices relating to managers; the extensive use of subcontractors to provide
flexibility; the financial
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linkages of the big firms to private banks and public credit intermediaries; or
some combination of the above? The basis for assessing the relative importance
of these various factors is very slim. Besides, the competitive pressures coming
from countries such as Korea or Brazil, where managerial practices differ from
those of Japan, also have to be explained. Accordingly, the part played by
managerial practices on the relative decline of U.S. industry continues to be
uncertain.
Another explanation that some analysts favor for the relative decline in
U.S. industry is the effect of an overvalued dollar. This condition has plagued
U.S. exporters since the early 1980s and has contributed to a significant
increase in U.S. imports.9 But the allegations of a U.S. decline in
competitiveness long antedate the recent period of marked overvaluation of the
dollar; the long-term fall in the U.S. share of world merchandise exports,
moving from 16.5 percent in 1955 to 12.2 percent in 1975, was already being
observed and commented upon in the 1960s (Lipsey, 1984, p. 70). No doubt the
overvaluation of the dollar in recent years has added to the difficulties of U.S.
manufacturers. But it would be prudent for policymakers to assume that the
overvaluation simply aggravated a tendency that had deeper causes and longer
antecedents.
In considering what policy responses might be desirable for the future, one
cannot escape the need for projections. For instance, it seems plausible to
assume that the rapid rate of industrial change will continue, requiring a
continuous change in product lines. To be sure, some factors may slow the rate
a little. For one thing, the initial surge of investment in Japan and the
developing countries after World War H was fueled by policies of import
substitution; and that factor is likely to play a lesser role in the future as the
limits of import substitution are approached. In addition, Japan's entry into new
product lines now requires her producers to take a much greater share of the
risks and burdens of innovation, rather than depending primarily on absorbing
and improving on existing technologies. The newly industrializing countries
also face new financial constraints that may slow the rate of change;
international lenders have grown much more cautious and governments much
more chastened in planning for additions to industrial capacity.
Nonetheless, the U.S. economy must count on continued rapid industrial
change. Despite the widespread current sentiment in the United States for
protection against imports, the probability that U.S. government policies can
effectively slow such change appears to be fairly low. With multinational
enterprises in the United States accounting for two-thirds or more of U.S.
industrial output, most U.S. producers will be ceaselessly looking for
opportunities to reduce their costs; and as the history of electronics,
automobiles, and steel graphically suggest, an important aspect of the
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adjustments to competition that such multinational enterprises will undertake is

to create offshore sources for some part of their output.
Are U.S. import restrictions likely to arrest this trend? Any U.S. decision
to restrain such activities would have to overcome the opposition of a
considerable sector of U.S. industry and could be implemented only with
draconian measures of restriction. It is inconceivable, for instance, that U.S.
policy would include prohibitions on U.S. firms from creating subsidiaries
abroad to serve their markets in third countries. (Indeed, under present
circumstances, it is hard to conceive of any market economy effectively
imposing such a prohibition on its enterprises for very long, unless the
enterprises are owned by the state.) Assuming that the conditions of rapid
change continue, then, what problems are foreseen, and what policies seem
indicated?

THE PROBLEM REDEFINED

Many economists have been skeptical that the apparent decline in the
relative position of U.S. manufacturing poses any serious problem in public
policy. They are quick to point out that, when a country loses markets to foreign
competitors, those very losses initiate a series of internal and external
adjustments that eventually make up the losses at levels of output that maximize
national welfare. This demonstration, however, typically sets off a reaction of
the deepest frustration on the part of politicians, newspapermen, and other
ordinary mortals, and a reaction of the deepest annoyance on the part of other
members of the economics fraternity, because of various critical and
unanswered questions:

• Are the economic costs associated with the consequent adjustments

being distributed to various groups in the economy on a pattern that is
politically tolerable?
• Is the new production mix conducive to the continued future growth of
the economy?
• Is the new production mix adequate for national defense requirements?

The Distribution Of Costs

The problems and opportunities created by the increasing openness of the
U.S. economy have fallen unevenly among the various U.S. industries. In other
countries, such a disparate distribution might not have been so disturbing. In
Japan, for instance, the remnants of the old zaibatsu organizations have created
interest groups or conglomerates who characteristically embrace both rising and
declining industries. Besides, operating according to a pervasive sense of ''fair
shares,'' Japanese policymakers
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have tended to limit the size of the adjustment burden that is placed on any
group or industry (Vogel, 1979, pp. 117-124). In Europe, an official readiness
to provide ad hoc support to faltering industries and laggard regions creates the
appearance—and perhaps even the reality—of lesser risk for industrialists and
their workers.
Among U.S. industries, some of those beleaguered by foreign competition
have had the prescience and the resources sufficient to escape from their U.S.
locations and to set up producing facilities in lower-cost locations overseas; but
others have failed to take such steps. According to various analyses, certain
U.S. industries have been especially vulnerable to foreign competition because
they have been paying wages in the United States well above the levels that
seemed indicated on the basis of their productivity relative to other U.S.
industries; in that category notably were automobiles and steel.10 A second
group of affected industries were those that had been insulated from
international competition by the frictional costs of distance, costs that had
previously restrained producers from acquiring the necessary technical
capabilities and from learning about foreign market opportunities; illustrative of
such products were various consumer soft goods and electronic items.
Some U.S. industries, however, have benefited from the shrinkage in the
frictional costs of distance. One such industry has been the mass merchandisers
of consumer products. With great rapidity, distributors such as Sears used the
changed situation to search out low-cost foreign sources of consumer products,
such as small black-and-white TV sets, for importation into the United States.
In addition to the mass merchandisers, the U.S. industries that have derived
advantages from the increased openness of the U.S. economy have been notably
the exporters of capital goods, intermediate materials, services, and
management skills. There are numerous indications that these offsets have been
very large, indications reflected in the expanding importance of the export of
technical services from the United States and of the flow of interest, dividends,
and royalty income to the United States.11 But the U.S. industries that have
profited from those expanded sales have not been the same as those affected by
the increased competition from abroad.
At least as important as the distribution of costs and benefits among U.S.
industries, however, has been the distribution of costs and benefits among
classes in the United States. Some U.S. residents see themselves as helped by
the trend toward open markets because they can offer their services or their
capital globally, thereby broadening their opportunities and their income. Other
U.S. residents see themselves as hurt by the trend, in relative if not in absolute
terms, because their jobs are displaced by increased foreign exports.
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To be sure, some of the displacements forced on U.S. residents may have

contributed so much to U.S. welfare as a whole as to justify the inequality in the
burdens of adjustment. Nor instance, workers in industries in which relative
wage levels have not reflected relative productivity, such as those in
automobiles and steel, have in effect been extracting a rent from the rest of the
U.S. economy. The reduction of that rent can be seen as a welcome contribution
to the country's aggregate welfare, including the welfare of low-income groups.
Moreover, increased international competition has probably helped low-income
groups in the United States disproportionately in the effects of such competition
on the prices of clothing, household appliances, food, and other staples. Yet the
polarization issue still remains: The increasing openness of U.S. markets
appears to reduce the going wage for factory labor as well as the ability of their
unions to bargain. Meanwhile, the growth of the U.S. position in the export of
capital, services, management, and high-tech products provides the most
obvious income benefits for relatively high-income groups.

The Requirements For Future Growth

As suggested earlier, economists are likely to take somewhat different
approaches from politicians in identifying the future problems of the United
States. Economists tend to look on the U.S. economy as endowed with a given
bundle of resources and to ask whether the U.S. economy, given its potential, is
maximizing its opportunities for growth. Politicians, on the other hand, usually
make no explicit assumptions about the U.S. potential and tend to. ask if the
U.S. economy is keeping up with the growth of other countries, notably Japan.
In political terms, it does little good to compare the U.S. economy's
performance with some full-employment potential or to observe that its slippage
in position for the most pan involves relative reductions in income, not absolute
declines. In policymakers' eyes, the objective is not only one of equilibrium but
also of a growth rate that matches the rates of other industrialized countries.
U.S. policies in the field of technology are bound to reflect that preoccupation.
With the prospects for future growth in mind, policymakers frequently
express the concern that the U.S. economy will be turned into a "service
economy," a phrase that conjures up a picture of an endless succession of ski
resorts and hamburger stands. As noted earlier, the manufacturing component of
the U.S. economy has been shrinking by some measures, holding its own by
others. In any case, it is not at all clear that a shift toward a service economy
would prejudice U.S. prospects for growth. A great deal depends on the nature
of the services. Some services allow an economy to capture large rents, such as
brain surgery and Disney World's
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EPCOT Center. And other services, such as research in biotechnology, are

building blocks for future growth. Nonetheless, some analysts argue that the
service industries, especially when separated geographically from
manufacturing activities, are in general a poor vehicle for capturing rents or
ensuring future growth.12
Questions of this sort take us into uncharted waters, in which none of the
diverse viewpoints is likely to represent more than an informed guess. Yet
policymakers find themselves obliged to shape their policies on the best
evidence available, even if the evidence is flimsy.

Requirements For Defense

Nations are doomed to prepare for the wrong war. No nation was much
prepared for the trench warfare of World War I, the war of movement of World
War II, or the jungle warfare of the Vietnam era; and none is likely to be much
prepared for the next. One factor in preparedness is the altogether
understandable desire for a minimax strategy. Of the various hypothetical
possibilities, the assumption that the next war will be much like the last,
however implausible that may be, still ranks very high. Hence the idea that a
country will need, for example, a national steel industry, a national aluminum
industry, and a national petroleum industry for defense purposes is bound to be
an unshakeable element in national defense planning.
If there were any significant probability of a prolonged conventional war
on a large scale, the case for maintaining a large core of such industries might
be reasonably strong. But conventional warfare on the Korean or Vietnamese
scale, extensive as these were, poses almost no problem for the U.S.
mobilization base, past or prospective. And if nuclear warfare is contemplated,
the maintenance of a core of industries is almost irrelevant to the actual conduct
of the war. On security grounds, therefore, the case for maintaining the usual
core of basic industries is not obvious.
The case for maintaining a large core of "defense" industries would be
particularly weak if the policy were to interfere with another security objective
of obvious importance, namely, that of maintaining a flexible work force,
capable of technical improvisation and adaptation on a large scale. That need
was evident even in the conventional warfare of World War II, when the
German and Japanese economies managed to support a large-scale war effort
for a sustained period despite the extensive damage done to their relatively slim
industrial base (Schultze, 1973, p. 526; Vernon, 1955, pp. 77-88). In a world in
which nuclear warfare cannot be excluded as a possibility, the capacity for
adaptation and flexibility should be a paramount security objective.
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Here again, more research is needed. But one must be realistic about the
extent to which any research on this point can influence policy. Whatever the
outcome of such research, it seems inevitable that the political process of the
United States and of other countries will require policy-makers to cover
altogether implausible contingencies, such as the possibility that World War H
will be repeated.

The Limits Of Policy

Upon identifying the main issues, one is propelled to a basic conclusion:
Given the nature of the issues, better data and closer analysis are unlikely to
have more than a marginal effect on the behavior of the U.S. government and
other governments. The problems are too large and too conjectural, and the
domestic and international mechanisms for action too feeble to generate more
than marginal impact. Yet as one sifts through the issues raised in this
summary, there are three areas in which some marginal influence is possible
and desirable.
One such issue is how the United States can enrich and enlarge factors of
production that are likely to operate on U.S. soil, especially the quality of its
labor and management. A second issue, intimately related to the first, is how a
tendency (or the appearance of a tendency) toward economic polarization
within the U.S. economy—an apparent consequence of the economy's increased
openness—can be arrested and reversed. A third issue, inseparable from the
first two, is how those objectives can be achieved without beggaring other
countries and thus setting in train a process that in the end would bring down
the U.S. economy as well.

ENHANCING THE FACTORS OF PRODUCTION

The Educational Challenge

As nearly as any analyst can tell, the ability of the U.S. economy to
maintain a high living standard relative to other countries will depend on its
being able to develop a literate and flexible labor force: literate so that it can
perform complex and demanding tasks; flexible so that it can take on new tasks
as products and processes continue to change. There is nothing new in that
generalization. Historians usually explain the spectacular rise of Germany and
Japan as well as the relative decline of the United Kingdom in part by reference
to their respective systems of education (Landes, 1969, pp. 340-347). And if
that factor was important in the environments of 50 or 100 years ago, it is many
times more important today.
Historically, the United States has provided its nationals with extensive
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facilities for basic education. And it has led the way among the advanced
industrialized countries in providing opportunities for higher education, at least
as measured by the number and proportion of persons attending institutions of
higher learning. Although illiteracy has been endemic in southern rural areas
and city slums, that fact has not been sufficient to prevent the country from
maintaining its high living standards.
Increasingly, however, the quality of education in the United States is a
matter of national concern. Pan of that concern is with the absolute quality of
the education provided at all levels, given the demands of modern society, and
pan is with the relative position of the United States as other countries extend
and improve their education systems.
In responding to that concern, the country's federal structure and traditions
of local rule demand that its states and localities exercise a considerable role in
determining the quality and content of education programs; but the
consequences of their decisions are bound to be national rather than merely
local. If Kentucky substitutes basketball for geometry, the consequences are felt
in California; and when the central cities fall behind the suburbs in providing
educational facilities, the suburbs cannot escape some of the consequences.
Accordingly, the dramatic reduction in the federal government's oversight
role in education during the past half-decade, although a logical corollary of the
New Federalism concept, is also deeply worrying in its implications. To be
sure, some localities have responded with sharply improved educational efforts.
But the variations in educational services from state to state and between city
and suburb are expected to grow, not decline. And the continuous influx of new
immigrants could exacerbate these distinctions by placing heavy burdens on
selected cities and 'states such as Los Angeles and New York.
The problem is not solved by simply reestablishing some measure of
federal oversight in the field of education. In the decade of the 1970s, while
federal oversight was being strengthened and extended and while federal
resources were being provided to supplement local financing, school curricula
nevertheless deteriorated, and illiteracy in the United States probably increased.
Yet as long as primary and secondary education is financed and controlled
largely at the local level, there is almost no hope of bringing large pockets of
the population up to the standards of literacy and flexibility that are consistent
with the maintenance of the world's highest living standards.
The problem is not limited to the fact that the U.S. labor force may be
unable to provide the productivity that is consistent with high living standards
for the country. A condition of that son is bound to sharpen the differences
between those who draw their income from operating in a
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world environment and those who rely on the U.S. environment for their
income. Polarization in income and polarization in political outlook are likely to
go hand in hand, leading to increasing bitterness over issues of transfer
payments within the country and issues of international economic policy at the
borders (Verba and Often, 1985, pp. 174-177). Of the various challenges that
the United States faces for maintaining a lead in the modem world, this one
heads the list.

Improving Industrial Innovation

Practically every econometric study of the sources of growth of the U.S.
economy ascribes a considerable part of that growth to some amorphous factor
beyond capital or labor, usually thought to be an amalgam of improved
technology, improved organization, and increased education (Denison, 1979,
pp. 104-107). Not surprisingly, therefore, the policy of the United States has
been to encourage research and development activities on the part of industry,
using tax credits and military procurement programs as the principal vehicles
for official support.
That government policies are capable of stimulating successful research
and development is clear beyond question. The extraordinary increases in
agricultural productivity in the United States and elsewhere during the past 50
years, although reflecting the joint efforts of the public and the private sectors,
would have been impossible without the public contribution (Nelson, 1982, pp.
251-252). The U.S. aircraft industry has been overwhelmingly dependent on the
military budget for much of its research and development; although various
factors help to explain the performance of the civilian aircraft producers,
including the existence of a large internal market, the support of the U.S.
defense establishment has been a critical part of the mix. The technology of
extraterrestrial space represents another partnership in which the public
contribution has been critical.
Not all public initiatives have been successful, however. Some have
foundered on technical grounds, as in the case of the "transbus," and others
because of a misreading of the market, as in the case of synfuels. Moreover,
public initiatives such as military procurement sometimes generate costs that
inhibit commercial research and development rather than support it. The
principal means by which military programs encourage commercial research
and development is through the spillover effects to nonmilitary applications.
But military hardware is becoming highly specialized, being developed in
systems that are increasingly remote from civilian applications; whereas the
bombers of the 1940s and 1950s could be adapted eventually to commercial
aircraft needs, the ICBMs of the 1980s offer no analogous possibilities (Brooks,
1986, pp. 134-135). In addition, some
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analysts are of the view that U.S. military programs on balance raise the cost
and reduce the availability of engineers and other technicians for commercial
enterprises in the United States (Brooks, 1985, p. 349). Since the U.S. pool of
engineers and technicians is smaller than that of Japan or Germany in relation to
the total labor force, the United States is obliged to divert a substantial part of
that pool to innovations that characteristically have no direct civilian use.
A larger problem associated with the stimulation of research and
development on the part of U.S. enterprise, however, applies not only to the
stimulation provided by military programs but also to the stimulation generated
by tax credits. The propensity of technology to cross national boundaries has
been growing rapidly, mainly as a result of the improvements in communication
and transport. That movement takes place through numerous channels: for
instance, through word of mouth, patent applications, scientific meetings,
licensing agreements, and communications among the affiliates in multinational
networks. Accordingly, R&D programs whose costs are borne in part by the
U.S. budget in the hope of increasing U.S. productivity eventually serve to
increase the productivity of other countries as well, including that of
competitors. To be sure, those benefits are not altogether lost on the U.S.
economy, given the intimate relationship between the prosperity of other
countries and that of the United States. But it cannot be assumed that the
benefits of that increased productivity are fully returned to U.S. investors; more
likely, they are shared with foreign workers, foreign governments, and foreign
consumers. In any case, those whose eyes are fixed on U.S. adjustment
problems resulting from the openness of the U.S. economy should not suppose
that the stimulation of research and development by U.S. firms necessarily
reduces those problems.
The implications of the fact that technology cannot easily be locked onto
any single national turf have not yet been fully assimilated in the minds of
science policymakers anywhere in the world. Once policymakers in the United
States grasp the point, they may be tempted to conclude that the U.S.
government should withdraw its support from efforts to stimulate research and
development. Yet if such a policy had been adopted as a guiding principle 50
years ago, the world's food production would be much lower today, and the
extraterrestrial communication satellite would still be a remote vision. If the
fruits of our technological efforts must inevitably be shared, however, there is a
case for encouraging joint national programs in the stimulation of technology
rather than unilateral national efforts, wherever that can be arranged. True, joint
national efforts usually generate formidable organizational problems that
national efforts can sometimes avoid; but confronting those problems may be
seen as
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preferable to assuming the full cost of research activities whose benefits, in the
end, will be shared with other countries.
In any case, the United States may have something to learn from the efforts
of other countries to stimulate research and development. Numerous reasons
have been cited why the efforts of other countries cannot always serve as a
useful guide for policy in the United States. One reason commonly adduced for
avoiding such policies is specious, but a second has to be taken more seriously.
The specious reason is that if it were economically wise for enterprises to
risk their funds in developing a given innovation, one or more enterprises would
already be attempting to develop it. As numerous analysts have pointed out,
there is a considerable risk that the private sector will underinvest in research
and development, especially when the private firms are unsure whether they
will be able to capture the profits that the invention might generate (Bozeman
and Link, 1985, p. 376; Freeman, 1982, p. 168; Mansfield, 1968, p. 187). This
is an acute problem, for instance, in products or processes that are not easily
protected by patents, or in products that might prove to have a very short life,
such as memory chips. In such cases, it may pay for the government to reduce
some of the perceived risk by guaranteeing a minimum return in effect to the
successful inventor.
The second ground on which many U.S. policymakers refuse to entertain
proposals for the public support of selected development targets is that the U.S.
government is inherently unable "to pick winners and losers." Sometimes the
contention is made as if it were axiomatic, an inescapable consequence of the
characteristics of the system; but it is unclear why a system that is capable of
producing the moon landing, agricultural research, and the space shuttle is
inherently incapable of successfully identifying research goals that are
technically feasible and socially profitable. Once one accepts that the market
may be failing to provide reliable signals for profitable R&D investment, there
is no reason to exclude the possibility that the government might do better.

Stimulating Management
With the swift changes of the past few decades in the structure of markets
and enterprises, the U.S. landscape is littered with anachronistic regulations and
outmoded precedents that tend to put a damper on managerial initiatives.
Among the most obvious are those relating to antitrust and restrictive business
practices.
U.S. antitrust policy is built in part on the principle that maintaining
competition depends on avoiding high levels of concentration of U.S.
production among a few firms in any given product line.13 But as markets
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have become global in scope, and as multinational enterprises have increased in

number, the standards by which U.S. law and regulation have traditionally
judged the effects of mergers and consolidations on competitive conditions in
the United States have grown less relevant. Obviously, imports have to be taken
into account in such an evaluation, a fact that lawmakers are just beginning to
appreciate. But imports alone do not begin to reflect the changed competitive
conditions of world trade and investment. The degree to which Fiat's existence
acts as a brake on General Motor's market behavior in the United States cannot
be judged simply by the level of U.S. imports of Fiat cars (which is small).
Instead, as executives in the United States design their product and pricing
policies, they are now obliged to consider the possibility that Fiat (or Toyota or
Saab or Peugeot or Hyundai) might use their vastly increased capability for
movement by establishing a production plant in the United States. As the
statistics of foreign direct investment in the United States dramatically
illustrate, that possibility is now very real.14
This profound change in international markets suggests the need for a
radical overhauling of the standards and precedents of which the U.S. antitrust
authorities are captive. It suggests the possibility of a more relaxed policy
toward various forms of cooperation and mergers among U.S. producers in
cases in which either foreign imports or foreign direct investment seem likely.
It does not follow, however, that antitrust problems are declining in
intensity in this new global environment. In fact, some of the new inter firm
arrangements that are appearing in response to these changed conditions raise
novel questions that could prove important in the decade ahead. During that
decade, the world may well see a period of relatively slow growth. In that event,
leading producers who are somewhat insulated from competition will be
understandably reluctant to spend on the creation of new technologies or to
apply all the technological advances that their laboratories are capable of
producing.
In the 1930s that combination of circumstances generated a substantial
crop of international cartels coveting electrical, chemical, and mechanical
products, many of them dedicated to holding back the introduction of new
products and new processes (Hexner, 1946, pp. 203-349). Today it is unlikely
that any arrangements among producers dedicated to such objectives would take
the transparent and explicit forms that the cartels of the 1930s sometimes
adopted. Since then, the antitrust programs of governments in the United States
and Europe have increased measurably in potency and sophistication. But the
recent proliferation of joint ventures among industry leaders of different
nationalities raises the possibility that leading firms may once again attempt to
control the introduction of new technolo
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gies.15 Parties to such alliances, it is true, usually have an initial intention of

pooling their technology in the interest of increasing productivity or generating
new final products, not of holding back on technological advances. But one
must realistically entertain the possibility that a spell of hard times will alter the
original direction of the alliances, especially when the alliances have linked the
technological leaders in any product line.
The risk that technological advances will be checked by cartel-like
international agreements arises from another direction as well. Numerous
agreements among governments limiting the international movement of various
types of steel now cover so large a part of the world's steel output as to take on
many of the characteristics of a world steel cartel. The slow growth in the world
demand for steel, when coupled with the curbs on international competition,
could easily have the effect of arresting the steel industry's investments in new
steel products and processes. That possibility is increased still further by the
movement of the U.S. steel industry toward diversification into other industries,
a movement that is likely to reduce the interest and the resources of
management devoted to improving the productivity of steel facilities.
The case of steel raises the question whether rapid technological change
always must be counted benign, or whether in some circumstances it generates
social costs that exceed its benefits.16 Many who support the international steel
agreements would argue in favor of such agreements in precisely such terms.
But that is a judgment better made by persons whose interests are centered on
the welfare of the national economy as a whole rather than on the steel industry
in particular.
A critical question for the future is whether the steel situation represents a
pattern that will be followed by other industries as the demand for their
products levels off. In that case, the antitrust laws of the United States and other
countries may prove irrelevant, even though the restrictive consequences of the
arrangements may be indistinguishable from those generated by private cartels.
Here again, we confront a problem for U.S. policymakers to which almost no
attention has so far been given.

REDUCING ECONOMIC POLARIZATION

Efforts to reduce the tendency toward economic and political polarization
that may accompany increased openness in the U.S. economy are desirable on
both social and political grounds. Some of the measures that could improve the
productivity of factors employed in the United States would at the same time
contribute to reducing economic polarization. Broad-based support for
elementary and high-school education, for instance,
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would contribute to both ends. But other measures also need to be considered.
One approach to this issue is to review and revise national policies that
now influence managements to respond to foreign competition by creating new
offshore facilities, rather than by attempting to increase their productivity and
lower their costs in the United States. Of course, the possibility of increasing
productivity in the United States in response to increased foreign competition is
not always realistic; some old U.S. industries must give way to such
competition if new U.S. industries are to flourish. But there have been enough
successful eases of U.S. firms holding their ground on U.S. soil through
productivity increases to suggest that more such possibilities exist; General
Electric's comeback in the manufacture of diesel locomotives is a spectacular
case in point.
At the margin, some policies in the United States may be tailored to
encourage such a response. For example, the tax forgiveness policies of other
governments in some cases mean that profits generated by the foreign
subsidiaries of U.S. firms are taxed at levels that are lower than the profits
generated in the United States, a fact that may tip the U.S. firm's response in
favor of an overseas location. Cases of this sort will increase as corporate
income tax rates begin to rise again in the United States. Because this is a
complex and tangled subject, answers to this problem do not come easily; but
the issue is worth further exploration. More generally, numerous U.S. policies
and programs are worth reviewing to determine whether modifications might
keep production on U.S. soil.
Any program that is aimed at reducing the polarizing effects of open
international markets, however, will be inadequate if it fails to provide for some
positive form of trade adjustment, that is, some substantial lubrication of the
process by which productive facilities are redeployed in the U.S. economy. By
now, the idea of trade adjustment has become a little shopworn. First adopted as
policy in the Trade Expansion Act of 1962, the trade adjustment program failed
to contribute very much to the adjustment process by the time it was abandoned
in the early 1980s (Aho and Bayard, 1980; Richardson, 1983). The fact is,
however, that the concept was abandoned almost before it was really tried.
During most of the two decades in which the program was on the books, its
contribution to the adjustment process was limited to extending the period in
which laid-off workers received unemployment compensation. In the latter
1970s some more imaginative approaches to adjustment at last began to be
undertaken; but within a few years of the commencement of such experiments,
the concept was abandoned. Whether effective retraining and relocation are
possible on a substantial scale in the United States remains an unanswered
question.
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Meanwhile, it should be remembered that the threat of increasing

polarization is as much a problem of attitudes as an issue of the actual
distribution of income. In this context, symbols count. For this reason, if for no
other, the salaries and fringe benefits that the top managers of large U.S.
corporations appropriate for themselves may be playing a role that is larger and
more significant than the economic cost. On the basis of informal inquiries of
knowledgeable observers, my impression is that U.S. managers are paid two or
three times the amounts received by their Japanese counterparts in companies of
comparable size and substantially more than their European counterparts.17
Those U.S. compensation levels cannot easily be justified as the
impersonal outcome of the play of market forces. Such levels are in effect fixed
by the managers who receive them; and the managers in each enterprise
determine those levels by making comparisons with other firms whose
managers are engaged in the same process. To be sure, any managerial group
that choses not to keep up with the others would probably find some of its
members, including valued ones, abandoning the firm. Accordingly, any
individual firm has little incentive to drop out of the race of matching increase
with increase. The situation, however, promises to exacerbate the division
between managers and workers. Whereas workers see themselves as living in an
atmosphere of givebacks and two-tier pay scales in order to remain competitive,
management continues on its course, relatively undisturbed, except for the risk
of takeover bids. The polarizing effects of a continuation of such trends
deserves the closest attention of policymakers.

AVOIDING A BEGGAR-THY-NEIGHBOR CYCLE

In the context of U.S. politics, however, the problems of managing
technological change are likely to be framed as problems in international trade
policy, and the instrumental responses are likely to be measures for restricting
trade. Managing technological change, therefore, embraces all the familiar
issues associated with trade policy.

The Shift In U.S. Position

According to various counts, something like 300 bills were introduced in
committees of the 99th Congress to deal with international trade problems of
one kind or another. Practically all called for some measures of restriction on
U.S. imports. Some provided for consultation with foreign countries as part of
the process leading to import restrictions, and others called for uninhibited
unilateral action. The extraordinary emphasis on
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unilateral action is one manifestation of the gravity of the present situation. The
United States seems prepared to court the obvious risk—one could almost say,
the near certainty—that unilateral measures by the United States will generate
unilateral countermeasures by others, contributing to a spiral that is hurtful to
all countries.18
The U.S. willingness to expose itself to that risk reflects several different
factors, including the ignorance of otherwise informed Americans about the
extent to which the well-being of the U.S. economy has become related to the
well-being of the world economy at large. Even a superficial review of the
content of our school curricula and our mass media suggests why that ignorance
exists. Courses in history and economics have almost disappeared from high
school curricula, contributing to a pervasive indifference or illiteracy on
subjects of international economic relations. To be sure, the media give
occasional attention to some political or military spectacular involving foreign
countries, such as an international hijacking, or a Gorbachev-Reagan encounter.
But the coverage of international economic events is almost nonexistent in the
mass media, whether in superficial or in serious form.
Ignorance and indifference, however, are not the only reasons for the spate
of trade-restricting bills. Another factor may be the polarization tendency
mentioned earlier, the perception of the growing differences between the
interests of those Americans whose stake lies directly in the growth of the world
economy, such as managers and stockholders of multinational enterprises, and
the interests of those whose livelihoods are linked more directly to the U.S. turf,
such as semiskilled textile and electronic workers. With such polarization, some
groups in the United States will be tempted to disregard the possibility that U.S.
trade restrictions might initiate a series of events that will do considerable
damage to all countries in the world, including eventually the United States
itself. In the eyes of disadvantaged groups, those consequences might appear no
worse than a set of policies whose costs have to be borne by them.
Still a third strand in the current wave of demands for unilateral action is a
mounting impatience among the American public and the Congress with the
behavior of other governments in international trade.19 It is true that most
governments are more active than the United States in devising special
measures to improve the competitive position of their own industries, a
reflection of a different approach to the role of government than exists in the
United States. But some of the impatience of the American public and the
Congress is based on the assumption—the largely erroneous assumption—that
other governments are more careless about their international commitments
than the U.S. government, a view that explains repeated references to restoring
a ''level playing field'' in international
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trade. To be sure, most governments are prepared to exploit every loophole

created by the copious exceptions in the General Agreement on Tariffs and
Trade (GATT) and axe sometimes prepared to disregard the agreement
altogether (Patterson, 1983). In this respect, however, the behavior of other
governments is not readily distinguishable from that of the United States, which
has frequently enacted legislation in fiat violation of the GATT's provisions
(Grey, 1983).
The gap between conventional U.S. opinion about the behavior of foreign
governments and cold reality is strikingly illustrated by the case of Japan. With
regard to the GATT's formal requirements, that country today is probably as
much in compliance as the United States (Saxonhouse, 1983). The principal
difficulties that the United States now encounters in U.S.-Japanese bilateral
trade relationships are of a kind that the GATT's provisions do not—and
perhaps cannot—address: the yen-dollar exchange rate, the tight vertical
structure of domestic Japanese industry, the attitudes of Japanese consumers,
and so on (Bergsten and Cline, 1985, pp. 21-105). To deal with issues of that
kind, we must begin thinking of new forms of international regimes and
international agreements far more ambitious than those represented by the
GATT.
Practically all multilateral agreements are also bedevilled by the problem
of the free rider. With more than 160 sovereign states of various sizes and
interests engaged in international trade, countries that will hope to profit from
open markets without opening their own are bound to appear in considerable
number. That was true in 1948 when the GATT was created, and it remains true
today. In 1948, however, the U.S. government believed that its interests were
being served if some of these governments could be persuaded to give lip
service to their adherence to a GATT regime, even if their role of free rider was
legitimated in the process. Accordingly, the developing countries that joined the
GATT were in effect exempted from any significant obligation under the
GATT's rules while being entitled to the rights of a GATT member. Today,
however, the United States no longer regards that lopsided situation as being in
its interest, especially as it applies to such rapidly developing countries as
Brazil and Korea.
From the U.S. viewpoint, the remaining alternative to unilateral restrictions
on trade is the increased use of persuasion or threat: persuasion aimed at
convincing a group of like-minded countries that it is in their common interest
to devise new rules of the game that are responsive to the demands for a "level
playing field," or threats aimed at increasing the inhibitions of the free riders.
The use of persuasion will not be easy. For instance, it should not be supposed
that the advanced industrialized countries are in a mood for joining the United
States in measures for the
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liberalization of trade. In recent years, indeed, the European Economic

Community has been pursuing its own program of trade-restricting measures, a
program that more than matches the U.S. measures in its restrictiveness. The
challenge is to turn this trend around, lest the remnants of the existing trade
regime disappear.

Constructive and Destructive Agreements

For several years, in fact, the U.S. government has been moving toward a
set of arrangements that have pointed away from the principles of non-
discrimination and universality. Some of these arrangements have been
constructive and benign, in the sense that they have probably improved the
position of the United States without damaging the position of other countries.
Others have been grossly destructive by these standards. Heading the list of
destructive measures are the so-called voluntary export agreements (VEAs) or
orderly marketing agreements (OMAs), which at present protect a considerable
part of U.S. industry.
The essential element of these agreements is that the U.S. government
coerces an exporting country into restraining its exports of a given product to
the United States. The U.S. government's objectives in having the exporter
impose the desired restrictions rather than imposing U.S. import restrictions are
reasonably clear: The U.S. government escapes some of the onus of imposing a
restriction on imports, especially if the conditions are such that an import
restriction would be in violation of existing U.S. law or in violation of
international trade agreements, notably the GATT. The U.S. government can
"target" specific threatening exporters rather than all exporters of a given
product, thereby discriminating in a way that would violate the GAIT if
incorporated in an import restriction; and the U.S. executive branch can buy off
congressional opposition without taking on a legislative straggle.
This practice has its obvious drawbacks. It allows the U.S. government to
pretend that the restriction is not of its doing, thereby reducing the government's
ability to extract programs of adjustment from the U.S. industries that are
protected. It encourages corruption and evasion in the trade practices of foreign
exporters, who commonly transship their goods through other countries as a
way of entering U.S. markets. And it makes a mockery of the rules on
international trade agreements. Worse still, it leads to a gross distortion of such
agreements as the U.S. government and others seek to legitimate their practices
by obtaining nominal absolution in the GATT. The headlong movement of the
U.S. executive branch toward the expanded use of the coercive bilateral
approach, incorporated in those VEAs and OMAs, could eventually destroy
what is left of the tattered
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rules of the GATT, before any successor regime can be devised. Finally, the
VEAs and OMAs, to the extent that they are effective, have the unfortunate
consequence of placing monopoly rents in the hands of the exporters, rents paid
by the consumers in the United States. The "voluntary" restriction of Japanese
car exporters from 1982 to 1984, for instance, was a bonanza for Japan's car
exporters, increasing their margins of profit and their financial resources well
beyond the levels they would otherwise have achieved and encouraging the
accelerated upgrading of Japanese automobiles for sale in U.S. markets (Gomez-
Ibanez et al., 1983).
Although the VEAs and the OMAs have been destructive to international
trade, it should not be assumed that all trade agreements that are less than
universal in scope are necessarily destructive. Economists have long recognized
that in some circumstances, trade agreements that are discriminatory in their
application may actually foster trade and may contribute to the welfare of
nonparticipating countries as well as of those that participate (Lipsey, 1960).
The European Economic Community and the European Free Trade Area, for
instance, were sanctioned by GATT members on that assumption; and although
the Community's policies are fundamentally at variance with the
nondiscrimination principles of the GATT, one can make a case that the
Community's operations contributed on balance both to international trade and
to global welfare.
The U.S. government also has negotiated a series of less-than-universal
agreements that presumptively have had benign rather than malign effects on
trade, including notably a series of codes that were negotiated under the aegis of
the GATT in 1979. More than a half dozen codes were initialed at the time,
covering subjects such as the sale of commercial aircraft, practices in
government procurement, and the use of certain types of subsidies that affect
international trade.20 These codes have been open-ended in the sense that any
member of the GATT has been free to subscribe, accepting the obligations and
procuring the fights provided in the code. But the codes are discriminatory in
the sense that GATT members choosing not to subscribe are likely to be denied
the benefits under the code.21 Ultimately, the signatories have proved to be
primarily the advanced industrialized countries.
Although the GATT codes have been feeble instruments in the first years
of their existence, they represent one of the few approaches that offer fresh
promise of the development of a benign trade policy. To be sure, they are
discriminatory in their application; but any country can cure the discrimination
by ratifying the code. Accordingly, such agreements do not turn away once and
for all from the principle of an open world trading system, a fact that has made
it possible for the GATT structure to tolerate and even to foster such agreements.
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The disposition of the United States to pursue trade-liberalizing measures

where it can, without being blocked any longer by the principle of universality,
is evident from a number of its other initiatives in recent years, such as its
bilateral discussions with Japan aimed at added liberalization of the conditions
of government procurement, its proposal for a free-trade area with Israel, its
interest in pursuing a selective free-trade arrangement with Canada, and so on
(Bilzi, 1985).22 Its eclecticism in trade matters now begins to approximate that
of the European Economic Community, which has never been restrained by the
principle of universality, as well as the approach of Japan, which also includes
numerous departures from that principle.
The approach, to be sure, courts some acute dangers. The line between
trade-creating and trade-destroying agreements can be exceedingly fuzzy.
Agreements that are ostensibly available for signature by any country can be
constructed in ways that shut many countries out. But it is difficult to envisage
any universal agreements on the GATT pattern that offer much hope of
arresting the trend to protectionism. Instead of addressing the relatively simple
question of the level of a tariff rate or the existence of a requirement for an
import license, future agreements must take up such complex and subtle
questions as the international effect of a domestic subsidy, or the international
impact of a regulation ostensibly applied for reasons of safety or environmental
control or the support of a lagging region. These are subjects in which facts are
hard to come by, consequences are complex, and domestic politics play a
dominant role.
Such factors may explain in pan why the existing GATT codes have
proved so feeble. The machinery required for any degree of effectiveness in
agreements that deal with complex nontariff trade barriers is more nearly
approximated by the institutions of the European Community, with its elaborate
provisions for fact-finding and adjudication. So far, the minds of U.S.
policymakers are far from considering any such ambitious possibilities. Instead,
their next efforts are being directed at extending the GATT to the liberalization
of services and of foreign direct investment, programs that seem even less
appropriate to the GATT structure than dealing with the new wave of trade
restrictions. We have scarcely begun, therefore, to fashion international
institutions that can cope with the new problems in the field of international
trade.

U.S. POLITICS AND U.S. GOVERNANCE

Before any constructive action can be envisaged among governments for
dealing with the problems of adjustment and accommodation to technological
change, the U.S. government itself must be prepared to sponsor
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the requisite international action. The conventional wisdom of the moment,

supported by the results of Gallup polls and the introduction of protectionist
bills in the Congress, is that such sponsorship is almost out of the question. My
own analysis, however, indicates that the U.S. position is far less determined
than conventional wisdom would suggest.
It has been repeatedly observed that U.S. policy is based on the outcome of
struggles among interest groups rather than on the rational conclusions of
thoughtful referees. On that basis, one could easily conclude that the U.S.
political process was as likely to produce a decision in favor of promoting open
international markets as at any time in modern history. To be sure, a surge of
imports has added to the acute difficulties of many domestic industries. But
U.S. industry as a whole—including some of the leading firms in the industries
threatened by exports—has never been more involved in world markets; the
dominance of multinational enterprises in the U.S. economy has no historical
parallel. The stake of the large U.S. banks in maintaining open markets is also
vital, especially if they are to hope eventually to collect some of their large
foreign loans. And the capacity of labor unions to support a protectionist policy,
while still strong, is diluted by three factors: the decline in labor union
enrollment; the growth in the relative importance of nonmanufacturing workers
in the labor union movement;23 and the decline in the level of unemployment. If
sheer interest-group calculations were determining the direction of U.S. trade
policy, therefore, one might reasonably expect a different atmosphere .than the
one that now prevails.
One key reason for the striking protectionist sentiment in Congress and the
public press is that a coalition of protectionist interests in the United States has
succeeded in a strategy that they have pursued persistently over the past 35
years. The strategy has been fundamentally to ensure that the problems
associated with increased international trade are always addressed on a case-by-
case basis rather than systemically. That result has been achieved by a
succession of statutory measures that have given aggrieved domestic industries
increasing powers to initiate individual proposals for trade restrictions. As long
as such issues arise case by case, the atmosphere surrounding discussions of
trade policy is bound to be protectionist, and the costs of imposing import
restrictions on the economy at large—costs such as the impact on consumers
and the risk of retaliation—are likely to play a secondary role in the decision-
making process.
From time to time during the past 50 years, despite the strategy of the
protectionist alliance, the U.S. government has moved dramatically in the
direction of liberalizing its trade regime. In each instance, that decision has been
taken in a context in which the decision makers were in a position to weigh not
only the benefits but also the costs associated with higher
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import restrictions. Such moves occurred with the adoption of the Trade
Agreements Act of 1934, the Trade Act of 1948, the Trade Expansion Act of
1962, the Trade Act of 1974, and the 1979 Trade Act. In each of these
instances, costs and benefits of the trade regime were framed and presented as a
single package.
Those same acts, however, carried the seeds of the eventual undermining
of the trade policy they supported, as a series of technical amendments made it
increasingly easy for special interests to raise their trade problems on a case-by-
case basis. Until those procedures have been curbed, U.S. policies will be
acutely vulnerable to the initiatives of such special interests.
Nevertheless, the bold moves by U.S. government toward trade
liberalization—moves taken in each instance with the acquiescence of the
Congress—underline a fundamental point with regard to congressional
behavior. Conventional wisdom usually takes it for granted that the Congress
will be protectionist, on the easy assumption that congressmen are doomed to
bow to the interests that have been mobilized in their districts. But the record
itself, as one or two studies indicate, is much more complex (Ahearn and
Reifman, 1984; Pastor, 1980, pp. 186-199). Confronted with major choices that
coupled the benefits with the costs, congressmen have been prepared to resist
the pressures of specialized interests in their districts. In their handling of
individual cases, administrators continue to be vulnerable to the tactical power
and tactical skills of the interests. Accordingly, those who are skilled in broken
field running through the sprawling governmental apparatus can often avoid the
full exercise of the system of checks and balances to achieve their desired
results in individual cases. The challenge is to find ways of restraining those
possibilities so that the larger interests of the United States can play an
appropriate role in the development of trade policy.
Because U.S. institutions and processes are so vulnerable to special
interests in the handling of individual cases, some analysts have resisted the
idea of having the U.S. government pursue selective policies of industry
targeting such as has been seen in Japan, France, and Korea. The fear is that the
U.S. process would produce results that were unrelated to any rational analysis
of the individual cases. On the record, that is not an unreasonable concern. Yet,
the swiftly changing character of the economy in which we live implies that
with increasing frequency, individual enterprises may encounter transitional
problems that threaten their very existence. In theory, such problems may be
solved in various ways, including merger and acquisition. But the experience of
the U.S. government in helping Lockheed and Chrysler bridge their transitional
difficulties a decade ago suggests that a role for government is not to be
excluded. Accordingly, the U.S. government may have to build new capabilities
into its system
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of governance that allow it to deal rationally with critical individual cases as

they emerge. Developing that capability is perhaps the most difficult of the
various challenges discussed in this chapter.

ACKNOWLEDGMENT
I am grateful for the critical comments provided by Harvey Brooks, Roger
Porter, Robert Reich, and Dani Rodrik, and for the research support of Debora
Spar.

NOTES

1. An excellent summary of the arguments on both sides of the issue is found in Norton, 1986.
Underlying studies particularly worth consulting are President's Commission on Industrial
Competitiveness, 1985, and Lawrence, 1984.
2. Between 1975 and 1983, the absolute size of the work force in U.S. manufacturing actually
expanded by 15 million jobs, but its size relative to the total work force slipped to 18.0 percent
from 20.9 percent (U.S. Bureau of the Census, 1985, p. 390).
3. From 1980 to 1984, foreign-direct investment as reported by U.S.-based firms has been
virtually unchanged. See Economic Report of the President, 1985, p. 349, and Survey of
Current Business, January 1986, p. 24. But that is probably the net result of a reduction in
liquid assets and an increase in fixed assets abroad, as well as the revaluations of foreign assets
related to an appreciating U.S. dollar.
4. A classic study of this phenomenon, covering the chemicals industry, is Stobaugh, 1968. For
more general-data, see Vernon, 1977, pp. 26-81.
5. On Japan, see Vogel, 1979, p. 72. On other countries, see Pinder, 1982a; a comparative
analysis of national policies in different industries appears in various chapters in Pinder, 1982b.
6. U.S. government expenditures in 1983 were well above the national R&D expenditures from
all sources in Japan, France, Germany, or the United Kingdom; see National Science Board,
1985, p. 187.
7. As of 1981 the proportion of the national market for manufactured imports affected by major
nontariff barriers was higher in the United States than in six other industrial countries, including
Japan. See Cline, 1984, p. 60.
8. A characteristic evaluation of this son was that of Jean-Jacques Servan-Schreiber, 1968, p. 67.
9. The growth in the relative importance of merchandise imports in the United States is
reflected in the increase in the ratio of nonagricultural nonpetroleum merchandise imports to
value added by the U.S. manufacturing and mining sectors. That ratio rose from about 15
percent in the mid-1970s to about 23 percent in the early 1980s. From various issues of Survey
of Current Business and Economic Report of the President, 1985, p. 244.
10. On steel, see Walters, 1983, pp. 484-486. On automobiles, see Cohen, 1983, p. 555.
11. Flows to the United States from abroad from royalties and fees, other private services, direct
investments, and other private receipts rose from 1.3 percent of U.S. GNP in 1965 to 2.6
percent in 1984, reflecting a growth rate substantially higher than the
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COPING WITH TECHNOLOGICAL CHANGE: U.S. PROBLEMS AND PROSPECTS 187

growth rate of total U.S. exports and of U.S. GNP. See SurVey of Current Business, June 1985,
pp. 40-41.
12. Stephen S. Cohen and John Zysman argue this position eloquently in the manuscript of their
forthcoming book: Manufacturing Matters: The Myth of the Post-Industrial Society, New York:
Basic Books.
13. The principal provision is Section 7 of the Clayton Act. See Sherman, 1978, pp. 38-41.
14. Between 1970 and 1984, the book value of all foreign direct investment in the United States
rose from $13.3 billion to $159.6 billion. The manufacturing component in 1984 amounted to
$50.7 billion. From various issues of the Survey of Current Business.
15. The joint-venture trend is described in Ohmae, 1985; and Mowery and Rosenberg, 1985.
16. The subject is explored in Crandall, 1981, especially pages 129-140.
17. Hard data on this subject are not easily available. One study, reflecting conditions in the
latter 1970s, concludes that in the United States, business executives received compensation
that was about 15 times that of an auto worker, whereas the comparable figure in Japan was 9
times, and in Sweden (after taxes) only a little over 2 times; the figures appear in an
unpublished manuscript by Sidney Verba and Gary Orren, which in turn relies on various
surveys by others to generate the comparison.
18. For an insightful summary of U.S. trade practices, see Grey, 1983.
19. For congressional reactions, see Abeam and Reifman, 1984.
20. For illuminating discussions of the place of these codes, see Jackson, 1983; and Hufbauer,
1983.
21. The issue of nonsignatory rights has actually been in dispute in the GATT, with an
ambiguous outcome; but the exclusionary intent in drafting the codes was reasonably clear. See
Tarullo, 1984.
22. The significance of these departures from longstanding U.S. policy is emphasized in
Samolis, 1984.
23. Although U.S. total manufacturing employment in 1983 was practically the same as in
1971, the number of union members in manufacturing declined by about 500,000, and the
relative importance of the total union membership represented by manufacturing unions fell to
11.4 percent from 15.8 percent (U.S. Bureau of the Census, 1985, p. 423; Economic Report of
the President, 1985, p. 275.)

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Aho, M. C., and T. O. Bayard. 1980. American trade adjustment assistance after five years. The
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Bozeman, B., and A. Link. 1985. Public support for private R&D: The case of the research tax
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Gomez-Ibanez, J. A., R. A. Leone, and S. A. O'Connell. 1983. Restraining auto imports: Does
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Grey, R. de C. 1983. A note on U.S. wade. Pp. 243-257 in Trade Policy in the 1980s, W. R. Cline,
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Lawrence, R. Z. 1984. Can America Compete? Washington, D.C.: Brookings Institution.
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Lodge, G. 1984. The American Disease. New York: Alfred A. Knopf.
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Norton, R. D. 1986. Industrial policy and American renewal. Journal of Economic Literature 24
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Ohmae, K. 1985. Triad Power: The Coming Shape of Global Competition. New York: Free Press.
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Samolis, F. B. 1984. SOS for the CBI: Lessons from the Caribbean basin initiative. Pp. 137-142 in
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Does Technology Policy Matter?

HENRY ERGAS

How do technology policies differ among nations? What impact do these

differences have on innovation and, more generally, on industrial strutures?
These questions are the central concerns of this chapter.
Innovation is the use of human, technical, and financial resources to find a
way of doing things. As an inherently uncertain process, it requires
experimentation with alternative approaches, many of which may prove
unsuccessful. Even fewer will survive the test of diffusion, where ultimate
economic returns are determined. The historical success of the capitalist system
as an engine of growth arises from its superiority at each of these levels:
generating the resources required for innovation, allowing the freedom to
experiment with alternative approaches, and providing the incentives to do so.1
Though relying primarily on market forces, the system has .interacted with
government at two essential levels. The first relates to the harnessing of
technological power for public purposes. Nation-states have long been major
consumers of new products, particularly for military uses, and the need to
compete against other nation-states provided an important early rationale for
strengthening national technological capabilities. Whether this rationale persists
as the primary motive for government action is a major factor shaping each
country's technological policies (Earle, 1986).
The second arises from the system's dependence on its social context. The
development and diffusion of advanced technologies requires a system of
education and training as a basis for supplying technology and skills, a legal
framework for defining and enforcing property rights, and processes
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DOES TECHNOLOGY POLICY MATTER? 192

such as standardization to reduce transactions costs and increase the

transparency and efficiency of markets. These are, at least in part, public goods.
The benefits of investment in education are appropriated by a multitude of
economic actors, and those of the system of property fights are even more
widely spread.2 The way these public goods are provided, and the role industry
plays in this respect, differs greatly from country to country.
This chapter examines the interactions between the technological system
and government policy in seven industrialized countries: the United States, the
United Kingdom, France, Germany, Switzerland, Sweden, and Japan. It pays
particular attention to the relation between innovation policy and industrial
structures. The countries examined are placed in three groups.
Technology policy in the United States, the United Kingdom, and France
remains intimately linked to objectives of national sovereignty. Best described
as ''mission-oriented,'' the technology policies of these nations focus on radical
innovations needed to achieve clearly set out goals of national importance. In
these countries, the provision of innovation-related public goods is only a
secondary concern of technology policy.
In contrast, technology policy in Germany, Switzerland, and Sweden is
primarily "diffusion-oriented." Closely bound up with the provision of public
goods, the principal purpose of these policies is to diffuse technological
capabilities throughout the industrial structure, thus facilitating the ongoing and
mainly incremental adaptation to change. Finally, Japan is in a group of its own.
Its technology policy is both mission-oriented and diffusion-oriented, and the
form the policy takes differs in important respects from that in the other
countries.
Every taxonomy involves a loss of information, and the one proposed here
does not escape this general rule. Thus, the United States has important policies
—for example, in agriculture and in medical research—that are diffusion-
oriented; equally, Germany and Sweden have major mission-oriented programs.
But the focus of policy does differ in the three groups, and this allows a clearer
examination of the relation between technology policy and innovation
performance.
These differences in policy stance—though not as sharp as they may at
first appear to be—are important in shaping patterns of technological evolution,
but the central hypothesis of this chapter is that technology policies are a
facilitating rather than explanatory factor. The critical variables lie in how
industry responds to the results and signals of efforts to upgrade national
technological capabilities. In turn, this depends to a substantial extent on the
environment in which industry operates. Technology policies cannot, in other
words, be assessed independently from their broader economic and institutional
context.
A central feature of this context is a country's technological infrastruc
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DOES TECHNOLOGY POLICY MATTER? 193

ture—its system of education and training, its public and private research
laboratories, its network of scientific and technological associations. The
effectiveness of this infrastructure depends not only on its internal functioning
but also on the way a country's factor and product markets respond to
innovation opportunities.
Overall, this suggests that, even within the framework of a market
economy, the process by which innovations are generated, selected, and
imitated will differ according to the features of each country's institutional and
economic structure. In exploring these features and their relation to countries'
technology policies, this chapter follows the broad grouping set out above: The
next three sections examine, respectively, the technology policies of the
mission-oriented countries, namely, the United States, the United Kingdom, and
France; the diffusion-oriented countries, namely, Germany, Switzerland, and
Sweden; and Japan. The last two sections present, respectively, a synthesis of
similarities and differences, with analyses of their broader implications for
economic performance, and conclusions for policy formulation.

THE MISSION-ORIENTED COUNTRIES

Mission-oriented research can be described as big science deployed to
meet big problems (Weinberg, 1967). It is of primary relevance to countries
engaged in the search for international strategic leadership, and the countries in
which it dominates are those where defense accounts for a high share of
government expenditure on R&D (Table 1). Though it has also been used in
these countries to meet perceived technological needs in civilian markets (for
example, in nuclear energy or telecommunications), the link to national
sovereignty provides its major rationale.
The dominant feature of mission-oriented R&D is concentration. First and
most visibly, this refers to the centralization of decision making. As
TABLE 1 Share of Defense-Related R&D in Total Government Expenditure on
R&D, 1981
Country Percent Defense-Related
United States 54
United Kingdom 49
France 39
Sweden 15
Switzerland 12
Germany 9
Japan 2

SOURCE: Organization for Economic Cooperation and Development.

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DOES TECHNOLOGY POLICY MATTER? 194

its name implies, the goals of mission-oriented R&D are centrally decided and
clearly set out, generally in terms of complex systems meeting the needs of a
particular government agency. Specifying these needs and supervising project
implementation concentrates a considerable amount of discretionary power in
the hands of the major funding agencies.
Concentration also extends to the range of technologies covered. Virtually
by its nature, mission-oriented research focuses on a small number of
technologies of particular strategic importance—primarily in aerospace,
electronics, and nuclear energy. As a result, government R&D funding in these
countries is heavily biased toward a few industries that are generally considered
to be in the early stages of the technology life cycle (Table 2).
The scale of mission-oriented efforts also limits the number of projects and
restricts the number of participants. At any particular time, only a small sham of
each country's firms, likely among the larger ones, will have the technical and
managerial resources required to participate in these programs. The
concentration of government R&D subsidies on a small number of large firms is
therefore also a feature of the countries in this group.
Overall, mission-oriented programs concentrate decision making,
implementation, and evaluation. A few bets are placed on a small number of
races; but together, these bets are large enough to account for a high sham of
each country's total technology development program. This concentration raises
two obvious questions: First, how successful are the bets in relation to their own
objectives? And second, do they have any effect on the efficiency with which
the many other races are run—that is, are
TABLE 2 Proportion of Total National Public R&D Funding by Type of Industry,
1980 Estimates
Country Percentage of Total Public R&D Funding
High-Intensity Medium-Intensity Low-Intensity
United States 88 8 4
France 91 7 2
United Kingdom 95 3 2
Germany 67 23 10
Sweden 71 20 9
Japan 21 12 67

NOTE: High-, medium-, and low-intensity R&D industries are defined as firms whose ratios of
R&D expenditures to sales are, respectively, more than twice, between twice and half, and less than
half the manufacturing average.
SOURCE: Organization for Economic Cooperation and Development.
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DOES TECHNOLOGY POLICY MATTER? 195

technological capabilities more broadly diffused through the industrial

structure? These questions will be considered in turn.

Direct Effectiveness
Attempting cost-benefit analyses of major mission-oriented programs
involves enormous difficulties (Hitch and McKean, 1960). Three criteria for
evaluating success can nevertheless be established: First, are stated product
development goals being met? Second, is this being done within the original
limits of time and cost? And third, are objectives for commercial markets being
achieved?
No country's programs perform extremely well when measured against
these criteria. On balance, the effort in the United Kingdom has probably been
the least successful, whereas that in France and the United States has generated
a mixed record. Three factors seem to be critical in differentiating success from
failure. First, do the agencies involved have the technical expertise, financial
resources, and operating autonomy required to design and implement the
program--and the incentives to ensure that it succeeds? Second, are relations
with outside suppliers such as to provide appropriate incentives and penalties
and do they allow for experimentation with alternative design approaches?
Third, can agencies be prevented from expanding their "missions" indefinitely
and, in particular, from moving into areas for which their capabilities and
structures are inappropriate?
The answers to these questions have differed in each of the three mission-
oriented countries considered in this section.

United Kingdom
The United Kingdom's major difficulties arise from the pervasive lack of
incentives in its system of mission-oriented R&D.3 The British system of public
administration—with its emphasis on anonymity, committee decision making,
and administrative secrecy—ensures that individual public servants have little
interest in "rocking the boat." The emphasis on internal and procedural
accountability also makes government reluctant to devolve major projects to
reasonably autonomous entities, so that responsibilities are tangled, decision
making is cumbersome, and the organizational and cultural context is
inappropriate for developing new technologies. At the same time, the propensity
of British agencies to form "clubs" with their suppliers—within which each
supplier is treated on the basis of administrative equity rather than commercial
efficiency—weakens whatever incentives suppliers may have to seek an early
lead, while also ensuring that the resources available are so thinly spread as to
be inef
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DOES TECHNOLOGY POLICY MATTER? 196

fectual. Finally, the reluctance to build penalty clauses into development

contracts, and to terminate unsuccessful projects (particularly when this would
jeopardize the viability of an indigenous supplier), aggravates an inherent
tendency to cost overruns.

France
France's relative success arises in considerable part from the great political
legitimacy, operating autonomy, and technical expertise of its user agencies,
combined with the strong incentives for success built into the highly
personalized nature of power and careers in the French public administration.4
Particularly over the last decade, them has also been an effort to increase the
competitive pressures bearing on suppliers, notably through tighter controls on
costs, recourse to penalty clauses, and easing previous market-sharing
arrangements. The effects of these moves have been heightened by improved
financial and operating control within the agencies themselves.
However, the French system has two major weaknesses. First, resource
constraints have usually prevented experimentation with alternative design
approaches, and the number of suppliers involved in each major project has
typically been small.5 Second, though the French system has been compared
favorably to that of the United Kingdom because there has been a reasonable
willingness to run down (if not terminate) failures, the system has been highly
vulnerable to goal displacement as a sequel to success. Agencies that have
successfully accomplished a mission perpetuate themselves by designing new
missions, frequently in areas unrelated to their original function. This
"Frankenstein" effect is particularly noticeable in the energy and
communications fields, where agencies have sought to expand their power base
by diversifying their operations, generally into markets for which their
technological capabilities and organizational structures are inappropriate. As a
result, success in one period has in several cases been followed by failure in the
next; and the system has had few mechanisms for reallocating resources
smoothly.6

United States
Considering only the efficiency with which projects are designed and
implemented, the United States is intermediate between the United Kingdom
and France; but it has over them the great advantage of scale.7 This advantage
has three important dimensions. First, U.S. agencies draw on a much larger pool
of external technological expertise both in selecting and implementing projects
—and have much better mechanisms for doing
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DOES TECHNOLOGY POLICY MATTER? 197

so, notably in university research. Second, funding for mission-oriented

programs in the United States, particularly in defense, rarely falls short of the
critical mass required to complete the development stage and usually has a
higher continuity than program funding elsewhere. Third, the scale of funding is
large, and the range of qualified suppliers is wide. Even the relatively small
sums spent by the U.S. Department of Defense on programs of the Defense
Advanced Research Projects Agency are large in relation to total defense R&D
in the United Kingdom and France. The result is that experimentation almost
invariably occurs with alternative design approaches and philosophies, even if
only in the early steps of program conception.
The United States may also benefit from the high degree of accountability
inherent in its system of congressional scrutiny. This system has generated
strong pressures for terminating unsuccessful projects, notably in the civilian
sector (the supersonic transport plane and synfuels being prime examples), but
seems to exercise much less control on the defense sector. Thus, an incidental
effect of the system is that military programs may be allowed to continue too
long, and some largely civilian programs are shut down too early. It has been
argued that this places an excessive burden of financing projects with a high
"public goods" content on the private sector. The safety and decommissioning
of nuclear power plants may be cases in point (Brooks, 1983).
Any overall assessment of the direct effectiveness of mission-oriented
research must therefore be mixed; but the immediate returns on the research do
appear to be higher in the United States and France than in the United
Kingdom. However, even in the United States the products conceived directly
by mission-oriented programs account for only a small share of the economy
(Riche et al., 1983); the extent to which technology generated in these programs
spreads to other areas of activity is therefore a major component of its overall
impact.

Secondary Effectiveness
There are relatively few studies of the extent of secondary effects of
mission-oriented technology policies or of the pace at which such effects occur.
The few studies that do exist come to widely differing conclusions, frequently
reflecting individual authors' views of the desirability of defense spending.
None of the studies draws international comparisons. Two broad statements can
nonetheless be advanced on the basis of the existing material: first, in every
country, the direct spin-offs—in the sense of immediate commerical use of the
results of mission-oriented research—are limited;8 second, the indirect spin-offs
—arising mainly from improve
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DOES TECHNOLOGY POLICY MATTER? 198

ments in skills and in technical knowledge transferable from the mission-

oriented environment to that of commercial competition—appear to occur both
in greater number and more rapidly in the United States than in the United
Kingdom or France.9
It can be argued that the greater number and frequency of indirect spinoffs
in the United States are partly due to differences in the way programs are
designed and implemented. But the impact of these differences is compounded
by differences in the countries' economic structures and scientific and
technological environments.

The Role of Program Design

Four factors distinguish the design and implementation of mission-oriented
programs in the United States from that of their counterparts in the United
Kingdom and France. The first is the more limited direct role of the public
sector in mission-oriented R&D in the United States. In general, the U.S.
government performs a small share of its research in-house; the bulk of it is
contracted to outside sources (Table 3). Even the management of national
laboratories has been separated to a considerable extent from the public sector
and devolved to universities or to private companies. Problems of technology
transfer from the public to the private sector therefore concern a smaller share
of government-funded R&D than is the case in France or the United Kingdom.
Second, mission-oriented research in the United States involves a greater
number and diversity of agents. It is true that within the private sector, most
government research and procurement contracts go to a small number of
suppliers. But the sums flowing to university research and to small and medium-
size businesses are large in absolute terms.10 Thus, the number of small firms
receiving 20 percent or more of their total R&D finance from government
sources is nearly 10 times larger in the United States than in the United
Kingdom or France. Moreover, insistence in defense
TABLE 3 Share of Government-Financed R&D Performed in the Government Sector
Country (Year) Share Performed by Government
France (1983) 46.8
United Kingdom (1981) 38.9
Federal Republic of Germany (1981) 31.6
United States (1983) 25.7
Switzerland (1981) · 24.7

SOURCE: Organization for Economic Cooperation and Development.

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DOES TECHNOLOGY POLICY MATTER? 199

procurement on "second-sourcing" of key components ensures a fairly broad

diffusion of technological capabilities.
The effects of this dispersion are compounded by a third factor, namely,
greater U.S. willingness to disseminate the results of mission-oriented
programs.11 Despite obvious security concerns, U.S. defense R&D programs
have generally either made their results public or at least made them known to a
wider circle than that immediately involved in the program. The information
inherent in these results—such as measurement standards, properties of
materials, or even identification of unsuccessful approaches to technical
problems—is an important "public good."
A greater U.S. willingness to disseminate results probably contains an
element of bowing to the inevitable: Given the number and range of
participants, results will be known sooner or later. However, other factors have
also been at work. The widespread dissemination of results has been important
in securing ongoing political approval for the programs. It has also been a way
of preventing contractors from consolidating a "first-mover advantage" over
competitors. At universities especially, dissemination has been facilitated by a
research community that generally has not questioned the legitimacy of the
program so long as their results could be fed into the system of "public or
perish!"
The dissemination of the results of mission-oriented programs in the
United Kingdom and France differs from that in the United States in three
respects. First, after programs are set up and running, there is little external
political pressure to disseminate results. Second, the members of the program
"club" themselves have little interest in seeing results publicized and tend to
count more heavily in decisions about dissemination. Third, the external
environment—notably that in the universities--has been perceived as probably
hostile and possibly untrustworthy. As a result, the information generated by
mission-oriented programs has tended to remain confined to a small circle of
participants.
Finally, the U.S. government moved somewhat earlier than its counterparts
in France and the United Kingdom to encourage commercialization of the
results of government-financed R&D. The National Aeronautics and Space
Administration and a few other federal agencies have long had specified units
concerned with technology transfer. Regarding government-financed R&D in
the private sector, the 1980 Patent Law Amendments Act established a uniform
policy allowing contractors—notably, small businesses, universities, and
nonprofit laboratories—to own inventions resulting from federal R&D funding.
The assurance this act provides of clear tide to government-funded inventions
has greatly facilitated patent licensing by universities and other federal
contractors to industry and has encouraged industrial participation in federally
supported university research.
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TABLE 4 Research Scientists and Engineers in the Labor Force, 1981

Country Number per 1,000 of Labor Force
United States 6.2
Japan 4
Federal Republic of Germany 4.7
United Kingdom 3.9
Norway 3.8
France 3.6

SOURCE: Organization for Economic Cooperation and Development.

Differences in the Environment

Economic interests in the United States therefore have greater direct or
indirect access to whatever may be transferable in the outcomes of mission-
oriented programs. At the same time they are well placed to exploit these results
for commercial purposes and have substantial incentives to do so.

Lower Degree of Crowding Out

The sheer size of the U.S. scientific and technological system means that
mission-oriented programs probably "crowd out" other research efforts only to a
limited extent. The size differential is particularly marked in terms of the stock
and flow of research manpower. The share of R&D scientists and engineers in
the U.S. labor force is one-third greater than that in the United Kingdom and
France (Table 4). The share of secondary students going on to university
training in the United States is about double that in France or the United
Kingdom (Table 5), and the proportion of those students choosing scientific or
engineering training is reasonably responsive to market circumstances.12 To this
difference in endowment must be added the effect of inflows of scientists and
engineers from overseas. In 1982, foreign-born scientists and engineers
accounted for fully 17 percent of all scientists and engineers employed in the
United States.

Accessibility and Mobility of Scientific Know-how

The U.S. stock of human and technological capital, in addition to being
relatively abundant is also more easily accessible. It is, in the first place,
accessible through contract research, both with private research firms and with
universities. Though the share of university research financed by industry in the
United States is not high, the links between universities and industry have
traditionally been strong (Noble, 1977; Ben-David, 1968)—far stronger, at
least, than in France or the United Kingdom, both these countries lagging even by
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European standards in this respect (Ahlström, 1982; Organization for Economic

Cooperation and Development, 1984a; Ben-David, 1968). These links take
several forms: active efforts by U.S. universities to commercialize their
technological skills, widespread consulting for industry by university scientists
and engineers, frequent coauthorship of journal articles by researchers in
industry and academia, and sizeable gifts of equipment by industry to university
research facilities.
The operation of the U.S. labor market also promotes the accessibility of
its stock of human and technological capital. In general, the U.S. labor force is
more mobile between employers and regions than the labor force in Europe:
Average job tenure is about 20 percent lower in the United States than in France
or the United Kingdom; the share of the labor force crossing regional
boundaries each year is—at about 3 percent—double that in Europe. Moreover,
U.S. scientists and engineers are almost as mobile as other segments of the
labor force: Their average job tenure is only about 15 percent higher than the
average. In contrast, mean tenure in France with a given employer is nearly 40
percent higher for highly qualified staff than for the labor force as a whole
(Pham-Khac and Pigelet, 1979; Stevens, 1986).
Differences in labor mobility are even greater regarding movement from
university to industry. Some 2 to 3 percent of all U.S. scientists and engineers
move from academia to industry or vice versa every year; the figure for Frantic
can be estimated at well below 0.5 percent.13 The civil service status of public
sector researchers in France makes movement difficult and eliminates
incentives to move.
TABLE 5 Diplomas Giving Access to Higher Education as Proportion of Age Group
Country (Year) Percent
Japan (1981) 87
Sweden (I 982) 82
United States (1980) 72
Federal Republic of Germany (1982) 26
Denmark (1980) 25
France (1983) 28
Italy (1981) 39
United Kingdom (1981) 26
Finland (1980) 38
Austria (1978) 13
Netherlands (1981) 44

SOURCE: Organization for Economic Cooperation and Development.

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Competition in Factor and Product Markets

High levels of mobility of scientists and engineers in the United States
ensure that technological capabilities generated by mission-oriented research
are rapidly diffused among firms but do not ensure that such capabilities will
rapidly be exploited. This in turn hinges on the intensity of competition in
product markets, which encourages rums to innovate. Three factors distinguish
the United States in this respect: the receptiveness of capital markets to
innovation efforts, the extent of the threat of new firm entry, and the incentives
to innovation arising from a large and unified market.
Capital markets in the United States are distinguished from those
elsewhere largely by two features: the depth and breadth of equity markets and
the availability of venture capital finance for start-up companies (Gönenç,
1986). It can be argued whether these institutions have proved appropriate for
financing long-term market share strategies; but—perhaps because they provide
a low-cost means for realizing capital gains—they appear to do reasonably well
at providing concurrent finance for a broad range of innovation efforts.
Certainly the balance of evidence indicates that they are effective mechanisms
for the monitoring and diversification of innovation-related risks and
opportunities.
The functioning of capital markets reinforces the degree of competition in
U.S. product markets in two important respects. First, the widespread
availability of venture capital—together with a range of other environmental
factors that reduce the costs of setting up and dissolving businesses-increases
the threat of entry by new companies. This is reflected in rates of creation and
disappearance of new manufacturing firms, which are nearly twice those in
France (Arocena, 1983; Ergas, 1984b). Ideas not exploited by large companies
are likely to be tried out quickly by an entrepreneur. This is of particular
importance in the early stages of a new technology, when a large number of
alternative design approaches are being explored (Clark, 1985; Freeman, 1974;
Nelson and Winter, 1982).
Second, an active market for corporate control provides an effective means
of liquidating new firms that do poorly and incorporating into larger concerns
the activities of those that do well. At the same time, the takeover market
reduces the risks associated with entry by diversification. Large U.S. firms have
tended to enter new markets by buying smaller firms already operating in those
markets, knowing that if the venture failed, it could be disposed of (Scherer and
Ravenscraft, 1984).
The effects of potential competition are compounded by the far greater
supply in the United States of potential entrants into advanced technology
markets. More than 15,000 firms in the United States have R&D laboratories;
this compares with about 1,500 in France and 800 in the United Kingdom. The
number of firms with some technological capability in any given area is likely
to reflect this differential. This provides the United
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States with a large seedbed capable of responding quickly to the ''focusing''

effects of innovations and acting as an incubator for potential entrepreneurs. It
also provides a large number of firms capable of acting as a "fast second"---
moving into a new market as its attractiveness is established and as the
appropriate technological approach becomes clear.

Size of the U.S. Market

The nature of competition in the U.S. market also intensifies firms'
interests in new product areas, notably as a technology approaches the stage
where mass marketing becomes essential. Three factors are of particular
relevance. First, because of the importance of economies of scale in a relatively
homogeneous market, firms vie for leadership in the transition to mass
production and marketing.14 Second, reliance on de facto or proprietary
standards provides the firm whose product emerges as a dominant design with a
considerable advantage. Third, the U.S. market appears to be highly sensitive to
"perceptual" product differentiation, which tends to favor early entrants to the
mass marketing and production stage.15
Each of these factors can create first-mover advantages, compounding the
benefits the United States derives from having a greater number of potential
first-movers. As a result, the two basic components of the "swarming" process—
by which firms flock to an emerging market—tend to operate particularly
rapidly in the United States: the experimentation stage, in which a range of
alternative design approaches is explored, frequently by smaller firms; and the
transition to mass commercialization, as the technology matures to the point of
market acceptability. Preeminence in both of these stages increases the
likelihood that U.S. firms will be well placed to spot an emerging dominant
design.

The Link to Performance

The preceding discussion of mission-oriented countries can be summarized
as follows. In the United Kingdom, mission-oriented research has tended to
yield few direct benefits while possibly crowding out a substantial share of
commercial R&D. The indirect spin-offs have been low, creating a "sheltered
workshop" type of economy: a small number of more or less directly subsidized
high-technology firms, heavily dependent on and oriented to public
procurement, and a traditional sector that draws little benefit from the high
overall level of expenditure on R&D.16
In France, mission-oriented research efforts have themselves been
reasonably successful. This has created export markets for France, notably in
the largest weapons-importing countries of the Third World and in other
countries where state-to-state trading is important. However, the spin-offs from
these efforts have been relatively limited, so that French industry
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has become increasingly dualistic in its access to, and reliance on, advanced
technology. This has been most visible in France's shifting pattern of
international trade. Exports of products requiring a high intensity of skills,
though rising, have concentrated to a growing extent on Third World markets,
reflecting the predominance of state-to-state trading, whereas in trade with the
advanced countries, the relative skill intensity of French exports has tended to
diminish. The centralized and concentrated nature of mission-oriented research
has therefore led to an increasingly polarized pattern of specialization.17
The situation of the United States is more complex. Although the direct
effectiveness of mission-oriented programs is no higher than in France, the
results of these programs tend to diffuse particularly rapidly through the U.S.
economy. This rapid diffusion is a result of three features: the wide range of
economic interests capable of exploiting these results for commercial purposes,
the low level of the obstacles they encounter in seeking to do so, and the
strength of the incentives for rapid exploitation. The mission-oriented stage of
research in the United States remains highly centralized, but its results are more
rapidly carried over into the decentralized experimentation of the commercial
market.
Particularly in recent years, the rapid carryover of the results of the U.S.
programs has generated advantages that may be cumulative at the level of the
firm but are not cumulative at the level of the product. More specifically,
although U.S. firms appear to retain many of their established strengths, U.S.
production sites have proved considerably better at the experimentation stage
than the follow-on to mass production (Lipsey and Kravis, 1985).18 This partly
reflects the macroeconomic circumstances associated with the overvaluation of
the dollar, but more fundamental factors may also be at work.
Historically, the United States has lacked a system for training craftsmen,
while possessing an abundance of higher-skilled (white collar) and lower-
skilled or unskilled workers (Floud, 1984; National Manpower Council, 1954;
Floud, 1984). At the same time, the structure of blue-collar earnings in the
unionized parts of U.S. industry (with low differentials between trainee wages
and those of craftsmen) and high labor mobility have discouraged employer
investment in transferable skills (Glover, 1974; Mitchell, 1977; Ryan, 1984).
Combined with a large and unified national market, this pushed U.S.
manufacturing firms in two directions: pioneering mass production techniques
that made little use of craft labor and developing organizational innovations
intensive in their use of managerial or supervisory staff--such as multiplant
production, multidivisional management, and the multinational firm.
The advantage that superior mass production techniques gave U.S.
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production sites has tended to erode over time, for at least three reasons. First,
in an increasingly integrated world economy, being located in the world's
largest single market is of diminishing importance as a determinant of
competitiveness. Second, the quality of the .U.S. labor force—and particularly
that part with only a high school degree or less—has probably declined relative
to that overseas, and notably relative to that in Japan (Murray, 1984, pp.
96-112). Third, classical mass production techniques along "Taylorist" lines
may be of diminishing effectiveness as the variability and differentiation of
products increases, as product workmanship becomes a more important factor
in consumer choice, and as new technologies for "mid-scale" production
become available Ergas, 1984a).
These factors place the U.S. manufacturing industry at a clear
disadvantage, but they have less impact, if any, on the service sector. As a
result, U.S. firms tend to reap the advantages of innovative capabilities in
manufacturing mainly at the early stages of the product life cycle (or, if the
dollar is low enough, in products that are mature). In services, the gains from
innovation have been consolidated further downstream as markets grow. Given
a reasonably flexible and open economy, this pattern is reflected in the structure
of trade. Thus, resources have tended to cluster around emerging or science-
based industries.
In this sense, the United States comes closest to the classical product cycle
model, abandoning mature industries in favor of activities with better growth
prospects.19 A system of mission-oriented research, which helps ensure that the
frontiers of these activities are constantly being explored, may provide a useful
source of ongoing stimulus to this process. It therefore has a certain degree of
coherence relative to the U.S. economy. Whether this process would not occur
of its own volition—that is, even in the absence of mission-oriented research—
remains an open question.

THE DIFFUSION-ORIENTED COUNTRIES

Diffusion-oriented policies seek to provide a broadly based capacity for
adjusting to technological change throughout the industrial structure. They axe
characteristic of open economies where small and medium-size manufacturing
enterprises remain an important economic and political force and where the
state, bearing the interests of these firms in mind, aims at facilitating change
rather than directing it.20
The primary feature of these policies is decentralization. Specific
technological objectives are rarely set at a central level. Central government
agencies play a limited role in implementation, preferring to delegate this stage
either to industry associations or to cooperative research organizations
dominated by industry. Whatever funds are disbursed tend to be fairly
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widely spread across firms and industries, with the high-technology industry
obtaining a far lower share than in the mission-oriented countries.
Given this degree of decentralization, the precise boundaries of technology
policy are often difficult to identify. Switzerland, for example, would certainly
deny having a "technology policy" in the sense in which France has one. A
more fruitful approach is to view technology policy in these countries as an
intrinsic part of the provision of innovation-related public goods: notably
education, product standardization, and cooperative research. These countries'
distinguishing feature is the importance they attach to the organization and high
quality of the provision of these goods and the decentralized mechanisms they
have developed for supplying them.

The Economic and Institutional Framework

The priority accorded to the provision of public goods has its origin in
process of industrialization in these countries. Two interrelated features
distinguished this process: an emphasis on "education push," notably through
innovations in higher education and in the training of engineers (Ahlström,
1982), and an early specialization in the chemical and electrical industries on
the one hand and in mechanical engineering on the other.21 This early pattern of
specialization fed back into the demand for innovation-related public goods.
The chemicals and electrical industries were distinguished from the start
by the closeness of their links to the science base (Beer, 1959; Freeman, 1974;
Liebenau, 1985; Rosenberg, 1976; Rosenberg and Birdzell, 1986). They needed
a high-quality university system, capable of training scientists for industry, of
monitoring scientific developments worldwide, of providing external support to
the emerging industrial research laboratories. Achieving this system in turn
depended on developing an increasingly efficient and effective school system,
which could prepare and select candidates for higher education. The Lutheran
tradition of universal literacy and broadly based instruction provided an ideal
basis for this evolution (Sandberg, 1979).
The chemicals and electrical industries therefore acted as a politically
powerful and well-organized lobby for education and for academic research.
Being highly concentrated and largely cartellized, they were fully capable of
mobilizing in their collective interest (Forman, 1974; Schröder-Gudehus, 1972).
But the needs of the mechanical engineering industries were different. First,
whereas chemicals and electricals were science-based, mechanical engineering
relied on learning-by-doing and on the tacit, unformalized know-how of skilled
craftsmen. Second, whereas chemicals and electricals tended to be concentrated,
mechanical engi
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neering was not, mainly because a high level of decentralization was more
efficient in monitoring the type of team production required to maintain the
quality of workmanship.
For decentralization to persist, the engineering industry had to resolve
three major problems. First, it had to be able to draw on an external pool of
skilled labor, since no single small or medium-sized firm could efficiently rely
on its internal labor market alone. Second, it had to reduce the transaction costs
involved in the decentralized production of components that are close
complements from an economic viewpoint— e.g., nuts and bolts. Third, it had
to find ways of keeping firms up to date with technological developments,
ensuring that the fruits of technical advance accumulated and were appropriated
at the level of the industry as a whole, rather than primarily or solely at the level
of the firm.
Mechanical engineering was therefore an active lobby for three policies:
comprehensive vocational education, product standardization, and cooperative
research. It sought these policies mainly through provision by industry
associations rather than by government; and, particularly in Germany and
Switzerland, this coincided with a governmental practice of according quasi-
public status and functions to private bodies, originally to regulate markets
(Berger, 1981; Katzenstein, 1985a).
As it has evolved in these countries, the overall system of public policy
affecting technological capabilities has therefore had three key features.

Vocational Education
The most significant feature is probably the depth and breadth of
investment in human capital, centering on the dual system of education. This
involves comprehensive secondary education based on streaming into a high-
quality university system that is paralleled by an extensive system of vocational
education.22
A distinguishing characteristic of the educational component of the system
in diffusion-oriented countries is high retention rates. More than 85 percent of
17-year-olds are in the education and training system in these countries; this
compares with around 60 percent in the United Kingdom and 70 percent in
France. The system is characterized further by a relatively high level of per
capita expenditure on education at all levels. Over the last decade, the elasticity
of total public educational expenditure with respect to gross domestic product
(GDP) has been around 5 times higher in Switzerland than in the United States,
starting from a base where Swiss expenditure per pupil was already a higher
share of per capita GDP. Finally, the system is notable for its far-reaching
certification. Only some 10-15 percent of the age cohort leave school with no
certificate or qual
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ification whatsoever, compared with 20 percent in the United States and as

much as 40 percent in France and the United Kingdom.
Particularly in the German-speaking countries, the skill certification of
large parts of the youth cohort occurs through the system of apprenticeship-
based vocational education. More than 50 percent of 17-year-olds in Germany
and Switzerland are enrolled in apprenticeships, compared with about 10
percent in France and the United Kingdom. These high rates of participation are
encouraged both by a substantial differential between trainee wages and those
of skilled craftsmen (Jones and Holenstein, 1983) and by a well-organized and
extensive system for training apprentices. Thus, apprenticeships are highly
structured programs of several years' duration. They include a combination of
enterprise training and college education and culminate in standardized formal
examinations. Moreover, completion of apprenticeships is only one stage in
skill training: The classification of examination-certified vocational skins forms
a continuum from the craftsman to the most highly trained engineer, and
movement along this continuum is a relatively standard feature of working life.23
There is a high level of industry involvement throughout this system. In
the general education sector, the main links are between industries and
universities (these will be discussed below). But the core of industry
involvement is in vocational education. The apprenticeship system is jointly
financed and controlled by employers (acting mainly through industry
associations) and local education authorities, with trade unions also providing
an important input. Industry associations play a major role in defining and
revising curricula and in monitoring the system's effectiveness. Combined with
the emphasis on formal, written examinations, this ensures that the skins
acquired are highly transferable between employers and can be adapted to
improvements in the industry's technology base.
Overall, this structure of investment in human capital yields two outcomes:
a university system capable of keeping up with the frontiers of · science, though
not necessarily pioneering their exploration, and a very high level of
intermediate skills in the working population.24 The fact that these skills are
certified through a standardized system of examinations erodes the advantages
that internal labor markets would otherwise have had in information about
individual workers' skins, and hence tends to favor smaller firms. In turn, the
ongoing nature of certification encourages relatively high levels of mobility for
skirted craftsmen with work experience, providing a further channel for the
interfirm diffusion of technology (Glover and Lawrence, 1976; Maurice et al.,
1982; Office Fédéral de I'Industrie, des Arts et Mötiers et du Travail, 1980).
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Industrial Standards
An emphasis on reducing transactions costs also pervades the second
important feature of diffusion-oriented countries, namely, the system of
industrial standardization. Of particular importance to the engineering
industries, the German system of industrial standardization is unique in the
range of intermediate goods and components it covers, the volume of detail it
specifies (notably in relation to performance), and the legal status of its norms.
This system emerged as part of a conscious effort to promote rationalization in
decentralized industries.25 Though it operates as a quasi-public authority, the
system is almost entirely funded and administered by industries. Although the
budget of the German standards operation (DIN) is 21/2 times that of its French
counterpart (AFNOR), the share of this budget provided by all levels of
government is less than half that in France.26 To this must be added the
considerable investment German industry makes in providing technical support
for the standardization process.
The immediate impact of the standardization system is to reduce
transactions costs by providing clearly specified interface requirements for
products. At the same time, it fulfills a quality certification function, which is
especially important for industrial components. But its indirect effects may be
even greater.
In particular, the standardization process itself—and notably the
preparation of new standards and the ongoing review of existing ones—
provides an important forum for the exchange of technical information both
within each industry and with its users and suppliers. Though this information is
ultimately rendered public in the published specifications, the long lead times
involved in drafting standards, and the relatively small share of the total
information generated that is contained in the published standard, ensure that
the exchange process operates as a local public good. The primary beneficiaries
are the firms most actively involved in industry associations. The density of
these information flows also ensures that by the time a new standard is
announced, German firms are in a position to adopt it. The system of industrial
standardization, in other words, functions as a means of placing ongoing
pressure on firms to upgrade their products, while providing them with the
technical information required to do so.

Cooperative Research and Development

A concern with assisting a decentralized industrial structure to adjust to
changing technologies also underlies the third feature of these countries'
policies, namely, the role of cooperative R&D.27 This takes two forms.
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The first is close industry-university links, which have traditionally been of

particular importance to the chemical industry and remain a dominant
characteristic in Germany, Switzerland, and Sweden. Thus, 15 percent of
university research in Switzerland is funded by industry—the highest share in
the OECD and more than 3 times higher than in the United States, France, or
the United Kingdom. The links go well beyond the chemical sector, as the close
ties between the EFTZ in Zurich and the Swiss mechanical and electrical
engineering industries attest. Similar links can be found in Sweden, notably
between the technical universities and the large science-based firms. A specific
feature of the German system is the role of the three large nonprofit research
organizations in cooperative research. The Fraunhofer Gesellschaft, in
particular, has 22 research centers, which have become increasingly involved in
providing technical support to small and medium-size firms.
The second major form of cooperation in R&D centers is industrywide
cooperative research laboratories. These account for a considerably higher share
of total R&D expenditure in Scandinavia than elsewhere. Thus, in Norway even
the largest firms have only small in-house research units, and most industrial
R&D is contracted out to cooperative laboratories. In Sweden an extensive
network of industry or technology-specific laboratories is jointly funded by
industrial firms and by the State Board for Technical Development. In addition
to ongoing programs aimed at the entire population of an industry, these
laboratories carry out contract research for individual firms. Similar
arrangements exist in Germany and (though on a smaller scale and with
considerably less government funding) for certain industries in Switzerland.
The most immediate impact of the availability of these outside sources of
research expertise is probably on the cost-effectiveness of R&D. They permit
sharing of costly instrumentation and research facilities and allow firms
occasionally to draw on specialists they could not afford to employ full-time. In
this sense, their role is similar to that played by the larger U.S. technical
consultancies (for example, Arthur D. Little or Battelle Laboratories) in
providing support to smaller laboratories.
This role may be secondary over the longer term, however, as it can be
argued that the important function of cooperative research is really twofold. The
first is technology transfer. Universities and cooperative research centers
inevitably have a higher ratio of research to development than have the
laboratories of small firms. This higher research intensity allows them to
generalize, and hence transfer, the results of individual development projects
from firm to firm, thus providing a degree of economies of scope to innovation
programs across an industry or activity.
The second function of cooperative research is technology focusing.
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The process of setting research priorities for the system encourages firms
to pool their perceptions of major technological threats and opportunities. This
in turn feeds back into the internal R&D planning.
However, the effective discharge of these functions requires that firms
have a certain degree of in-house R&D capability, which they complement
through recourse to external sources. Thus, the evidence for Germany suggests
that the most intensive users of contract research are small and medium-size
firms with an internal research unit—on average, these firms spend on external
(contract) research an mount equivalent to 30 percent of their in-house R&D
spending.

The Role of Policy: An Example

It has therefore been a major concern of policymakers, particularly in
Germany, to ensure the existence of an in-house R&D capability to complement
other forms of R&D. The Federal Ministry of Economics has in recent years
helped finance a scheme providing a partial subsidy for the employment of
research scientists and engineers in small and medium-size firms. Assessments
suggest that the program has been a considerable success and that about 10
percent of the eligible firms participate. The scheme is worth examining
because it provides a particularly good example of German diffusion-oriented
policies and notably of what are referred to as indirect specific programs. The
latter are government programs specific to the technology of a particular
industry but implemented through a trade or industry association rather than by
a government department. Three features of these programs stand out.28
The first is that the funds involved are small. In total, in 1985 expenditure
on the R&D employment subsidy was around 420 million DM—less than 1
percent of German expenditure on R&D. Moreover, the funds were thinly
spread, going to about 7,000 firms, a third of which have fewer than 50
employees.
The second is the decentralized process of implementation. The major
responsibility for administering the project lies not with the funding agency, but
with the German Federation of Industrial Research Associations (AIF), which
groups some 90 nonprofit industrial R&D associations, which in turn represent
25,000 firms in 32 industrial sectors. The AIF—70 percent of whose funds
come from industry—operates some 60 research laboratories, employing 4,000
scientists and engineers.
Though the AIF has operating responsibility for the project, a low level of
discretionary decision making is involved. Eligibility criteria are clearly set out,
and question of whether a firm is eligible is straightforward. The risks of
discrimination against particular firms are therefore low. However,
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being administered by the AIF provides the scheme with high visibility among
industrial associations, and more than 50 percent of the firms participating in
the scheme learned about it from trade associations or local Chambers of
Industry and Commerce.
Decentralized implementation is closely related to the third feature of the
scheme, namely, the simplicity of its administrative formalities. The application
forms do not call for any particular expertise—90 percent of participants
completed these forms without any external assistance. This limits the fixed
costs involved in participating and further reduces the risks that the program
will degenerate into a privileged club.

Defense Research and Development

The importance accorded to the diffusion of technological skills has even
affected these countries' not insignificant activities in armaments. Sweden has
placed great emphasis on promoting and to some extent organizing the diffusion
of defense-related technological skills into the commercial sector. By law, no
Swedish company may have more than 25 percent of its business in defense.
Thus, defense contractors are forced to develop civilian operations (Gansler,
1980, pp. 245-257). Specific policies have also been implemented to increase
the technical capabilities of subcontractors to the larger companies involved in
defense work. Financing is provided by the Swedish Industrial Development
Fund.

The Effectiveness of the System

The diffusion-oriented countries are therefore characterized by policies
that encourage widespread access to technical expertise and reduce the costs
that small and medium-size firms face in adjusting to change. In essence, the
policy framework serves to increase the capacity for absorbing incremental
change without threatening the basic structure of industry.
From this point of view, the policies have indeed been successful. It
remains a striking feature of these countries that industrial production is more
decentralized than it is elsewhere, notably in mechanical engineering; and that,
while providing the benefits of highly focused management, decentralization
does not prevent coordination of interdependent decisions and the reaping of
economies of scale and scope. Though firms in these countries are smaller than
their competitors overseas, higher levels of specialization minimize any relative
cost disadvantage.29
The system has also functioned effectively in promoting adjustment to
incremental change. New skills are transmitted relatively rapidly through labor
training and re--g, as well as by interfirm labor mobility. The
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standardization system itself provides an ongoing flow of technical information;

and industry associations and cooperative research institutes allow for interfirm
economies of scale in R&D while focusing firms' attention on emerging
technologies.
However, two major concerns have been expressed. First, the system as it
has evolved is geared to the existing industries, which basically set the
technology agenda: That is, they determine the direction of research, dominate
the process of standardization, and have a large role in training and education
policies. Entirely new industries and technologies may find it difficult to
capture the attention they deserve. Second, even in the existing industries, the
decentralized, ''bottom-up,'' approach leads to a strong emphasis on movement
along technological trajectories, while reducing the visibility of, and
preparedness for, major shifts in trajectories.
These features--concentration on established industries and moving along
set technological trajectories--are apparent in the evolution of these countries'
external trade, which has been distinguished by three trends30
The first is that the diffusion-oriented countries have tended to consolidate
and even sharpen their traditional patterns of specialization. They have indeed
retrenched in the areas where their original performance was poor but without
moving into entirely new areas of activity. Rather, their performance has
remained strong in the areas where they have traditionally specialized, and
within these product areas they have tended to become stronger across the
board. As a result, their net exports are highly concentrated in "product
clusters," mainly in products for which world demand is growing relatively
slowly, so that improved performance has required a long-term gain in market
share.
Second, this gain in market share has occurred in products with unit values
well above the average for their product category. For engineering products,
around 85 percent of Swiss exports, 75 percent of German exports, and 65
percent of Swedish exports in 1970 had unit values above the average for their
disaggregated product category; this compared with around 35 percent for
France and the United Kingdom. Specialization in the higher-quality segments
of markets has tended to increase over time.
Third, and most recent, this pattern of specialization has been seriously
threatened by competition from Japanese firms, which have used electronics-
based technologies to challenge the European countries' traditional
predominance in mechanical engineering. Lags in adjusting to shifts in
technological trajectories have led to major losses of market share.
These lags arise less from a lack of technological capabilities than from the
conservatism inherent in industrywide decision-making processes. The Swiss
watch industry and the German machine-tool industry provide striking
examples in this respect.
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In both cases, the research community associated with the industry was
aware of the impact electronics would have—and, in fact, made important
contributions to the technology. But research awareness could not be translated
into industrial action—partly because of complacency among firms, but also
because there were few prospects for adjusting without drastic changes in the
industry structure. These changes could not be fitted into the consensus-
centered decision-making process; both industries severely lost market share to
their Japanese competitors.
Once the loss in market share had begun to occur, however, the industries
were relatively well placed to respond. The basic technological skills had been
accumulated, and the mechanisms for transferring them to industry were in
place. Particularly the German machine-tool industry—which benefited in the
early 1980s from the effective devaluation of the DM relative to both the U.S.
dollar and the yen—succeeded in reversing its loss of market share and making
a quick though painful transition to the new technology.
The criticism that the system slows adjustment to entirely new
opportunities while reinforcing specialization in the traditional areas of activity
may therefore have some foundation. As these cases bear out, however, the
system's capabilities for adjustment—albeit delayed—should not be
underestimated. An ongoing response to the Japanese challenge will require
important changes in certain aspects of the institutional context. Thus, it has
been argued that the apprenticeship system should provide a broader range of
generic skills, which could be complemented through continuing vocational
education. The Swedish educational reform, which has somewhat reduced the
vocational component of secondary education, clearly goes in this direction
(Hodenheimer, 1978). But given these changes, the diffusion-oriented countries
should remain' important on the world industrial scene.

JAPAN
In this typology, Japan is in a class of its own. Like the countries in the
first group, it has deployed coordinated efforts to advance national
technological goals. At the same time, like the countries in the second group
(and with a clear element of imitation from those countries), it has emphasized a
broadly based capacity to diffuse innovation-related public goods. In both cases,
however, the specific policies and their implementation have been modified to
the requirements of the Japanese context.
Two features of this context stand out. The first is that even in the recent
past, Japan was at a far lower level of development than the other countries
examined in this chapter (Nakamura, 1951; Shinshara, 1970). As late as
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1965, Japanese GDP per capita was half the OECD average and less than one-
third that in the United States. The gap in per capita GDP was closely linked to
lower levels of capital and skill per unit of output throughout Japanese industry.
This was accentuated by a dualistic industry structure that combined relatively
high productivity in the large-firm sector with considerably lower productivity
in the smaller manufacturing firms, in agriculture, and in services. More so than
for the other countries in our sample, material well-being in Japan depended on
whether Japanese industry could fundamentally reshape its comparative
advantage in international trade, rather than simply adapt it to incremental
advances in the technological base.
The second factor that sets Japan apart is the relation of the state to
industry (Johnson, 1982). Unlike the diffusion-oriented countries, Japan entered
the 1950s with an economic bureaucracy able and willing to deploy an active
strategy of industrial transformation. Compared to previous periods in its
history, and even to the present day, this bureaucracy was at that time uniquely
powerful relative to the other political actors on the national scene. However,
particularly with the end of postwar reconstruction, the bureaucracy's power
depended on its capacity to generate a consensus among the major actors, so
that the "administrative guidance" it provided would be smoothly carried
through into corporate decision making. This resulted in a combination of
consensus-based but relatively centralized decision making with a more
decentralized approach to implementation.

The Development Strategy

Combined, these factors have led the Japanese bureaucracy toward a
development strategy that emphasizes the rapid upgrading and transformation
of the nation's technological skills but does so in a manner both more
decentralized and more broadly based than in the mission-oriented countries.
The constraints arising from industrial dualism have led to a greater emphasis
on diffusion, whereas those arising from the nature of governance have led to a
greater emphasis on indirect implementation.
There are three major elements to this strategy: investment in human
capital, promoting activities at the "leading edge" relative to the core sector's
technological capabilities, and facilitating the transfer of new technologies from
the core to the periphery.

Human Capital
A key component of the strategy has been the progressive upgrading of
Japan's base of human capital. Japan has a long tradition of engineering
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training, having been among the first countries to integrate engineering into
university curricula (Nakayama, 1984). But its emergence as one of the world's
leading centers (at least in numerical terms) for the training of engineers is
nonetheless spectacular (Table 6). This has been paralleled by a sustained
increase in the average educational attainment of successive cohorts.
The emphasis on the upgrading of human capital is, in many respects,
reminiscent of German, Swedish, or Swiss industrialization. But, in contrast to'
these countries, the expansion of the Japanese skill base has occurred on a more
general and less industry-specific basis (Stevens, 1986). More particularly, the
Japanese education system is one of general rather than vocational education.
The growth in enrollments has consisted in increasing the share of the cohort
remaining in the general stream, gradually bringing this share toward U.S.
levels (Table 7). Even in postsecondary education, the level of specialization is
low, and engineering training in Japan is considerably more superficial than that
in Scandinavia or the German-speaking countries.
As a result, the tasks of directing the labor force toward specific
occupations and developing the relevant skills has largely been left to industry,
and particularly to the larger, "lifetime employment" firms.31 Finns have had
access to a progressively better-educated flow of labor force entrants, notably as
regards general mathematical and engineering skills, but little attempt has been
made in the education system to shape the capacities of students toward
particular vocations. This has given the Japanese labor force a high degree of
malleability, decentralizing a set of decisions that critically affect a country's
technological capability.

Sectoral Promotion
A high degree of decentralization has also characterized the promotion of
particular industries.32 Three features are important in this respect. First, the
areas being promoted have generally been fairly loosely defined, cov
TABLE 6 Higher Education Engineering Qualifications
Country First- Per Million Below Per Million
(Year) Degree Population First- Population
Level Degree
Level
Federal 7,000 110 16,000 260
Republic of
Germany
(1981)
United States 80,000 350 — —
(1982)
Japan (1982) 74,000 630 18,000 150

SOURCE: National Economic Development Office (U.K.) and Manpower Services Commission
(U.K.).
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ering a broad range of market segments rather than focusing on a particular

product. Second, the policies adopted have primarily provided a framework
within which the activity could develop, notably through import protection,
restrictions on foreign direct investment, assistance in licensing overseas
technology, and measures aimed at reducing the entry barriers to domestic
firms. Beyond providing this framework, policies have rarely involved
promotion of a particular domestic company to the apparent detriment of others.
Little use has been made of "national champions," and efforts have consistently
been made to diversify risk by promoting competition in the domestic market.
Third, direct financial assistance has played a very limited role. Though "soft
loans" have at times been important, the primary emphasis has been on
nondiscretionary instruments such as tax expenditures. Whereas the volume of
these tax expenditures may in certain cases have been large relative to the size
of the activity being promoted, the subsidies involved have probably been
small, partly because of the generally low incidence of corporate taxation.
There has, of course, been a subsidy element in public procurement, but given
its low defense expenditure, the Japanese government has been a relatively
marginal consumer of high-technology equipment (though this is not true in
some of the areas discussed below, notably telecommunications and aerospace).
TABLE 7 Distribution of Students in Upper Secondary Education (Full-time and
Part-time Enrollments), Around 1980-1982
Country General Education Vocational and
(percent) Technical (percent)
Japan 70 30
United States 76 24
Federal Republic of 21 79
Germany
France 40 60
Italy 34 65
Netherlands 40 60
United Kingdom 57 43
Switzerland 25 75
Austria 17 83
Belgium 44 56
Denmark 37 63
Finland 50 50
Sweden 30 70

SOURCE: Organization for Economic Cooperation and Development.

Technology Transfer
The technology transfer policy itself is highly decentralized in Japan, both
in implementation and funding (Ergas, 1984b, p. 22). The core of
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this policy is the network of prefectural laboratories whose primary function is

to provide technical assistance in developing or adapting new technologies,
notably to small and medium-size firms. Central government finances haft the
laboratories' capital equipment costs, and regional authorities and firms
themselves provide the rest of the laboratories' income.
There are now 195 regional laboratories in Japan: The 47 prefectures
average four laboratories each, and each prefecture has at least one. Some
laboratories axe "problem-oriented" (for example, around textiles, food,
ceramics, paper, leather, metals) and are linked to the various regional
industries and located accordingly. The others (about 30 percent) are more
broadly based and multidisciplinary. Generally, they operate in three or four
complementary fields (e.g., mechanical engineering, metals, woodworking).
The 195 laboratories employ more than 5,000 research technicians and
engineers. They are connected with central government laboratories, which
provide high-level expertise and sophisticated equipment for R&D when
needed. Moreover, the staff of the prefectural laboratories are systematically
retrained by the central government to keep them abreast of the latest
developments in science and technology. However, the laboratories' activities
are determined mainly by their local clients.

Effectiveness
Given the degree of decentralization, notably in the implementation stage,
the overall effectiveness of the system has mainly been due to industry's strong
response to the opportunities signaled. In part, this response has reflected the
high legitimacy the economic bureaucracy enjoys in Japan, so that the advice it
provides is taken considerably more seriously by industry than is similar advice
in other countries. This legitimacy is reinforced by the fact that a consensus of
views with industry is reached well before policies are announced. However,
the strength of Japanese industry's response has also been due to a set of factors
that have increased the benefits and reduced the costs of exploiting new
opportunities.
The first, most obvious, and in some respects most pervasive of these
factors is the favorable macroeconomic context. An economy where savings
and investment are abundant and where consumer demand is rapidly increasing
and shifting to progressively higher-quality goods provides a supportive
framework for technological upgrading.
This macroeconomic environment reinforces a second factor contributing
to rapid adjustment, notably the low levels of social resistance to change. In
addition to steady growth in employment, resistance to change has also been
weakened by the lack of strong industry lobbying for declining manufacturing
sectors, by the assurances of retraining provided
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within the lifetime employment system of large firms, and by the "sunset"
policies adopted by the Ministry of International Trade Industry (MITI) to ease
the process of decline in industries—such as textiles, shipbuilding, or most
recently, aluminum—that have lost their competitiveness (Launer and Ochel,
1985). These factors have also made firms less reluctant to enter new areas,
since they know they will be able to withdraw if the opportunities prove
ephemeral.

The Role of Competition

A final factor accelerating the response to new opportunities is intense
rivalry between the large industrial groups. This rivalry--reflected in far-
reaching price competition, in investment "races," and in competition in R&D—
is accentuated by several features of the Japanese industrial environment.33
The rapid growth of demand--and the perception that growth will continue
—has made oligopolistic coordination difficult, while focusing firms' attention
on long-term market share rather than short-term profitability. The low cost of
funds has reinforced the tendency to take a long view in investment decisions,
notably by reducing the implicit discount rate for capital budgeting decisions.34
The strategy and structure of Japanese industry also tend to increase the
importance of first-mover advantages, so that once a new area emerges,
competition to be an early participant is intense (Kono, 1984). Although first-
mover advantages in the United States are probably concentrated in the mass
marketing stage, production cost factors appear to be more important in Japan.
Operating with a fairly fine division of labor relative to smaller enterprises, the
major Japanese firms specialize in large-scale fabrication and in mass assembly.
These operations are characterized by substantial static and especially dynanic
economies of scale. As a result, a large firm's unit costs are highly sensitive
both to the rated capacity of its plant and to accumulated production. Given
these characteristics, and especially in a rapidly growing market, the penalties
of late entry are likely to exceed the costs of building ahead of demand. Market
entry and capacity expansion therefore tend to occur quickly as firms seek
footholds in new areas of activity.35
These pressures are accelerated by each major firm's reliance on a
reasonably stable group of smaller suppliers (Imai and Itami, 1981). Unlike the
situation in the United States, a late entrant in Japan cannot reduce its costs by
acquiring a firm already established and experienced in the business. Moreover,
its competitive disadvantage can be aggravated by the fact that its more or less
fixed circle of suppliers will also lack experience
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in the new area. Entering a new market early provides an insurance that the firm
will not be severely handicapped should the market prove particularly promising.

Lifetime Employment
The lifetime employment system itself creates strong pressures for large
rums to enter emerging markets. Finns committed to lifetime employment seek
to diversify their portfolio of activities to cover different stages of the product
life cycle, so as to stabilize employment requirements over time. The search for
new areas of activities is likely to be a particularly high priority for younger
professional staff, given the impact it will have on their career prospects.
The lack of interfirm mobility of managerial staff (who constitute the bulk
of the personnel covered by the lifetime employment system),36 and the
consequent need to ensure a sufficient growth to keep internal planning
resources fully employed, creates insistent pressures for diversification.
However, since diversification must rely on internal expertise, it is largely
confined to areas related or similar to the firm's principal activity. Japanese
firms consequently tend to expand through related diversification, and the
growth of conglomerates is extremely rare (Imai et al., 1984; Nonaka et al.,
1983; Kono, 1984).
This creates a system that breeds on itself. The drive for related
diversification pushes firms' R&D efforts into adjacent areas. The fact that one
firm is seen to do this propels other firms to do the same. Particularly when the
technologies involved are generic, in the sense of spanning several product
fields, the degree of interfirm competition for footholds in emerging product
areas rapidly becomes intense (Suzuki, 1985). This increases the extent of
experimentation in the Japanese market, providing a competitive advantage to
the economy as a whole.

Interfirm Cooperation
The system involves a high degree of horizontal and vertical cooperation,
mainly within each family of firms. The dual structure of Japanese industry is of
obvious relevance in this respect. Three factors perpetuate this structure: the
problems inherent in a system without well-developed equity markets; the high
rigidities associated with internalizing activities into the larger firms, given the
lifetime employment system; and an abundant supply of entrepreneurs.
However, this structure could hardly survive without constant upgrading of
technological capabilities in the secondary sector. This need is mainly
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met by the direct technical assistance large firms supply to their smaller
subcontractors (Gönenç 1984; Gönenç and Lecler, 1982), but the decentralized
laboratory system discussed above also plays an important role, as do trade
associations and the standardization system, both originally modeled on
German lines.
Another important type of cooperation among firms occurs in the context
of precompetitive research, notably for the development of generic
technologies. These research efforts, in particular those promoted by MITI,
provide for investigatory research in the phases of R&D generating the highest
content of information in the "public good." They are to some extent a
substitute for university-industry links, which appear to be extremely weak in
Japan. Whether they are effective in this respect is the subject of considerable
controversy, but cooperative research does appear to have allowed Japanese
firms to resolve some of the critical bottlenecks confronting them in the
"generic technology" aspects of the industry they were entering: for example,
the production of cathode ray tubes for color television receivers (Dore, 1983;
Peck and Wilson, 1982).

Centralized Programs
These factors go a considerable way toward explaining the responsiveness
of Japanese firms to the signals emerging from Japan's largely decentralized
system of industrial planning. However, it would be foolish to deny that the
Japanese bureaucracy has at times engaged in highly directive and centralized
attempts to promote particular activities and that these attempts have involved a
considerable mobilization of resources.
Prominent examples are mainframe computers, central office
telecommunications equipment, aerospace, and the Japanese railway plant.
Policy in these areas has been similar to that in Europe, with the important
difference that a greater number of competing firms have been present in each
area. Despite this difference in policy design, the outcomes do not suggest a
high level of policy effectiveness: Japan's output of videotape recorders far
exceeds its production of computers; Japanese central office electronic
switching systems have not emerged as major competitors on world markets;
the Japanese bullet train is far less cost-effective than its French counterpart, the
Train à Grande Vitesse; and aerospace remains a weak point in the Japanese
industrial structure.

Overall Impact
Japan's policies have tended to be most successful when they combine
three features: consensus decision making on broad goals, decentralized
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implementation, and a reliance on the dynamics of competition to ensure a rapid

response. Sustained by good macroeconomic management, a steady increase in
human capital, and a willingness to adjust to change, this has proved to be a
formidable engine of growth.
In particular, it has allowed Japanese firms to modify their specialization in
international trade into progressively more technologically advanced product
areas (Boltho, 1975; Orléan, 1986). The striking feature of this shift is not only
its breadth but its depth: Like the diffusion-oriented countries, Japan's export
pattern is highly specialized, the bulk of net exports being concentrated on a
small number of comodities. Unlike the diffusion-oriented countries, however,
this pattern has shifted markedly over time, as the first wave of Japanese
exports (mainly textiles) was replaced by a second (steel, shipbuilding), a third
(automobiles), and now a fourth (electronics and machinery). Such drastic
changes in international specialization have inevitably entailed major
modifications in the structure of Japanese industry. The capacity of the Japanese
industrial structure to carry out such shifts is what sets it apart from the other
countries considered in this chapter.
However, this does not imply that what has proved successful until now
will remain so. Particular concern has been expressed in Japan about whether
the system for promoting innovation is resilient.37 The central question in this
respect is the system's continuing effectiveness once Japan arrives at the
technological frontier. It is presumably easier to set broad goals in the catching-
up stage of growth than in pushing beyond the state of the art. Moreover, the
skills needed to implement these goals differ. Up to now, Japan has not suffered
from the weakness of its scientific base, but it may prove vulnerable to a
blurring of the boundaries between pure and applied research.

SHIFTING AND DEEPENING: AN ATTEMPT AT SYNTHESIS

Directions for Research

In recent years, economists have made significant progress in analyzing
technological advance as an evolutionary process—that is, a process of
experimentation, selection, and diffusion.38 The work done provides a
convenient analytical structure for synthesizing the arguments presented above
and for examining their implications for overall economic performance.
A central concern of recent analyses has been the mechanisms by which
innovation shapes market structure, notably its impact on concentration and on
the extent of the barriers to potential competition. The assumption
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has been that this relation operates similarly from country to country; but the
data presented above suggest that this is not the case. Rather the material
reviewed suggests important differences between countries along three
dimensions:

• Who appropriates the gains from technological advantage? Is it the

innovating firm alone or is it the firm and a broader group (for
example, a firm's suppliers)?
• To what extent are these gains cumulative and sustainable over time?
Where does the process of skill accumulation occur--in the individual
firm, in the industry, or in the industrial structure as a whole?
• How much flexibility is there in responding to innovation? Does
flexibility occur through adjustment by existing firms or through shifts
in the firm population?

The material reviewed also suggests that differences in each of these

respects affect the evolution of each country's industrial structure. In essence,
this relation operates through the balance between two (not necessarily
alternative) ways of increasing the efficiency with which resources are used:
shifting, or transferring resources from old to new uses; and deepening, or
improving their productivity in existing uses.
The greater the mobility of technical, managerial, and financial resources,
the greater the contribution that shifting is likely to make to overall growth.
Conversely, the greater the extent to which assets are firm-or industry-specific,
the greater the importance of deepening to long-term competitiveness. This
relation can be highlighted by reexamining four of the countries in our sample;
these countries (the United States, France, Germany, and Japan) can be
considered to be roughly representative, given the similarities between the
United Kingdom and France, and between Switzerland, Sweden, and Germany.
A broad characterization of the four countries is given in Table 8, which
summarizes many elements of the discussion above and can be analyzed as
follows.
The United States can be considered paradigmatic of shifting. An
extremely large applied research system, operating at the frontiers of
technology, continuously generates potential new areas of commercial activity.
Adjustment to these opportunities occurs through competition between firms on
the open market for mobile technical and managerial skills and financial assets.
The ease with which these resources can be bid out of existing uses discourages
productivity-enhancing investments in skills and capabilities that are specific to
a particular firm or activity, as such investment can be justified only through
longer-term commitments. However, high mobility also ensures that entirely
new areas of endeavor are rapidly exploited, first in the domestic market and
then through world sales.
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TABLE 8 Technology Systems and Industrial Structures

Characteristic United France Germany Japan
of System States
Appropriation Firm State Finn and Industrial
industry group
Skill Labor Technocracy Industry and Large firm
accumulation market research system
Flexibility Mainly Determined Adaptation to High, but
by entry through the incremental major
and exit political change; low actors
system intersectoral remain the
flexibility same
Industrial roduct Dualism Inherited ''Moving
structure and cycle specialization clusters''
trade pattern
In France, the transfer of resources to new activities does occur, but largely
(though not solely) through major state-initiated programs aimed at both public
and private markets. The technical elite, which is a more or less integral part of
the state apparatus, is the essential repository of technological skills and plays
the key role in designing and implementing programs. However, the
concentration of power in this elite and the limited diffusion of skills and
capabilities outside its area of activity has two consequences. First, the
"shifting" is constrained to those pans of the economy directly affected by the
large public programs. Second, the rest of the economy lacks the resources (and
often the incentives) to "deepen" its competitive advantage.
Germany, in contrast, is paradigmatic of deepening. Skills and resources
are highly industry-specific, and their development follows paths largely
charted by the industries themselves. Relations between firms, between firms
and their employees, and between firms and the financial system have
traditionally included long-term' commitments favoring investments in activity-
specific capabilities. At the same time, high levels of education, industrial
standardization, and cooperative research provide powerful mechanisms for
diffusing capabilities throughout each industry, so that progress is made across
a broad front. The pattern of industrial capabilities is largely inherited, yet it is
constantly renewed by "doing what one has always done, but better."
The distinctive feature of Japan is the extent to which it combines shifting
with deepening. The key component is the large firm, closely linked to its main
sources of finance and surrounded by a network of smaller suppliers. The large
firm—and more generally the industrial group—seeks
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to maximize the productivity with which resources are employed in existing

uses. However, it also faces powerful incentives to shift its operations toward
emerging areas of activity, bringing the entire industrial structure in its wake.
Three factors are at work: first, the long-term nature of commitments permits
productivity-enhancing investments in firm-specific skills; second, the intensity
of competition between large firms encourages early entry into new markets;
third, each large firm, as it moves, seeks to shift its suppliers with it.

Implications for Overall Economic Performance

But between what does one shift, and along what does one deepen? And
what implications does the balance of shifting and deepening have for overall
economic performance?
The concept of a technological trajectory provides a helpful building block
in exploring these questions. A technological trajectory can be defined as a path
of technological development, drawing on a given set of basic scientific
principles and propelled by an internal dynamic of improving performance with
regard to a few key design criteria (Dosi, 1982; Nelson and Winter, 1982;
Rosenberg, 1976). At the risk of considerable simplification, evolution along
this path can be characterized as following an S-shaped curve (Figure 1):

• The emergence phase includes experimentation among alternative

design approaches, as attempts are made to identify approaches with
the greatest promise for subsequent developments.
• In the consolidation phase, the concentration of R&D on a few critical
parameters, within the framework of a broadly set design approach,
allows rapid improvement both in performance and in cost.
• The maturity phase occurs as the most easily exploited opportunities
have been fully used, while entirely new design approaches, possibly
based on an area of applied science different from that of the original
trajectory, emerge as substitutes in a growing range of uses.

The development of vacuum tube technology illustrates these processes

and their pattern of evolution over time (Baker, 1971; Maclaurin, 1949;
Sturmes, 1958). After a phase of open experimentation, Lee de Forest's triode
tube set an underlying structure for the workable amplification of small
electrical signal voltages. Subsequent progress in tube technology, though
yielding dramatic improvements in performance, concentrated on a few
variables, such as the energy efficiency of the cathode, tube life and reliability,
and automation of the manufacturing process. However, the development of
solid-state semiconductor technology beginning in the
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late 1940s dramatically cut across this path of improvement (Webbink, 1977).
Transistor-board devices rapidly established themselves as a more reliable and
space-saving alternative to the vacuum tube, with enormous potential for cost
reduction through progressively larger-scale integration and automated
manufacturing and testing.

Figure 1
Technological trajectories.

As the technology developed, so the structure of the industry changed. In

the early days of the vacuum robe industry, the field was open to competition.
With many differing approaches to tube design, manufacturing, and application,
overall profitability in the industry was probably low, since the small number of
"hits" was more than offset by high initial development costs and a large
number of "misses" (de Forest himself suffering repeated bankruptcies).
Profitability increased only after the basic technology had stabilized, and
patents and proprietary know-how blockaded entry, weakening price
competition, improving R&D focus, and allowing cost reduction as output
grew. The industry's consolidation phase was dominated by a tight-knit
oligopoly, including some of the largest, most technologically advanced firms
of its day: General Electric, West
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DOES TECHNOLOGY POLICY MATTER? 227

inghouse, RCA, and AT&T in the United States; Marconi, Siemens, and Philips
in Europe.
Large size and (for the time) huge R&D budgets did not allow these firms
to transfer their dominance to the emerging market for solid-state devices.
These drew on an applied science base quite different from that they had
mastered over the years. However, the vacuum tube industry did not disappear,
for four reasons: initial uncertainty about the capabilities of solid-state devices
slowed substitution, the emergence of solid-state competition encouraged
manufacturers to bring forward improvements in tubes, rapid growth occurred
in applications where there were no practicable substitutes for tubes (notably
television receivers), and new tubes were developed for applications requiring
frequencies unsuitable to solid-state technologies. Substantial opportunities
persisted in the industry 40 years after its technological base had been
superseded, but these opportunities relied on a progressively narrower and more
vulnerable base.
Three broad conclusions can be drawn from this account:

• The emergence of a technological trajectory is not usually associated

with high rates of return on investment, given large R&D costs, the
substantial risk of failure, and the intensity of competition.
• It is in the consolidation phase that the greatest improvements are made
in product cost and performance and the largest scope exists for
supranormal profits.
• As improvements in critical parameters become more difficult to
achieve, the maturity phase creates new challenges for the industry,
with the development of substitute products intensifying competition
and increasing the importance of capturing the least vulnerable niches.

Clearly these. conclusions do not have the force of laws, nor can one
indiscriminately generalize from the level of individual industries to that of
national industrial structures.39 Nonetheless, they suggest several hypotheses of
interest:

• The performance of an industrial structure specializing in the emerging

phase is likely to depend first on its capacity to experiment on a broad
front, thus increasing the .probability of success. ,am important factor
in this respect is proximity to a pool of sophisticated customers, who
can rapidly distinguish promising from less promising alternatives.
Second, performance will depend on the extent to which the industrial
structure can carry successes over from the emergence to the
consolidation phase. However, there is no a priori reason to expect
such an industrial structure to show a high rate of growth of real
incomes or productivity, at least as conventionally measured (Ergas,
1979).
• Conversely, an industrial structure specializing in the consolidation
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DOES TECHNOLOGY POLICY MATTER? 228

phase can expect to capture substantial gains in productivity and per

capita income. Whether these gains will persist, however, depends on
the capacity of the industrial structure (a) to exploit the results of
successive emergence phases without having fully borne their costs,
and (b) to transfer resources from one technological trajectory to
another as the maturity phase sets in.
• To succeed, an industrial structure pursuing technological trajectories
into the maturity stage will require high levels of efficiency both in
R&D and in applications engineering, allowing it (a) to obtain a
maximum of performance improvements out of a given path of
development, thus slowing the substitution process, and (b) to retain
profitability by specializing in the product segments least vulnerable to
intensified competition. Nonetheless, it may be supposed that the long-
term performance of such an industrial structure will be constrained by
the gradual slowing of market growth and the decreasing number of
technological opportunities.

These hypotheses merge naturally with the country analysis presented

below.
Thus, the predominance of "shifting" behavior in the U.S. economy
corresponds to specialization in the emergence phase of technological
trajectories. The returns to this pattern of specialization are maximized by (a)
the scale on which experimentation occurs, increasing the probability of
success; (b) the sophistication of the U.S. market (including its public
procurement component), which accelerates the process of selection among
competing alternatives; (e) the rapidity with which breakthroughs in the
noncommercial parts of the technological system diffuse into the sphere of
commercial experimentation; and (d) the existence of a substantial pool of large
U.S. firms capable of transferring the results of experimentation in the U.S.
market into world sales.
However, the inherent characteristics of this phase of technological
evolution limit the rate of growth of per capita incomes to which it can give
rise. These limits have been accentuated by the declining competitiveness of
U.S. sites (though less so of U.S. firms) in the mass production operations
characteristic of the consolidation phase.
The "imperfect shifting" that is sometimes considered a major feature of
France's technological system limits the returns obtained from concentrating on
the emergence stage of technological trajectories. High levels of investment in
R&D are incurred to establish a presence in this stage, although the scale of
experimentation may still be too small to achieve a reasonable chance of
success across the board. Even when successful outcomes are obtained,
numerous factors slow their transfer from the
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DOES TECHNOLOGY POLICY MATTER? 229

mission-oriented environment to that of commercial exploitation and hence the

prospects for going from emergence to consolidation.
The growth of French incomes has therefore depended heavily on sectors
such as motor vehicles, tires, and food processing, which are outside of— and
only weakly linked to—the core technological system. However, performance
in these sectors has proved difficult to sustain. This is partly because the decline
of traditional industries and the implicit protection accorded high-technology
activities has forced other sectors to bear a disproportionate share of
unfavorable macroeconomic developments.
At the other extreme, the deepening processes characteristic of Germany's
industrial structure are associated with far-reaching specialization in pursuing
technological trajectories into their mature phases. An institutional framework
that is, in many respects, uniquely suited to this pattern has allowed German
industry to exploit fully the higher value-added segments of the markets in
which it operates. The experience of the last decades, however, has highlighted
some of the risks this pattern of specialization entails. In particular, it creates
vulnerability on two fronts:

• Up-market, from competitors operating in the same product markets,

but exploiting new technological trajectories as they enter the
consolidation phase. These competitors are well placed to provide
rapid rates of increase in cost-to-performance ratios—as Japanese
firms have done in numerically controlled machine tools; and
• Down-market, from competitors whose technological capabilities may
lag, but whose factor costs are substantially lower.

The slowing of total factor productivity growth as technological

opportunities along the original trajectory diminish, combined with the
rationalization pressures arising from greater rivalry on world markets, could
make rising living standards more difficult to achieve. This could endanger the
high degree of social consensus that underpins the diffusion-oriented countries'
industrial model.
Between these extremes of shifting among emerging trajectories and
deepening along mature trajectories, Japan has been extraordinarily successful
in exploiting successive trajectories in their consolidation phase. Concentration
on this phase has provided numerous advantages to Japanese firms:

• By avoiding the stage of greatest technological and commercial

uncertainty, the return on scarce R&D capabilities could be maximized.
• Entering activities at the consolidation (rather than emergence) stage
also minimized the importance of close proximity to sophisticated users
—until recently a major constraint on Japanese competitiveness.
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DOES TECHNOLOGY POLICY MATTER? 230

• Greatest benefit could be drawn from accumulated skills in managing

large-scale fabrication and assembly processes and from the cost-
reducing pressures of competition for a growing market.

Rapid growth of real income has been achieved by exploiting these

advantages. At the same time, Japanese firms' share of world markets has
increased at the expense of firms more specialized in the emergence or maturity
stages of technological development. This pattern of specialization has relied on
a high degree of social consensus, which has made it possible to shift resources
rapidly from one trajectory to another. It has also relied on:

• an elaborate network for gathering information from abroad about

emerging technologies;
• the low-cost availability of the results of U.S. R&D on entirely new
technologies; and
• access to world markets in which to achieve economies of scale.

These premises now appear vulnerable in several respects. Access to U.S.

technology is not as easy as it once was, mainly because U.S. firms now
consider Japanese firms as major rivals. Moreover, Japanese technological
performance has passed the stage at which large improvements could be
obtained simply by learning from overseas. Finally, access to world markets is
threatened by the spread of protectionist measures. Nonetheless, the capacity of
Japanese industry to meet these threats should not be underestimated, Japanese
R&D capabilities are now more than sufficient to engage in highly advanced
research, the Japanese domestic market is large and sophisticated enough to
provide a good seedbed for experimentation, and Japanese firms have
established the global brand image and distribution channels needed to sell a
more diversified range of products internationally.
This discussion suggests that there are different paths to happiness, as
countries' institutional structures and social arrangements facilitate
specialization in differing stages of technological evolution (see Figure 2). Each
of these stages has advantages and disadvantages in providing for the growth of
real income, but countries also differ in the extent to which they succeed in
securing the greatest benefits from any given pattern of specialization.
Over the longer term, these differences in R&D efficiency may be most
important. Consider France and Germany: The French state has encouraged
specialization in the emergence phase of technologies, whereas German
industry has largely retained its traditional pattern of specialization. However,
the disparities in performance among these countries arise less from this
difference in specialization than from the efficiency with which the
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DOES TECHNOLOGY POLICY MATTER? 231

potential economic gains implicit in each pattern of specialization are exploited.

In other words, location on a technological trajectory may be less important
than the efficiency with which the advantages of that location are pursued. This,
in turn, depends on institutional features (broadly defined) that may be more or
less appropriate for a given pattern of specialization.

Figure 2
National strengths along technological trajectories.

It is by no means obvious that the institutional features typical of one

economy can be transplanted to another. But a few general factors underlie the
differing outcomes countries obtain from similar patterns of specialization. It is
to these factors and particularly their implications for policy that we now turn.

POLICY IMPLICATIONS
The dominant feature of national technological systems is diversity. This
partly reflects differences in policy stance between countries, but many other
factors are also at work. Examination of these factors suggests several
conclusions relating to the scope and limits of technological policy.
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DOES TECHNOLOGY POLICY MATTER? 232

The first and most fundamental is the dependence of technology policy

outcomes on their economic and institutional environment. The policies pursued
in the United Kingdom or France do not differ greatly from those of the United
States, but the outcomes do. The masons for this lie partly in the details of
policy design and in the manner in which policies are implemented. But deeper
and more pervasive factors are of far greater significance.
In pan, the U.S. advantage arises from the very size of its scientific and
technological system. This ensures that mission-oriented research crowds out
commercial R&D to only a limited extent and that there is a huge stock of firms
and individuals capable of absorbing and commercializing the results of
mission-oriented research. But this advantage of size is accentuated by other
features of the U.S. system.
In particular, new technological capabilities spread rapidly in the U.S.
economy, both through the direct transmission of ideas—for example, between
industry and university—and through the high mobility of technologically
skilled personnel. Moreover, lower entry barriers into U.S. industry, combined
with pressures for firms to be among the early entrants into new product
markets, accelerate the transformation of technological advances into
commercial innovations.
In France, by contrast, several factors slow the transfer of the technological
advances generated by mission-oriented research into the commercial sector.
These include the paucity of contacts between universities and industries, the
low mobility of scientists and engineers, the pervasive obstacles to the entry of
new firms, and the protective atmosphere of government procurement in which
larger firms prefer to remain.40 Those differences mean that in the United States
the results of government-supported R&D diffuse quickly into the commercial
sector of the economy, but in France, and even more so the United Kingdom,
they remain more or less confined to their sector of origin.

The Importance of Diffusion

This suggests a second conclusion, which is that the key problem of
technology policy (as distinguished from science policy) lies less in generating
new ideas than in ensuring that they are effectively used. The "high-technology
industries," however defined, are inevitably a small pan of total output; taken on
its own, even predominance in these industries will have a limited impact on
living standards (Nelson, 1984; Riche et al., 1983). Rather, long-term growth
mainly depends on the capacity to deploy technical capabilities across a broad
range of economic activities.
This goal can be achieved in various ways. In the United States, the
diffusion of technology is largely a market-driven process, which relies
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DOES TECHNOLOGY POLICY MATTER? 233

on high levels of mobility of human and financial resources and the existence of
a marketplace of ideas. In Germany and Switzerland, in contrast, organized
social mechanisms for promoting technology diffusion play a more important
role—these include the apprenticeship system, the system of industrial
standardization, and the network of cooperative research.
Seen purely in institutional terms, these experiences are not easily
transferable among countries. Japan borrowed heavily from overseas in
designing its institutional framework, but at an early stage of industrial
development. It is questionable whether policymakers in the United Kingdom
or France could quickly set up processes of industrywide technological
cooperation akin to those that developed over a long period of time in the
German-speaking countries. The institutional mechanisms for technology
diffusion must inevitably reflect broader features of a country's economic,
social, and even political environment. However, there are common elements to
the countries with a record of success in technology diffusion. These elements
can provide a useful indication for technology policy.. Three such elements
emerge from this study.

Investment in Human Capital

The first element in the successful diffusion of technology is the role of
investment in human capital. This investment has both a flow and a stock
dimension. The flow of newly trained personnel into the active population
allows the continuous upgrading of skills and capabilities. At the same time, the
better educated the labor force is, the greater will be its capacity to adjust to
sophisticated new techniques. Higher levels of education are also likely to make
this capacity more widespread, both throughout industry and throughout the
active population.
Countries whose investment in human capital lacks depth or breadth may
be among the pioneers in generating new technologies, given a sufficiently
strong scientific elite. But as far as using these technologies is concerned, they
will be disadvantaged on two counts: an inadquate rate of expansion or
replacement of the skill base at the margin and difficulties in adjusting the
existing stock to the demands of technological change. Moreover, their
difficulties are likely to persist or even mount. The production of human capital
is highly intensive in human capital, and the lags involved in correcting
deficiencies in the human capital stock can be extremely long (Sandberg, 1979).

Policy Decentralization
A second factor in promoting diffusion relates to the design of technology
policies. Whether those policies actually promote the best use of tech
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DOES TECHNOLOGY POLICY MATTER? 234

nological advance appears to be closely related to the range of actors they

involve--that is, to their degree of decentralization.
This, it can be conjectured, occurs for three reasons. First, centralized
programs frequently concentrate resources on the wrong areas. In both the
United Kingdom and France, for example, excessive resources have been
devoted to projects that are technologically glamorous but not economically
relevant. Second, the concentration of resources on a small number of projects
itself increases the risk of costly failures, particularly when each project being
supported entails a high level of risk. Finally, even if successful in terms of their
mediate objectives, large, centralized projects usually pose considerable
problems of technology transfer once the R&D phase is completed.
Program decentralization can be achieved in different ways. In the United
States, the very scale of the defense R&D program is such that a fairly high
level of dispersion of funds is almost inevitable, but conscious policy choices—
such as the emphasis on second-sourcing and the support of R&D by new and
small firms—are also significant. In Germany, Switzerland, and, to a lesser
extent, Sweden, the delegation of policy-setting and implementation functions
to industry associations and regional bodies averts the risks inherent in
centralized, bureaucratic decision making. The Japanese emphasis on consensus
probably plays a similar role.
But abstracting from these differences, similarities emerge. The risks of
placing too many eggs in one basket (and choosing the wrong basket at that)
can be reduced by making support policy less discriminatory in the range of
firms and sectors covered and by placing less emphasis on discretionary
choices among alternative approaches. This implies a preference for measures
with a high degree of automaticity—for example, tax expenditures. It also
implies preference for the delegation of power and public support to broadly
based rather than narrowly based groups—for example, to an industry or
research association as a whole rather than a formal ''club'' of subsidy receivers.
Traditionally, the major argument against nondiscretionary policies is that
funds may be provided to firms for projects that would have been carried out in
any case. Equally, the case against decentralizing decision making rests on the
risk that support programs will be "captured" by organized interest groups who
will abuse them to advance narrow sectional concerns. However, experience
suggests that the risks of capture are greatest when decisions are highly
centralized, since this usually leads to a symbiotic relationship between a small
number of policymakers and a few large firms. Experience suggests further that
it is in this situation that public support is most likely to become a permanent
feature of the cash flow of a narrow range of privileged firms (Bauer and
Cohen, 1981; Cawson et al, 1985; Cohen and Bauer, 1985; Young and Lowe,
1974).
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DOES TECHNOLOGY POLICY MATTER? 235

Providing Incentives
Even an improved policy framework need not lead to better performance
of the incentives to make the best use of technological resources are too weak.
At a most obvious level, this is a problem of ensuring that firms are exposed to
competition so that ideas are quickly transferred from the research environment
to that of commercial use.
The problem of providing adequate incentives merits particular attention in
three areas: public research laboratories and other nonprofit research
institutions, publicly funded commercial R&D, and public procurement. The
first of these areas should include scope—notably in the United Kingdom and
France—both for reducing the share of public laboratories in government R&D
expenditure and for shifting a greater part of their recurrent funding onto a
matching grant basis. In the second area, opportunities should be explored for
building incentives for success into the system of public support for commercial
R&D—for example, by making access to continuing finance more clearly
conditional on past performance. The third area, public procurement—notably
of complex technological systems—too often serves to subsidize long-term
inefficiency rather than to encourage the best use of resources and capabilities.
Dismantling these protective devices could impose short-term costs, but these
are likely to be small in relation to the longer-term benefits.
In summary, it is true that the institutional framework of any one country
cannot be mechanically transplanted to others. Nonetheless, comparative
analysis suggests three priority areas for action:

• easing constraints and rigidities that slow the diffusion of new skills
and technical capabilities;
• improving the human capital base while enhancing the efficiency of
markets for highly trained personnel; and
• increasing the extent to which technology policy relies on market
signals and incentives, rather than on the administrative allocation of
resources.

ACKNOWLEDGMENTS
The author thanks Bruce Guile of the National Academy of Engineering;
Rolf Piekarz of the National Science Foundation; Professor David Encaoua, of
the Direction de la Prevision, Ministére de l'Economie, des Finances, et de la
Privatisation; Christian Sautter, Inspectcur Général des Finance; and P. D.
Henderson, H. Fest, J. Sharer, D. Baldes, and many other colleagues at the
Organization for Economic Cooperation and Development for their valuable
comments on earlier drafts of this paper. Special thanks are also given to the
author's colleagues Rauf Gönenç, Andreas Lindner,
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DOES TECHNOLOGY POLICY MATTER? 236

Anders Reutersward, and Barrie Stevens for generously providing data and
advice. However, the author wishes to stress that unless otherwise indicated, the
views expressed in tiffs paper are attributable only to the author in a personal
capacity and not to any institution.

NOTES

1. See especially Rosenberg and Birdzell, 1986. Nove, 1983, provides an interesting
comparison by the relatively sympathetic description of the functioning of a socialist economy
and of its difficulty in innovating.
2. This is a key component of the classic "market failure" argument for public support for R&D.
See Antonelli, 1982; Freeman, 1974; Kamien and Schwartz, 1982; Mowery, 1983a; Rothwell
and Zegveld, 1981.
3. This description of the United Kingdom draws on Carter, 1981; Dickson, 1983; Hall, 1980;
Henderson, 1977; Hogwood and Peters, 1985; Vernon, 1974; Young and Lowe, 1974.
4. This description of France draws on Bauer and Cohen, 1981; Cawson et al., 1985; Cohen and
Bauer, 1985; Dupuy and Thoenig, 1983; Grjebine, 1983; Shonfield, 1965; Stoffaes, 1984;
Vernon, 1974.
5. See especially Ponssard and Pouvoirville, 1982. The high concentration levels of overall
transfers from the state to industry (including public procurement) are discussed in Centre
d'Economie Industrielle, n.d., and Commissariat Général du Plan, 1979.
6. On telecommunications see Cohen and Bauer, 1985; Darmon, 1985; Ergas, 1983b; Peterson
and Comes, 1985. On energy, see specifically Feigenbaum, 1985; Picard et al., 1985.
7. This discussion of the United States draws on Fox, 1974; Gansler, 1980; Nelson, 1982, 1984;
Phillips, 1971; Research & planning Institute, Inc., 1980.
8. Thus, Scherer (1982) estimates that in the United States only 12 percent of 1974 defense
R&D funding generated technologies that flowed directly to clearly nondefense uses.
9. Secondary effects are examined by, among others, Ettlie, 1982; Hers, 1977; Malerba, 1985;
Rothwell and Zegveld, 1981; Scribberas et al., 1978; Teubal and Steinmueller, 1982. An
interesting international comparison of secondary effects can be obtained by contrasting U.K.
and U.S. surveys of the effects on defense funding on national semiconductor industries:
Dickson, 1983; Mowery, 1983b.
10. The role of U.S. government funding in the growth of small firms is discussed in Bollinger
et al., 1983; Research & Planning Institute, Inc., 1980. A survey is given in Ergas, 1984b.
Defense funding of university research and its growing importance is discussed in National
Science Board, 1986, chap. 2.
11. Compare Katz and Phillips, 1982, and Lavington, 1980.
12. See especially Freeman, 1971; Freeman, 1976; National Science Foundation, 1985.
Compare with Wilson, 1980.
13. Compare National Science Board, 1986, p. 86 and appendix table 4-17; Le Monde, 6
February 1986.
14. See Ergas, 1984b, pp. 10-11. A fascinating case study is National Academy of Engineering,
1982. The role of scale economics in intensifying rivalry in the transition to mass production is
dearly brought out by recent literature on strategic competition. See, for an excellent survey,
Kreps and Spence, 1985.
15. See especially Schmalensee, 1982. Advertising-related product differentiation also
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DOES TECHNOLOGY POLICY MATTER? 237

appears to be a particularly significant factor explaining persistent profitability in U.S. industry.

See Geroski, 1985; Mueller, 1985.
16. Aspects of this pattern are highlighted in Prais, 1981. Robson et al. (1985) examine the
diffusion of technology in the United Kingdom. See also the analysis of the United Kingdom's
trade structure in Orléan, 1986.
17. See, in addition to the references in note 4 above, analyses of France's trade patterns
presented in Lafay, 1985; Orléan, 1986; Vellas, 1981.
18. The results of Lipsey and Kravis, 1985, conflict with those of Dunning and Pearce, 1985,
who find a sharper decline in U.S. firms' overall share of revenues and profitability.
19. The classic formulation of this process is Vernon, 1966. For empirical analysis of U.S. trade
patterns, see inter alia the contrasting results set out in Hatzichronoglou, 1986; Lafay, 1985;
Learner, 1984; Vernon, 1979.
20. The general characteristics of these countries are explored in Katzenstein, 1985a and 1985b.
21. On Germany and Switzerland, see Henderson, 1975; Milward and Saul, 1977. On
Scandinavia, see Hecksher, 1984; Hildebrand, 1978.
22. The general characteristics of these educational systems, and international comparisons, are
set out in Stevens, 1986. See also Organization for Economic Cooperation and Development,
1979; Prais and Wagner, 1983a and 1983b; Worswick, 1985.
23. A recent survey reports that in Germany 45 percent of labor force participants with
vocational training at a high school level undertook continuing training during the period
1974-1979.
24. According to population census estimates, some 50 percent of the civilian labor force in
Germany and Switzerland has completed an apprenticeship. See Organization for Economic
Cooperation and Development, 1986.
25. The classic study is Brady, 1934.
26. Estimates are provided in Laboratorio di Politica Industriale, 1982. The literature on
standardization is reviewed in Ergas, 1984b.
27. I am indebted to my colleagues in the Science, Technology and Industry Directorate of the
Organization for Economic Cooperation and Development for assisting me in compiling the
information presented here.
28. See especially Meyer-Krahmer et al., 1983. My colleague Andreas Lindner provided me
with particularly useful information on the subjects discussed in this section.
29. See George and Ward, 1975; Prais, 1981; Pratten, 1976. Particularly useful case studies are
Aylen, 1982; Daly and Jones, 1980.
30. This discussion draws on Aglietta and Boyer, 1983; Learner, 1984; Ohlsson, 1980; Orléan,
1986. A particularly useful discussion of the balance between shifting resources among
competing uses, as against increasing their productivity in existing uses, is in Carlsson, 1980.
31. It has been estimated that Japanese firms' total expenditure on vocational education is 5
times greater than public expenditure on vocational education.
32. See especially Collins, 1981, 1982; Saxonhouse, 1984; Uena, 1977.
33. See Caves and Uekasa, 1976. On price competition, see Encaoua et al., 1983.
34. A theoretical model in which collusion is less stable in a growing than in a declining market
is set out in Rotemberg and Saloner, 1984. Estimates of the cost of funds arc given in Ando and
Auerbach, 1986.
35. Thus, in the United States, the number of large takeovers (valued at $100 million or
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DOES TECHNOLOGY POLICY MATTER? 238

more) has increased steadily over the last decade, rising from 14 in 1975 to 116 in 1982; in
Japan, in contrast, the number of large transfers (exceeding $50 million) has been virtually
constant, with only 10 such transfers occurring in 1981. See Organization for Economic
Cooperation and Development, 1984b.
36. See Tachibanki, 1984, who estimates that lifetime employment applies to no more than 10
percent of the Japanese labor force, almost entirely at higher levels of educational attainment.
37. On the blurring of frontiers between basic and applied research, see Committee on Science,
Engineering, and Public Policy, 1983; on its implications for Japan, and concern about the
future, see Sciences and Technology Agency (Japan), 1985.
38. Useful overviews are in Antonelli, 1982; Bollinger et al., 1983; Dosi, 1982; Kamien and
Schwartz, 1982.
39. Some of the caveats in this respect are set out in Ergas, 1983a. See also Clark, 1985.
40. The fact that France and, to a lesser extent, the United Kingdom have lagged in applying
competition policy to their respective national industries has also presumably been a factor
reducing the pressure on firms to innovate.

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National and Corporate Technology

Strategies in an Interdependent World
Economy

LEWIS M. BRANSCOMB
The broad public perception that important conflicts occur between the
sovereignty of nations and the business interests of transnational corporations
can be illustrated by a lecture given a quarter century ago by Tony Wedgewood
Benn—first U.K. Minister of Technology. Speaking at the British Embassy in
Washington, D.C., he introduced the idea that Her Majesty's government should
appoint ambassadors to the largest multinational companies—on the grounds
that the companies' gross revenues exceed the gross national product of many
small countries and that their policies had more impact on U.K. interests than
did those of small states.
In introducing the metaphor of foreign relations as a means for dealing
with significant external forces with which one must cope, Mr. Benn was
reflecting the presumption of most governments that multinational operations in
their countries pose a threat that has to be defended against, rather than an
opportunity that coúld be exploited to the countries' advantage. Either. way, of
course, foreign ministries are clearly not the most competent instruments of
government to deal with technological issues.
In his modest proposal Mr. Benn also caricatured the notion of
sovereignty, which, of course, refers to the authority vested in a nation-state to
exercise control over its own territories. His humor anticipated a certain mount
of political agitation that exists today over these conflicts. In fact, however,
when analyzed more closely, the fundamental interests of nations and
corporations are surprisingly similar. And learning together to balance national
activities and international dependencies is the key to relieving
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current stresses and to achieving both parties' long-term economic and social
interests.

THE DIFFERENT RESPONSIBILITIES OF GOVERNMENTS

AND CORPORATIONS
During the nineteenth century, great mercantile firms such as the British
East India Company—with either tacit or explicit support from their
governments—did indeed challenge sovereign authority in many parts of the
globe. During the declining phases of colonialism in that century, news stories
persisted of banana companies, such as United Fruit, manipulating corruptible
Central American governments. This experience of many developing countries
emerging from their colonial past still colors national attitudes today. It makes
such governments hypersensitive to maintaining their sovereignty unsullied by
either military or economic challenge.
Very few matters of current corporate interest in industrialized
democracies result in direct confrontational challenges to sovereignty by
companies. When the governments of India, Nigeria, or Indonesia decide to
adopt policies that IBM believes reduce its prospects of success below
acceptable levels, the company does not hire mercenaries; it leaves the country
or changes the way it does business. Though direct corporate challenges to
national sovereignty are disappearing, there is, it seems, a concomitant growth
in the ways in which an increasingly global economy impinges on sovereignty.
At the heart of the friction between interdependent nations and
corporations is a simple truth: Although neither companies nor nations are
absolute masters of their fate, companies have a great adaptive advantage in
their ability to redefine their commitments in response to opportunity or to
changes in their political environment. Governments' responsibilities, on the
other hand, are less flexible. Governments are responsible to and for individuals
living within their national borders, are directed by a constitution or set of
political norms that specify relatively inflexible commitments, and are both
burdened and inspired by the blood, suffering, and heroic myths invested in the
defense of their physical boundaries.
The issue of interest, therefore, is not companies challenging sovereignty,
but a more complex question of synergy or conflict between the interests of two
types of global organizations. Both nations and companies have interests that
cross physical borders, but nations are committed to a particular piece of
geographic "turf" and companies are not. The complexity of interaction between
these two types of organizations is rising fast for both political and
technological reasons.
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Technology diffuses faster and further than ever before, and most of the
effective transfer of technology is planned and accomplished by corporations.
However, no nation can leave the acquisition of technological capability to
chance. Governments not only engage in the direct promotion of technology but
increasingly seek to influence the strategies of enterprises. They have a keen
interest in the success of technology-promotion activities, even when prospects
for success are low, but businesses are unlikely to invest if success is unlikely,
unless the potential rewards are commensurate. Companies choose their own
strategies to match expectations of market opportunity to investment risk, while
accommodating the policies of governments in each country where they choose
to do business.
The current situation in the People's Republic of China (PRC) is a good
illustration of these issues, because a unique high-risk/high-reward situation
exists there for both the government and foreign business. Businesses starting
joint ventures in China may be pessimistic about their likely commercial
success, but the potential markets are so huge that, in the long run, even a small
chance of success warrants a considerable effort and investment. The PRC's
need to master certain key technologies also creates a high-risk/high-reward
situation, in that the importance of the technology may warrant considerable
political risk in trying to acquire it through joint ventures with foreign firms,
even when this might give a particular firm undesired market power in the
country or lead to unwanted foreign political or cultural influences. As
illustrated by the next section, trade-offs are less clear in other situations.

GOVERNMENTAL POLICIES, AFFECTING TECHNOLOGY

Just as tolerance for risk and expectations for success are sometimes
perceived differently by businesses and political bodies, motivations also may
differ greatly. Trade policy and national security concerns dominate U.S.
government interest in corporate technology strategy. The expansion of federal
R&D investment is now largely in defense. Encouraging friendly governments
to participate in the Strategic Defense Initiative (SDI) coexists uneasily in the
U.S. technology policy agenda with export controls on technology and access to
foreign markets for U.S. "high-tech" companies.
At the same time, both in the United States and abroad, there is concern
that the country not become dependent for strategic goods on a supplier in a
foreign nation that might not be reliable under certain future political
conditions. All countries naturally feel the need to preserve political control
over their defense industrial base, because future alignments of their suppliers
of key components for military purposes are unpredictable.
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In the case of SDI, the United States invites European participation to

encourage political support for the program in return for a certain amount of
technology sharing. But, on the other hand, the U.S. government does not want
to increase the chances of leakage of the militarily relevant pieces of the
technology to the Eastern Bloc. Reducing budgetary costs through cost sharing
is also an important motivation, but the effort is to achieve the maximum
amount of cost sharing and political solidarity behind SDI without sharing more
technology than is absolutely necessary.
Many Europeans, for their part, fear that failure to participate in SDI might
disadvantage their economies if the SDI technologies turn out to stimulate U.S.
commercial competitiveness. They harbor the suspicion that U.S. reticence to
share fully is based at least as much on reluctance to accept European industrial
parity as it is on fear that technology will leak to the Soviets.
The same considerations are apparently operating in negotiations over
European and Japanese cost sharing and cooperation in the Space Station
program. Here again the U.S. objective appears to be to achieve a foreign
financial contribution without sharing any more critical technology than is
necessary. Expectations at present appear unrealistic in this regard.
Japanese policy, on the other hand, is focused on industrial
competitiveness in export markets as the primary strategy for dealing with
Japan's dependence on imported food, energy, and raw materials. Industry has a
strong voice in the government's technology strategy, and government concerts
industry action in the export arena, leaving domestic competition largely free of
government direction.
In Europe there is superposed on each country's national policy a regional
attempt to gain the benefits of European economic integration without paying
the political and cultural penalty of more extensively shared sovereignty. The
success of U.S. and Japanese firms in the strategic high-tech industries and
concern about European competitiveness are motivating a variety of national
and European government programs to encourage collaboration among firms
and universities in research of strategic commercial importance. The extent to
which national companies and the national subsidiaries of transnational
enterprises seek—and are allowed—to participate in these programs provides
an interesting test of the compatibility of corporate and governmental
technology policies.
The People's Republic of China offers a particularly interesting example
because public policy for technology promotion is in such a rapid state of
change. The liberalized economic policy of the current government seeks to
leverage foreign-owned technology through encouraging foreign investment
under negotiated terms and thereby attain technological self-sufficiency as
quickly as possible. Corporate and national strategies for
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technology mastery by indigenous Chinese enterprises are explicit and often

central elements in that negotiation.
A final example is Brazil, which follows a mixed strategy, centrally
directed, to encourage foreign investment in selected areas and reserve the large
domestic market in others. This market-reservation policy is pursued with
considerable tenacity, even to the point of refusing permission to foreign firms
willing to export from Brazil the majority of their manufactured output. The
conflict between the interests of firms and the policies of government is highly
visible in this situation, since there is such deep disagreement on the
effectiveness—and risk—of this strategy for technical development.
It seems clear that Brazil is trying to use the protected, elevated price
structure derived from reservation of its domestic market to finance learning-by-
doing in technology, regarded as key to the country's economic future. The
government believes this will produce the most rapid feasible achievement of
self-sufficiency in technology. In effect, domestic customers are being asked to
subsidize the self-education of local technologists, without the stimulation of
external competition.
The underlying assumption is apparently that this costly learning-by-doing
will be more effective in the long run than assimilation of foreign technology
through joint ventures and foreign direct investment. This strategy contrasts
with that of the PRC, which apparently believes that more rapid technology
transfer through carefully controlled foreign investment more than offsets the
risk that technology assimilation by this mechanism will be superficial and
ineffective.
These examples illustrate the diverse motivations and approaches to
technology policy around the world. In each country, the national enterprises
seek the support of their government while seeking freedom of action within its
policies. But, in most cases, conflicts of interest between transnational
companies and the central government do not turn on challenges to the
sovereign authority of government. Rather, they hinge on the straggle for
domestic political consensus on economic and industrial policy and debates
about sharing those policies with other nations. Therefore, the following
discussion focuses on the subsidiaries of transnational companies and their
relations with host governments and national enterprises.
Although the interests of governments and transnational corporations
differ, it should be noted that they share many—indeed most—objectives in
common. Companies are often eager to invest in building high-tech capability
in countries where local markets are accessible and need local support
capabilities. Political leaders in such countries are often equally cage: to
accelerate technological development in the search for new jobs
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and productivity and to ease industrial readjustment. In many countries the

subsidiaries of transnationals enjoy a special relationship with government close
to that enjoyed by domestically based transnationals, even to the extent of
substantial participation in joint ventures, government-funded enterprises, and
sales to government agencies.
The IBM Corporation's experience in Europe and in Japan has been very
positive, despite occasionally publicized controversies. IBM Japan is a wholly
owned subsidiary of IBM, dating back to the 1930s, which participates
effectively in Japanese and Asian markets, making a substantial positive
contribution to Japanese exports to Asia and South America. IBM Italy is
officially designated a national Italian company because of its contributions to
the country's employment, economy, and development of science, technology,
and professional skills.

SOURCES OF CONFLICT
Given this synergy of interest, why do the inevitable divergences in
technology policies of governments and transnational business attract so much
attention and occasionally cause so much friction? Conflict between the
interests of transnational companies and those of national governments arises
from several chief sources. First, transnational companies are sometimes better
positioned to take advantage of policies for enhancing regional competitiveness
than are national companies. When the European Economic Community (EEC)
sought to integrate the European economies, firms such as IBM had little
difficulty organizing their businesses to take advantage of the special strengths
of each country, avoid needless duplication, and serve the entire market with a
product line of minimum national diversity. IBM's success demonstrates the
effectiveness of the EEC strategy, provided there are private firms willing and
able to take advantage of it.
Transnationals based in Europe have been much slower to find those
advantages, which are equally available to all. Indeed, in 1970 three
governments urged three of their domestically based multinationals— Siemens,
CII-Honeywell-Bull, and Philip—to organize a joint marketing venture called
Unidata to aggregate a Europewide market for their computers. It soon fell apart
when the Dutch withdrew and the French consortium encountered hard times.
Commercial marriages made through political efforts are vulnerable to failure if
the natural forces of business motivation are weak or absent.
A second source of conflict is the inevitable political perception that any
strategy that increases economic dependence on foreign enterprises and their
governments necessarily reflects a diminution of control over
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the nation's destiny. There are plenty of signs of increasing U.S. sensitivity to
dependence on foreign suppliers. Indeed, the defense market in the United
States has tended to remain a highly protected market through buy-American
laws and other policy interventions to ensure that U.S. military capability is
based primarily on a domestic industrial base, even at high incremental cost.
This is especially evident, for example, in shipbuilding.
Overall, however, Americans are still much less sensitive to the political
burden of an ever-increasing dependence on wade for national survival.
Europeans and Japanese have lived with this reality for a very long time. We
will learn to live with it too as our dependence grows. It is to be hoped that
when our dependence equals theirs, our government's chauvinism in dealing
with foreign enterprises is no worse than theirs.
Third, all governments must deal with the realities of employment,
inflation, and growth, and also with public perceptions of the nation's ability to
improve its prospects. In most democracies those public perceptions, as
amplified by the media, are the politically relevant measure of the effectiveness
of government policies. Indeed, the more severe the challenges of
unemployment and inflation, the more conspicuous is the public concern about
foreign dependence and control.
Everyday policies are often pragmatic, designed to encourage both foreign
and domestically owned enterprises to invest and expand the economy. But
structural economic change is hard to measure objectively; the perception of
change may be politically much more salient than the reality. Thus, most
governments give great political weight to the significance of domestic
ownership of national enterprises. When acting in the public view, government
officials may favor a domestically owned company that imports goods of
foreign manufacture over a transnational firm's local subsidiary, even though it
employs thousands of people; invests heavily in training, research, and
development; and contributes more to national economic performance and the
balance of wade than the domestic firm. Local ownership is, therefore, a symbol
of national self-sufficiency, but it is often a poor criterion for economic
development policy.
Fourth, conflict can arise when governments, including that of the United
States, assert the right to extend national sovereignty to domestic firms'
subsidiaries on foreign sod and thereby exacerbate nationalistic political
reactions. IBM's ability to market its largest computers to French government
agencies is still adversely affected by French memories of the U.S.
government's refusal to license large IBM computers to the French atomic
energy authority as a point of pressure on Charles de Gaulle over French
nuclear policy. These old memories have been revived by current processes for
licensing large vector processors to Western Europe. The Caterpillar Tractor
Company has only recently recovered from the dis
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ruption of its European business by the U.S. government's intervention in

contract compliance on the Europe-USSR pipeline. In the meantime, Japanese
competitors have greatly increased their market share in this business sector.
Finally, political leaders of countries experiencing economic difficulties, or
nurturing nascent industries, may also discriminate against foreign investment
even when it builds local infrastructure, reduces unemployment, and helps solve
serious balance-of-trade problems. National subsidiaries, in response, attempt to
demonstrate in every way they can that they are, in fact, national companies and
make positive contributions to national well-being.
The more enlightened companies recruit and train nationals to manage and
staff their local subsidiaries. They work hard to integrate the subsidiary into the
social, economic, and technical life of the community. Yet, they too must
balance this emphasis on national identity with the extranational interests of the
enterprise of which they are a part. They are often tom between the imperatives
of a global strategy and the perceived priorities of local national economic
development.

NEW TECHNOLOGICAL STRATEGIES

Companies as wen as governments share an increasingly complex task.
The world is evolving from a loosely coupled set of independent nation-states to
a highly complex world economy whose institutions of extra-and international
sovereignty are still undeveloped, and in which national boundaries are often a
poor fit to more natural economic regions.
Reflecting their awareness of these political realities, managements of both
transnational companies and governments pursue technological strategies that
are designed in part to reinforce perceptions that are important to them.
Companies, for example, try to locate their manufacturing facilities to minimize
negative balance-of-trade impacts and to demonstrate a significant contribution
to national technological capability. Nations, alone or in regional concert,
embark on highly visible technology projects in the hope of stimulating
industrial collaboration, building consensus around long-term, technology-
intensive industrial strategies.
The long series of 10-year projects sponsored by the Ministry of
International Trade and Industry (M) in Japan, perhaps the best-known recent
example of such a long-term industrial strategy, stimulated much of the
enthusiasm for Europe's response in similar vein. Conditions in culturally
homogeneous Japan, however, are much more propitious for cooperative
technology ventures on a national scale than the conditions for regional
cooperation in Europe. In addition, many people exaggerate
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the importance of technical projects supported by MITI, which are more a

symptom of a nationally concerted strategy for capturing a larger share of world
markets in selected industries than the source of that trade success.
Nevertheless, there is no doubt that, even though some of the MITI programs
(such as Pattern Information Processing Systems, or PIPS) are not regarded as
successful by many, the Japanese government does direct a substantial mount of
funding into carefully selected, commercial technologies of perceived future
importance. In most programs, although surprisingly not in its current artificial
intelligence program at the Institute for New Generation Computer Technology
(ICOT), the government gives strong emphasis to field trials and applications
research to test market acceptance.
In Europe, the EEC sponsors the European Strategic Program for Research
and Development in Information Technology (ESPRIT), which includes a large
number of relatively small research-oriented projects at the precompetitive
level. The most commercially important of these projects is probably the
collaboration between Siemens and Philips in submicron integrated circuit
technology. IBM does participate in ESPRIT. After careful and protracted
negotiations, the IBM Europe/Middle East/Africa Corporation was allowed to
submit proposals, two of which have been accepted and are under way. One, for
example, deals with the application of artificial intelligence techniques to
computer-integrated manufacturing. The breadth of participation in ESPRIT is
probably due primarily to the availability of EEC funds, representing ''new
money'' that is less subject to parochial national interests than the funds of
national governments would have been and also the precompetitive nature of
the projects.
A second EEC program, called RACE (Research in Advanced
Communications in Europe), funds cooperative projects in digital
telecommunications, anticipating the broad-band, integrated voice and data
networks of the future. In this case, transnational companies share with the EEC
the hope that the RACE project will put pressure on the national post,
telephone, and telecommunications authorities to adopt more ambitious and
compatible technical goals. The balkanization of the telecommunications
infrastructure of Europe is a significant handicap, to both technological and
economic modernization. Whether a set of cooperative technology projects such
as RACE can achieve this result is, of course, an open question, but in this case
national, EEC, and company interests—both European and foreign based—
strongly coincide.
Another example is the Community in Education and Training for
Technology (COMETT) program, in which advanced satellite-based industrial
education experience will be shared. IBM is willing to make an important
contribution to COMETT, and it is highly likely that this will be welcomed.
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In the United States, government-initiated projects to promote commercial

strategies may have their origin in response to military R&D initiatives. As
noted earlier, in 1985 the United States put considerable political pressure on
European governments to participate in the vastly expensive and ambitious
research and technology development for the SDI. The European reaction,
especially in France, was to accept the proposition that spin-off technology
from SDI might give them commercial advantage in the future (or at least
prevent them from experiencing a further commercial disadvantage relative to
the United States), yet to fear that U.S. export controls would be used later to
limit European freedom to use the technology commercially if they did
participate.
President Mitterand's response was to launch the European technology
cooperation program called EUREKA, whose projects are chosen for their
commercial, not military, value and unlike ESPRIT are not limited to
precompetitive research.
European governments have embraced EUREKA in principle and
officially regard it as "complementary" to the EEC's "Technology Community"
proposal. Like EUREKA and ESPRIT, the Technology Community proposal
focuses on the set of technologies that all countries generally regard as strategic:
informatics, biotechnology, advanced materials, automation,
telecommunications, lasers, and educational technologies.
A mechanism is in place for selecting EUREKA projects, and 26 have
been selected. But there is no reserved funding at the EEC or intergovernmental
level for EUREKA projects. They are referred back to national governments for
possible support. Thus, it is not surprising that private enthusiasm for EUREKA
does not match the political support it enjoys in public, indicating that private
assessment of the commercial benefits is considerably less optimistic than the
public assessment.
Nevertheless, there is a broad movement, in Europe and Japan especially,
to put high on the political as well as the business agenda the quest for what
Hubert Curien, French Minister of Research and Technology, called the
"technical renaissance of Europe." The leaders of companies and governments
alike must surely welcome this new priority, even as they debate what forms of
public action will produce the desired results.
Since such highly visible national or multilateral projects require the
participation of commercial firms across national lines, difficulties do arise at
this juncture. Firms, like governments, appreciate the symbolic importance of
technological success, for they too have a vital interest in public perceptions.
But firms measure the results of their investments by more conservative criteria
than do governments: high expectation of a contribution to competitive success.
Thus, the prevailing pattern is that firms publicly support the goals of
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NATIONAL AND CORPORATE TECHNOLOGY STRATEGIES IN AN 256
INTERDEPENDENT WORLD ECONOMY

the government projects and will generally seek to participate, especially if their
competitors do. The projects are generally not only "preproprietary" but are
smaller than mainstream corporate projects. The occasionally much larger
projects are sometimes joint ventures already under negotiation among private
firms.
Both transnational companies and governments must manage the balance
between national activities and 'international interdependences. A company's
subsidiaries in different countries are 1, not competing, with each other. The
company has an incentive to build its technical strategy on the totality of its
worldwide capability. A government more typically regards the national
economy in competition with all others, and its leaders seek to optimize the
economic advantages of their electorates, independent of the others.
A problem here is that "economic advantage" tends to be defined as
benefits to producers rather than to consumers, who are much less well
organized to protect and register their interests. It is not at all clear that, even in
the narrowest terms, the quality of life of electorates overall is improved by
nationalistic strategies.
Of course, since national subsidiaries work hard at earning acceptance as
national entities, they too share national economic aspirations, and their
political views may well be in full accord with their governments'. In most
regions of the world, both political and economic realities are forcing nations to
make common cause at least regionally, and the European Common Market is
the most conspicuous example.
Thus, the tensions between self-sufficiency and interdependence, between
nationalism and global development, between technology for profit and
technology for investment in public perception, between strategies seeking
market access and political acceptance and strategies optimizing near-term total
business performance, will continue. Eventually, the international diffusion of
culture and ethnicity, and the imperatives of global interdependence, will begin
to relieve these stresses and soften the more strident nationalistic trends. But it
will take a long time. Meanwhile, we must work toward trade policies,
international technological exchange, and international cooperation that is based
more on economic realities that nations and companies face than on time-
honored symbols of sovereignty that may not accord with anyone's long-term
national interest.
Technology and Global Industry: Companies and Nations in the World Economy
ADVISORY COMMITTEE FOR SYMPOSIUM ON WORLD TECHNOLOGIES AND 257
NATIONAL SOVEREIGNTY

Advisory Committee For Symposium On

World Technologies and National
Sovereignty

CHAIRMAN
HARVEY BROOKS, Benjamin Peirce Professor of Technology and Public Policy,
Emeritus, Harvard University

MEMBERS
ANN F. FRIEDLAENDER, Dean, School of Humanities and Social Science,
Massachusetts Institute of Technology
FREDERICK W. GARRY, Vice President, Corporate Engineering and
Manufacturing, General Electric Company
HENRY KRESSEL, Managing Director, Warburg, Pincus and Company
JACk: D. KUEHLER, Senior Vice President, IBM Corporation
JAMES BRIAN QUINN, William and Josephine Buchanan Professor of
Management, Amos Tuck School of Business, Dartmouth College
RAYMOND VERNON, Clarence Dillon Professor of International Affairs Emeritus,
Kennedy School of Government, Harvard University
Technology and Global Industry: Companies and Nations in the World Economy
ADVISORY COMMITTEE FOR SYMPOSIUM ON WORLD TECHNOLOGIES AND 258
NATIONAL SOVEREIGNTY
Technology and Global Industry: Companies and Nations in the World Economy

CONTRIBUTORS 259

Contributors

LEWIS M. BRANSCOMB is Professor from Public Service at Harvard University

and director of the Science, Technology, and Public Policy Program at the
John F. Kennedy School of Government. Dr. Branscomb came to Harvard
University in October 1986 from the IBM Corporation, where he was vice
president and chief scientist and a member of the Corporate Management Board.
HARVEY BROOKS is Benjamin Peirce Professor of Technology and Public Policy
Emeritus at Harvard University and a member of the National Academy of
Engineering and the National Academy of Sciences.
YVES DOZ is associate professor of business policy at the European Institute for
Business Policy. His current research interests cover the management of
innovation in large, complex firms, with emphasis on information technologies
and pharmaceutical industries.
HENRY ERGAS is counsellor in the Advisory Unit to the Secretary-General at the
Organization for Economic Cooperation and Development (OECD), in Paris.
He joined the OECD in 1978 and has mainly been responsible for work in the
areas of telecommunications, industrial, and trade policy.
BRUCE R. GUILE is associate director of the Program Office of the National
Academy of Engineering.
ALVIN P. LEHNERD is executive vice president, North American Appliance
Technology and Global Industry: Companies and Nations in the World Economy

CONTRIBUTORS 260

Group, Allegheny International. Before joining Allegheny International in

1982, Mr. Lehnerd spent 13 years with the Black & Decker Manufacturing
Company, where his last position was as vice president for advanced
technology, new business, and new ventures.
JAMES BRIAN QUINN is William and Josephine Buchanan Professor of
Management at the Amos Tuck School of Business Administration, Dartmouth
College. Professor Quinn is a consultant to leading U.S. and foreign
companies, the United States and foreign governments, and a number of small
enterprises. He has published extensively on strategic planning,
entrepreneurship, and technology policy and has served on numerous
committees for the National Research Council and the National Academy of
Engineering.
DAVID J. TEECE is professor of business administration at the School of
Business and director of the Center for Research in Management at the
University of California, Berkeley. He earned his Ph.D. in economics at the
University of Pennsylvania and joined the faculty of the Stanford Business
School in 1975. Professor Teece came to the University of California in 1982.
JAMES M. UTTERBACK is the director of the Industrial Liaison Program of the
Massachusetts Institute of Technology and an associate professor in MIT's
School of Engineering. Since receiving his Ph.D. in the MIT Sloan School's
technology management program, Professor Utterback has held faculty
positions at Indiana University and the Harvard Business School.
RAYMOND VERNON is Clarence Dillon Professor of International Affairs
Emeritus at Harvard University. He was formerly the director of Harvard's
Center for International Affairs, as well as director of the Multinational
Enterprise Study of the Harvard Business School.
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 261

Index

A compared to integration strategies,

Aircraft and airlines industries, innova- 80-85
tions in, 34 integration strategy for access to 76-77,
imitators profiting from, 67 79-85;
standardization of, 74 see also Integration strategy
Antitrust policies, affecting international loose, 68, 74, 80, 81, 82, 90-91
competitiveness of United States, parterning strategy concerning, 3, 78-79,
174-175 90, 102, 103, 107, 115
Apprenticeship system, 208 and profitability, 67-68, 72-76
Appropriability of innovations, 67-68, in international wade, 90-93
89-90 specialized, 71 72, 75-76, 84
access to complementary assets affect- strategies for access to, 76-88
ing, 70-72, 77, 80, 89-90 AT&T
industry differences in, 89-90 breakup of, 132-133
and profitability, 67-68, 72-76 worldwide affiliations of, 138
in international trade, 90-93 Automation
Assets required for commercialization of in process innovations, 26
innovations, 21, 23, 26, 39-40, in services sector, 125, 133, 137
70-72, 76-88 Automobile industry
contractual strategies concocting, 73-74, complementary assets in, 71
77-79 innovations in, 34, 38-39, 40
combined with integration strategies, standardization of, 74
85
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 262

B breakup of, 132-133

Banking and financial services, see Finan- worldwide affiliations of, 138
cial and banking services and automation of data flow, 137-139
Black & Decker Corporation, revitalizing improvements in
product manufacture and design in, and economies of scope, 137-138
3, 50-62 and globalization of industries, 98-99,
impact on new product development, 107, 161-162
61-62 interaction of corporate and government
by increasing integration, 58-59 interests concerning, 254
Brazil, interaction of government and cor- and protectionist issues concerning
porate interests in, 250 international data flow, 111-113
transfer of technology in, see Transfer
C of technology
Competitiveness, international, of United
Capital
availability of, for financing innovations, States, 9, 160-166
202 antitrust policies affecting, 174-175
and investments in human capital, 233 communication and transportation
improvements affecting, 98-99, 107,
in Japan 215-216
161-162
in services sector, 123-124
costs and benefits of changes in, 166-168
Centralization of activities
in consolidation phase of technological decline of, 160-166
trajectory, 225, 227-228, 229-230 education affecting, 170-172
management techniques affecting,
in integration strategy, see Integration
strategy 164-165, 174-176
requirements for future growth of,
in Japan, 221, 229-230
in mission-oriented technology policy, 168-169
193-194, 234 services sector affecting, 6-7, 144-152,
in research and development programs, 157
104-107 tax policies affecting, 173, 177
trade policies affecting, 162-163,
in services sector, 132-137
165-166, 177, 178-186
Chemical industries
appropriability of innovations in 72-73, value of dollar affecting, 165
77 wages as measure of, 8, 9, 168, 178
in Federal Republic of Germany, Swe- Complementary assets, see Assets
required for commercialization of
den, and Switzerland, 206, 210
innovations
China, People's Republic of, interaction of
Computer industry
government and corporate interests
in, 248, 249-250 access to complementary assets in, 70,
76, 78-79, 85, 86-88, 90
Cola beverages, imitators profiting from
development of, 66-67 in automation of insurance industry,
importance of flexible designs in, 137
COMETT (Community in Education and
Training for Technology), 254 imitators profiting from innovations in,
66-67, 86-87
Communications
and AT&T
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 263

interaction with government interests, defense expenditures in, 212

251, 252, 254 economic and institutional framework
partnering strategy in, 78-79, 90 of, 206-212
standardization of innovations in, 74, education and training in, 206, 207-208,
87-88 210
worldwide affiliations in, 138 effectiveness of, 210, 212-214
Computerized axial tomographic scanner, industrial standards in, 209
imitators profiting from development research and development in, 209-212
of, 65-66, 85-86 specialization pattern in, 213
Consolidation phase in technological tra- transfer of technology in, 210, 233
jectory, 225, 227-228 Diffusion of technology, see Transfer of
in Japan, 229-230 technology
Containerized shipping, 71-72 Distribution systems, globalization trends
Contractual strategies for access to com- in, 4-5, 96-118;
plementary assets, 73, 76-79 see also Globalization of industries
combined with integration strategies, 85 Drug industry, appropriability of innova-
compared to integration strategies, 79-85 tions in, 89
Cooperation
interfirm, in Japan, 220-221 E
university-industry, 200-201, 208, 210 Education
Corporate strategies, interaction with gov- in diffusion-oriented technology policy,
ernment policies, 11-12, 246-256 206, 207-208, 210
common interests in, 250-251 apprenticeship system in, 208
new approaches in, 253-256 as investment in human capital,
sources of conflicts in, 251-253 215-216, 233
in Japan, 216
D in mission-oriented technology policy,
Data flow, see Communications 200-201, 204-205, 207, 208
Decentralization of technology policies, national differences in, 217
205-206, 207, 233-234 quality of, affecting international com-
Defense industries petitiveness of United States, 170-172
government expenditures on, 172-173, and university-industry links, 200-201,
193, 197, 198-199, 212 208, 210
national differences in, 193 Emergence phase in technological trajec-
interaction of government and corporate tory, 225, 227, 228
interests in, 248-249 Engineering industries, mechanical,
requirements for, 169-170 206-207, 209, 213
role of services sector in, 156 Entrepreneurs, role in organizational struc-
Diffusion-oriented technology policy, ture and manufacturing innovations,
192, 205-214 27-33
decentralization of activities in, Environmental differences in national
205-206, 207 technology policies, 200-203, 232
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 264

Equipment in manufacturing France, technology policy in, 192,

and process innovations, 23-26, 29 203-204, 223, 224
and product innovations, 21, 22 and accessibility of scientific informa-
ESPRIT (European Strategic Program for tion, 200
Research and Development in Infor- and defense expenditures, 193
mation Technology), 115, 254, 255 and design of research and development
EUREKA projects, 113-114, 255 programs, 198, 199
European Economic Community, technol- effectiveness of, 196
ogy strategies of, 254 and funding of research and develop-
Evolution in manufacturing industries, ment programs, 194, 198, 199
2-3, 16-48 interaction of corporate and national
life cycle concept in, see Life cycle con- strategies in, 255
cept, technological and labor force involved in research and
Exchange rate fluctuations development programs, 200, 202
affecting globalization of industries, and labor mobility, 201
101, 110-111 and shifting to new uses of resources,
affecting international competitiveness 224, 228, 229
of United States, 165 and technological trajectory, 228-229
Exports and transfer of technology, 232
of product innovations, 25, 42, 43
of United States G
decline-in, 161 GAFF (General Agreement on Tariffs and
with military applications, restrictions Trade), 180, 181, 182, 183
on, 113 Germany, Federal Republic of, technol-
ogy policy in, 192, 207, 210,
F 211-212, 223, 224
Financial and banking services and deepening uses of resources, 224, 229
automation of, 133 and defense expenditures, 193
changes in scope of, 138-139 and education, 208
competition in, 142-143 and funding of research and develop-
complexity of, 140 ment programs, 194, 198, 211-212
international, 146-147 and industrial standards, 209
Fluid phase of innovations, 19, 21, 23, 29, and industry-university links210
69 and labor force involved in research and
organizational structure in, 27, 31 development programs, 200, 211
in process innovations, 23, 29 and technological trajectory, 229
in product innovations, 19, 21, 25 Globalization of industries, 3-8, 96-118
profits in, 74-75 compared to centralization of research
Fragmentation of industries, compared to and development activities, 104, 107
globalization trend, 4-5, 96-118; driving forces for, 100-102, 107
see also Globalization of industries empirical evidence of, 102-104
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 265

enabling conditions for, 98-99, 107 on shifting and deepening uses of

historical development of, 96-97 resources, 222-231
limits to, 108-115 supporting national industries, 104,
organizational structure of companies 162-163, 216-217.
affecting, 99, 114-115 in Sweden, 192, 193, 194, 210, 212
protectionist policies affecting, 111-114 in Switzerland, 192, 193, 198, 206, 207,
services sector changes affecting, 208, 210
146-152, 157 and technological trajectories, 225-231
Government policies, 8-12, 191-245 on trade, international, 177, 178-186
cross-national comparison of 10-11 affecting profits from innovations,
decentralizaion of, 205-206, 207, 91-92
233-234 General Agreement on Tariffs and
diffusion-oriented, 192, 205-214; Trade in, 180, 181, 182, 183
see also Diffusion-oriented technology import restrictions in, 163, 175-179,
policy 151-152, 184
diversity of, 232 liberalizing measures in, 183, 184, 185
environmental differences in, 200-203, protectionist, 97, 184
232 special interest groups affecting, 184,
in France, see France, technology policy 185
in voluntary export agreements and
in Germany, see Germany, Federal orderly marketing agreements in,
Republic of, technology policy in 181-182
and globalization or fragmentation of on transfer of technology, 200-201, 210,
industries, 97, 101, 103, 110 232-233
incentives provided in, 235 in United Kingdom, see United King-
interaction with corporate strategies, dom, technology policy in
11-12, 246-256 in United States, 9-10, 192, 196-205,
common interests in, 250-251 223, 224
new approaches in, 253-256 Gross national product of United States
sources of conflicts in, 251-253 components of, 122
and international competitiveness of manufacturing sector in, 6, 161
United States, 162-163, 165-166 services sector in, 6
antitrust prances affecting, 174-175
in education, 170-172 H
in research and development, 172-174 Health services
tax programs affecting, 173, 177 complexity of, 141-142
trade legislation affecting, 177, 178-183 integration of, 133-137
on investment in human capital,
215-216, 233 I
in Japan, see Japan, technology policy in IBM Corporation
mission-oriented, 192, 193-205, 232; access to complementary assets of, 78,
see also Mission-oriented technology 85, 86-85
policy
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 266

interaction with foreign governments, research and development investment

251, 252, 254 decisions concerning, 88
partnering strategy of, 78 in small and large firms, comparison of,
worldwide affiliations of, 138 88-89
Imitation of innovations, 3, 4, 65-95 specific phase of, 21, 22-23, 25, 26, 29
access to complementary assets affect- competition in, 35-37
ing, 70-72, 76-88 organizational structure in, 31, 32-33
emergence of dominant design affect- in process innovations, 26, 29
ing, 68-70, 74-76, 87-88 in product innovations, 21, 22-23, 25
in international trade, 90-93 transitional phase of, 19-22, 23-26, 29
Imports of United States, government organizational structure in, 27-32
restrictions on, 163, 178-179, in process innovations, 23-26, 29
181-182, 184 in product innovations, 19-20, 25
Incentives in national technology policies, uncertainty concerns in, 19, 22, 25
235 Insurance industry, changes in scope of,
Innovations in manufacturing industries, 137
16-48, 52, 58-62 Integration strategy, 76-77, 79-85
appropriability of, 67-68, 89-90; combined with contract strategies, 85
see also Appropriability of innovations compared to contract strategies, 80-85
assets required for commercialization and globalization of industries, 96-118
of, 21, 39-40, 70-72, 76-88; limits to, 108-115
see also Assets required for commercial- and innovations, 29, 40-41
ization of innovations and profits from innovations, 3, 79-85
comparative analysis of, 39-42 in services sector, 133-137
and competition between productive Interest groups affecting government trade
units, 17, 35-37 policies, 184, 185
emergence of dominant design of, International companies, see Multina-
68-70, 74-76, 87-88 tional companies
fluid phase of, 19, 21, 23, 29, 69 International competitiveness of United
organizational structure in, 27, 31
in process innovations, 23, 29
in product innovations, 19, 21, 25
profits in, 74-75
government policies stimulating, 172-174
imitation of, see Imitation of innovations
and integration strategies, 29, 40-41
and international trade, 42-44, 90-93
legal protection of, 67-68, 72-73, 89-90
and organizational structure, 18, 27-33
relationship to international trade,
42-44
in paradigmatic stage, 68-70, 75-76
in pre-paradigmatic stage, 68-70, 74-75
in process, 16, 17, 23-27;
see also Process innovations
in product, 16, 17, 18-23;
see also Product innovations
productive trait in analysis of, 17-18
profits from, 19, 25, 65-95;
see also Profits from innovations
radical and evolutionary patterns of,
33-35
rate of, affecting output and productivity
levels, 18-22
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 267

States, see Competitiveness, interna- and investments in human capital,

tional, of United States 215-216, 233
International trade, see Trade, international in manufacturing
Irons, steam and dry, revitalizing manufac- location advantages in cost of, 110
ture and design of, 63-64 and process innovations, 26, 27, 29
mobility of, 201-202
J in services sector, 123
Japan and average wages, 152-153
interaction of government and corporate and number of job opportunities,
interests in, 249, 253-254 152-153, 154
productivity of services sector in, 149 Legal protection of innovations, 67-68,
technology policy in, 192, 214-222, 223, 72-73, 89-90
224-225 Licensing agreements for access to com-
and centralized programs, 221, 229-230 plementary assets, 3, 72-73, 77
and competition, 219-220 Life cycle concept, technological, 2-3
and defense expenditures, 193 and competitiveness of productive units,
development strategy in, 215-218 35-37
and education, 216 and distribution of profits from innova-
effectiveness of, 218-222 tions, 68-70, 74-76
and funding of research and develop- and international trade, 4, 42-44
ment programs, 194 and organizational structure, 27-33
and interfirm cooperation, 220-221 and process innovations, 23-27, 29
and investment in human capital, and product innovations, 18-23, 25
215-216 and revitalizing manufacture and design
and labor force involved in research of mature products, 49-64
and development programs, 200 and technological trajectories, 225-231
and lifetime employment system, 216, three-stage pattern of, 12-13
220 Lifetime employment system in Japan,
and promotion of certain industries, 216, 220
216-217
and shifting and deepening uses of M
resources, 224-225, 229-230 Management techniques affecting interna-
and technological trajectory, 229-230 tional competitiveness of United
and transfer of technology, 217-218 States, 164-165, 174-176
trade relationship with United States, 180 Manufacturing industries
transfer of technology to, concerns antitrust policies affecting, 174-175
about, 112 changing role of, in United States, 148,
transfer of technology within, 217-218 153, 160-166
communication and transportation
L improvements affecting, 98-99, 107,
Labor force 161-162
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 268

costs and benefits of changes in, 166-168 Medical services

defense-related, see Defense industries complexity of, 141-142
globalization of, 98-104, 107 integration of, 133-137
limits to, 108-111 Mergers
government policies affecting, 162-163, antitrust policies concerning, 174-175
165-166, 172-174 in services sector, 132, 134-135
innovations and evolution in, 2-3, 16-48; Military power, see Defense industries
see also Innovations in manufacturing Mission-oriented technology policy, 192,
industries 193-205, 232
management techniques affecting, accessibility of scientific information in,
164-165, 174-176 200-201
organizational structure of, 27-33; competition in, 201-203
see also Organizational structure of concentration of activities in, 193-194,
manufacturing industries 234
productivity of, 170-177 design of research and development pro-
rate of innovations affecting, 18-22 grams in, 198-199
requirements for future growth of, education and training in, 200-201,
168-169 204-205, 207, 208
services sector changes affecting, effectiveness of, 195-198, 203-205
147-148 direct, 195-197
standardization in, see Standardization secondary, 197-198
in manufacturing environmental differences in, 200-203
trade policies affecting, 177, 178-186 labor mobility in, 201-202
unit production costs in, compared to transfer of technology in, 200-201, 232
volume of production, 27 Multinational companies
value of dollar affecting, 165 antitrust policies affecting, 175
Market segments, 17 communication and transportation
competition in, see Competition in prod- improvements affecting, 161-162
uct markets in globalization of industries, 96-118, 162
homogenization of, and globalization of historical development of, 96-98
industries, 98, 107 interaction with government policies,
Marketing systems, globalization trends 246-256
in, 4-5, 96-118; common interests in, 250-251
see also Globalization of industries new strategies in, 253-256
Materials required for commercialization sources of conflicts in, 250-251
of innovations, see Assets required
for commercialization of innovations N
Matrix organization of companies, 114-115 National policies, see Government policies
Mature phase of technological trajectory, National security, see Defense industries
225, 227, 228 Norway, research and development pro-
in Federal Republic of Germany, 229 grams in, 200, 210
Mechanization in services sector, 125, 133
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 269

O revitalizing mature products, 49-64,

Organizational structure of manufacturing 50-62, 63-64
industries, 27-33 uncertainty concerns in, 19, 22, 25
entrepreneurial roles in, 27-32 Product(s) interchangeable with services,
and globalization trend, 99, 114-115 131, 144
and innovative capacity, 18, 27-33 Production systems
relationship to international trade, globalization trends in, 4-5, 96-118;
42-44 see also Globalization of industries
mantrix, 114-115 process innovations in, 16, 17, 23-27;
mechanistic, 32 see also Process innovations
organic, 27 unit costs in, compared to volume of
production, 27
P Productive units in manufacturing, 17-18
competition between, 17, 35-37
Paradigmatic stage of innovations, 68-70,
75-76 hierarchical arrangement of, 17
Productivity
Partnering strategy, 3, 78-79, 90, 102,
factors enhancing, 170-177
103, 107, 115
education, 170-172
Patents protecting innovations, 67-68
innovations, 172-174
affecting distribution of profits, 72-73
management techniques, 174-176
industry differences in, 89
rate of innovations affecting, 18-22
Performance criteria in product innova-
of services sector, 149
tions, 19, 25
increases in, 125-128
Petroleum industry, appropriability of
problems in measurement of, 130
innovations in, 72-73, 77
Profits
Polarization, economic, in United States,
from globalization of industries, 100
166-168, 172
limits to, 108-111
reduction of, 176-178
from innovations, 3-4, 19, 25
Power tool industry, revitalizing manufac-
access to complementary assets affect-
ture and design of mature products
ing, 3, 70-72, 76-88, 90-93
in, 50-62
appropriability affecting, 67-68,
Pre-paradigmatic stage of innovations,
72-76, 90-93
68-70, 71, 74-75
distribution of, 65-95
Price of product, innovations affecting,
emergence of dominant design affect-
19, 22, 25, 57-58, 62
ing, 68-70, 74-76
Process innovations, 16, 17, 23-27, 29
in international trade, 90-93
cost of, 26, 29
in product innovations, 19
revitalizing mature products, 49-64,
research and development investment
50-62, 63-64
decisions affecting, 88
trade secrets protecting, 68
in small and large firms, comparison
affecting distribution of profits, 72-73
of, 88
transitional phase of, 23-26, 29
Protectionist trade policies, 10, 97, 184
Product innovations, 16, 17, 18-24
affecting globalization of industries,
and emergence of dominant design,
111-114
68-70, 74-76
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 270

R competition in, 142-144

RACE (Research in Advanced Communi- complexity in output of, 139-142
cations in Europe), 113, 254 concentration of, 125, 132-137
Rental agencies, changes in scope of, 139 definition of, 119-121
Research and development programs problems in, 130
centralization of, compared to globaliza- and distribution of wealth, 152-155
tion of marketing and manufacturing, growth of, 168-169
104-107 and interchangeability of products and
and diffusion of new technology, 232-235 services, 131, 144
government policies stimulating, 172-174 in international trade, 6-7, 130-131, 132,
in Japan, 194, 200, 218 144-152, 156-157
in mission-oriented technology policy, labor in, 123
193-205 and average wages, 152-153
design of programs in, 198-199 and number of job opportunities,
effectiveness of, 195-198 152-153, 154
environmental differences in, 200-203 limits of current data on, 129-131
labor force involved in, 200, 202 mechanization and automation of, 125,
national differences in funding of, 194, 133, 137
198 mergers in, 132, 134-135
and profitability of innovations, 88 myths about, 121-128
in technological trajectory, 225-230 and power of society, 156
Resources, industrial productivity of, 149
required for commercialization of inno- increases in, 125-128
vations, see Assets required for problems in measurement of, 130
commercialization of innovations scale of activities in, 132-137
shifting and deepening uses of, 222-231 scope of activities in, 137-139
structural changes in, 131-153
S technological intensity of, 124-125
value of activities in, 121, 128
Scale, economies of
Soviet Union, transfer of technology to,
and globalization of industries, 96-118
112-113
and profitability of innovations in small
Specific phase of innovations, 21, 22-23,
and large firms, 88
25, 26, 29, 69-70
and relationship of unit production costs
competition in, 35-37
to volume of production, 27
organizational structure in, 31, 32-33
in services sector, 132-137
in process innovations, 26, 29
Semiconductor industry, innovations in,
in product innovations, 21, 22-23, 25
33-34, 40
Standardization in manufacturing
Services sector, 5-6, 119-159
affecting distribution of profits, 74-75, 87
affecting manufacturing industries,
in Black & Decker program, 51, 53-55, 59
147-148
capital intensity of, 123-124
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 271

and competition between productive domestic impact of, 9

units, 35-37 dynamic networks in, 91
in emergence of dominant design, exports of United States in
68-70, 74-76 decline in, 161
and international trade, 42 with military applications, restrictions
organizational changes in, 32 on, 113
in process innovations, 23-26 General Agreement on Tariffs and
in product innovations, 22 Trade concerning, 180, 181, 182, 183
Steel industry, international agreements and globalization of industries, 96-118
concerning, 176 government policies concerning, 177,
Supplies required for commercialization 178-186
of innovations, see Assets required import restrictions in, 163, 178-179,
for commercialization of innovations 181-182, 184
Sweden, technology policy in, 192 liberalizing policies concerning, 183,
and defense expenditures, 193, 212 184, 185
and funding of research and develop- net balance of United States in, 149,
ment programs, 194 150, 151
and industry-university links210 of product innovations, 25, 42, 43
Switzerland, technology policy in, 192, protectionism affecting, 10, 97,
198, 206, 207 111-114, 184
and defense expenditures, 193 relationship to innovation and industry
and education, 207, 208 structure, 42-44
and funding of research and develop- services sector in, 6-7, 130-131, 132,
ment programs, 198 144-152, 156-157
and industry-university links, 210 special interest groups affecting, 184, 185
voluntary export agreements and orderly
T marketing agreements on, 181-182
Target uncertainty of product innovations, Trajectory, technological, 225-231
19, 22 in Federal Republic of Germany, 229
Tax policies in France, 228-229
affecting international competitiveness in Japan, 229-230
of United States, 173, 177 phases in, 225, 227-228
stimulating research and development in United States, 228
programs, 173 in vacuum tube industry, 225-227
Technical uncertainty of product innova- Transfer of technology, 200-201, 210,
tions, 19, 22 232-233
Technology transfer, see Transfer of tech- decentralization of policies affecting,
nology 233-234
Textile industries, 42 incentives affecting, 235
Trade, international investments in human capital affecting,
adjustment programs concerning, 177 233
data flow concerns in, 111-113 in Japan, 112, 217-218
distribution of profits from innovations
in, 90-93
Technology and Global Industry: Companies and Nations in the World Economy

INDEX 272

Transitional phase of innovations, 19-22,

23-26, 29, 69
organizational structure in, 27-32
in process innovations, 23-26, 29
in product innovations, 19-20, 25
Transportation
and containerized shipping, 71-72
improvements in, and globalization of
industries, 98-99, 107, 161-162
and innovations in airlines industries, 34
imitators profiting from, 67
standardization of, 74

U
United Kingdom, technology policy in,
192, 203
and accessibility of scientific informa-
tion, 200
and defense expenditures, 193
and design of research and development
programs, 198, 199
effectiveness of, 195-196
and funding of research and develop-
ment programs, 194, 198, 199
and labor force involved in research and
development programs, 200, 202
and labor mobility, 201
University-industry links, 200-201, 208,
210

V
Vacuum tube industry, development of,
225-227
Value
of dollar, and exchange rate fluctuations
affecting globalization of industries,
101, 110-111
affecting international competitiveness
of United States, 165
of innovations, and distribution of prof-
its, 65-95
of services sector activities, 121, 128
and national wealth, 152-155

W
Wages
and international competitiveness, 8, 9,
168, 178
in services sector, 152-153
Wealth, national, services sector affecting,
152-155