Laissez-Faire, Picking Winners, and Other Myths of National Competitiveness

10:32 AM Monday January 31, 2011
by Gary P. Pisano 

In the wake of President Obama's State of the Union addressand his appointment of Jeff Immelt of GE to chair his new Council on Jobs and Competitiveness, there has been a heated debate in the United States about the role of government in improving the competitiveness of American businesses.

Arguing that "the rules have changed," the President outlined a series of policy themes — from improved education and investment in research to changes in tax policy — to shore up American competitiveness. The Republican reaction: This was simply code for more big government.

Let me say upfront that I thought the President got it just right. The U.S. does have a competitiveness problem and the policies he proposed generally struck the right balance between what government can and cannot do about it........

Let's remember that international trade is not a zero-sum game. Americans are not necessarily worse off because Chinese or Indians have become more competitive on global markets. For instance, during the 1990s, China became a low-cost producer of computer hardware (much of which was designed in the U.S.). Declining prices of computer hardware enabled American companies to invest heavily in information technology, which in turn, drove a surge in U.S. productivity. Moreover, growing prosperity in China, India, and Latin America is good news all around: Prosperous countries tend to be more stable and they become larger markets for American-made goods and services.Does this mean that competitiveness is irrelevant — or, in the words of Nobel Laureate Paul Krugman, a "dangerous obsession"? Not at all. The prosperity of regions can rise or decline, depending on how attractive they are as places to carry out certain economic activities. When the Detroit and upper-mid-west region of the U.S. became a relatively less attractive place to manufacture automobiles, unemployment skyrocketed (at one point hitting a high-water mark of nearly 30% in Detroit), wages and living standards eroded, real estate values plummeted, and public services crumbled. At the same time, economic opportunities blossomed and wages and living standards increased in places,,,,,,,

that became more attractive to locate auto plants (such as the southern U.S. and Mexico).

A few decades ago, Americans were spoiled. We did not have a lot of competition for developing and producing high-value-added products like semiconductors, airplanes, software, complex electronic systems, high-end computers, telecommunications equipment, and pharmaceuticals. We were content to let the Chinese and the Indians take the low-valued-added, low-skilled stuff. Who needed manufacturing when we had the brainy stuff, right?

The problem is, we are losing the brainy stuff. Since 2000 or so, the U.S. has run a trade deficit in high tech. And that deficit has gotten bigger just about every year. (China runs the largest trade surplus in high tech.) We find ourselves falling behind in several industries of the future, including solar energy and other areas of green tech. The U.S. trade deficit in manufactured goods has swelled every year, and our small (and declining) trade surplus in services is not enough to offset that decline. This helps explain how the U.S. went from being the word's biggest creditor to its biggest debtor.

This is a big deal. It means that American workers will have fewer opportunities for high-value-added, high-wage jobs. It also potentially means that we will lose our advantage in innovation. If you don't think this can happen, just read the economic history of Britain.

What, if anything, can be done to restore U.S. competitiveness? Here, the political debate becomes muddied, polarized, and even silly. At one extreme, we have heavy-handed "industrial policy" types who think that salvation lies in directed "strategic" investment by government in "industries of the future." Let's call this the French model. To be honest, it has not worked very well wherever it's been tried (not even in France!). At the other, we have laissez-faire types, who see any kind of government involvement as harmful (let's call this the Tea Party model). This model has never really existed, even in the U.S.

The U.S. has generally been one of the most market-oriented economies in the world. But that does not mean the U.S. government has not played an active and productive role in stimulating and fostering innovation.

The Morrill Act of 1862 established land grant colleges to focus on teaching "mechanical arts" and "agricultural science"; they were a direct response to the industrial revolution. The Hatch Act of 1887provided federal funding for state agricultural experimental stations, which played a pivotal role in driving massive improvements in U.S. agricultural productivity. The federal government's support for aerodynamic research and testing facilities provided a foundation for the U.S. aircraft industry. Since the early 1950s, heavy federal government investment in basic and applied science has laid the groundwork for industries like semiconductors, computers, advance materials, the internet, and biomedical science. So to say government has no business being involved in innovation ignores history to an absurd level.

Where government policies have been most effective is where they complement, rather than substitute for, market mechanisms. The internet was seeded by funding and organizational efforts by a government agency, DARPA, but it was the private sector that took the ball and invented thousands of ways to use the web that no one (and certainly no government agency) could have imagined. Government can lay the foundation; but governments are lousy at picking winners. It's best to leave commercial development to the private sector and competitive markets.

This brings us back to the President's speech. Most of the policies he advocated were about building the foundations: investing in education and research, and helping to foster conditions that make the U.S. fertile ground for innovation. Yes, I have some quibbles with some elements of green energy; that gets a bit too close to "strategic investments" (remember ethanol?). But by and large, I thought he got the balance right. He wants to build the basic capacities of the economy but leave it up to private enterprises to take the ball and run with it.

Can we afford such investments given our deficit? That is really a separate topic. But perhaps a better question is: Can we afford not to?

Gary P. Pisano is the Harry E. Figgie, Jr., Professor of Business Administration at Harvard Business School.