Ev Ehrlich's Everyday Economics

5Jun/03Off

How Economies Grow: A New Look at the Evidence

In 1674, Antoine van Leeuwenhoek looked at a drop of water under a microscope for the first time and discovered a range of microorganisms never before seen, setting biology on a trajectory that claims today's remarkable life sciences as its descendant.

Economists are now having a similar moment, thanks to remarkable data developed at the Department of Commerce' Bureau of the Census. By tracking tens of thousands of manufacturing plants for as long as two decades, Census research demonstrates that economic growth and the struggle for competitive success are inextricably intertwined, and that technology lies at the heart of that process. And that finding, in turn, has important implications for the way we develop policies for economic growth at all levels of government.

Here are some examples of what we've learned. Almost one in ten jobs in manufacturing is created anew each year, and a full one in ten is lost. But a full two-thirds of those new jobs occur in plants that either start up anew or that expand their hiring by at least 25 percent in that year. And two-thirds of all the jobs destroyed each year are lost in plants that either shut down or shrink by 25 percent or more.

Moreover, two-thirds of total manufacturing productivity growth occurs because plants with high productivity growth rates supplant less productive rivals.

In short, the economy creates jobs and increases its productivity -- and therefore its standard of living -- because some plants and firms race ahead in the competitive struggle and displace their competitors.

A further look through the microscope shows that advanced technology -- particularly the tools of the Information Revolution -- lies at the heart of this process. Manufacturing plants that use information technology to design or manufacture goods, configure their plant floors, coordinate with suppliers, or handle materials hire workers with more skills at over 14 percent higher wages, even when worker skill levels and other plant characteristics are taken into account.

Advanced technologies also enhance plant survival and thus job security. Advanced-technology plants had failure rates 22.6 percent lowers over a four year period relative to their counterparts. And they're more profitable: their gross margins are three percentage points higher than their competitors.

And employment at plants using advanced technologies grew about 14 percent more than their low-tech twins, even after taking other plant characteristics into account.

Growth and job creation, therefore, depend on our firms' abilities to innovate, compete, and win. And, in other research, Census data yields preliminary evidence that firms that export play the same dynamic role as do firms that innovate.

These finding tells us to rethink the way we help our economy grow. For too long, our nation's economic policy has been caught in the throes of an outmoded debate between two ideological camps. The "trickle down" devotees generally oppose government involvement, unless it's to subsidize all our firms through the tax system, be they winners or losers. At the other extreme, "industrial policy" advocates seek to pick both winners and losers: they like jobs, but seem to distrust the private sector that creates them. The laissez-faire side says that government and business need to stay at arm's length, that we need to put government in the stands as the game is played. The industrial policy types advocate putting the government on the field to be the quarterback -- and all too often on Monday morning.

But this new research outlines a third strategy -- creating the environment and the tools that let more "winners" flourish. And in a world in which economic growth depends on our firms' ability to innovate, that means working in partnership with the private sector to advance the technological frontier and to help our firms -- particularly small and mid-sized ones -- to reach it.

The Clinton Administrations' technology programs are designed to realize these twin goals. The Department of Commerce' Advanced Technology Program, administered by the National Institute of Standards and Technology (NIST), shares with private companies the cost of developing high-risk but powerful technologies that underlie a broad spectrum of new applications, commercial products, and services. The Commerce Department is also establishing a nationwide network of more than 100 manufacturing extension centers to assist manufacturers in learning about opportunities to modernize their production capability. These programs, working in partnership with the private sector, will help more U.S. firms become the job-creating "winners" that drive our growth.

And what's true at the national level is true at the local level as well. Toledo's local economy is expanding as new plants in the steel and aluminum industries come on line. These new plants deploy the cutting-edge technologies that their predecessors lacked. And they are tied to an auto industry that is also rapidly learning these new ways of producing.

And the strategy of "creating winners" is underway at the National Center for Tooling and Precision Components, the first tenant in the University of Toldeo's R&D park. The Center brings together local firms and the University to build a new technological base for economic growth in the area.

The American people too often look at technology as a source of dislocation and disenfranchisement. But we can find opportunity amidst these changes if we have the will and the wisdom to promote technology as an engine for economic growth. The old debate no longer serves us. We have embarked on a new, third path, one of providing our firms (and our families, through President Clinton's Middle Class Bill of Rights) with the tools to become winners. The economy is growing under President Clinton's program. Let's not revisit the old debate when this new path is just beginning to work.

20Oct/97Off

The American Economy in the 1990’s: A Brave Same Old World

In the Jewish community of 17th century Holland there arose a self-designated, widely-followed, and, ultimately, false Messiah known today as Sabbatai Zevi. In his self-proclaimed Messianic Era, the very concept of “sin” became irrelevant. Freed by their savior's arrival from the moral burden associated with wrongdoing (today we would say liberated from the dictates of the superego), Zevi's followers embarked on a veritable jamboree of transgression, from rampant carnality to boiling meat in milk. Imagine their chagrin when, faced with a choice between apostasy and death, Zevi chose a life-extending conversion to Islam, thus ending his brief Reign on Earth.

Whoops!

Financial market participants should bear this story in mind as they consider whether we are in a proto-Messianic “New Economy” in which inflation and the business cycle are as outdated as sin seemed to be for the Dutch Jews of centuries ago. There is a very real danger that today's proponents of economic neo-Messianism will feel as chagrined as their Sabbatianist counterparts did when reality reasserts itself.

That's not to say that the American economy isn't functioning marvelously. Why shouldn't it? First, it's been blessed with a sensational policy mix. The 1993 budget package changed the course of fiscal policy for at least a decade, a change ratified by this year's package. Monetary policy has been guided by well-exercised, pragmatic judgment, rather than by the kind of unyielding ex ante rules and constructs that killed Billy Budd, not to mention some past economic expansions.

And, perhaps even more important, the economy is in the throes of technological change as profound as the rise of scale-driven mass production and process-based manufacturing. That technological progress has let loose a wave of restructuring in the economy that has improved its performance dramatically.

But does this all mean that we're living in a “New Economy” in which inflation is no longer a risk, or that the business cycle is obsolete? Hardly. The U.S. economy is better, and perhaps different, but not fundamentally changed. Keep those old rulebooks: They will come in handy before this expansion is over.

If a New Economy is not at hand, then why has macroeconomic performance been so impressive? Or, more to the point, where's inflation, and why haven't wages risen more rapidly?

A big piece of the puzzle is simply the high rates of capacity expansion we've seen in the past several years. Despite a brief respite at the end of 1996 and beginning of 1997, investment in durable equipment proceeds at double-digit rates. Thus, despite the economy's admirable growth record (admirable for its longevity rather than pace — this is a Cal Ripken expansion, not a Babe Ruth one), we're operating at lower levels of capacity utilization than we would otherwise have experienced.

But, more importantly, the economy has more capacity, and uses it more efficiently, than the official data suggest. First, of course, our measures of capacity are based on manufacturing and utilities. But the service sector is readily equal in importance and, relatively speaking, its capacity is plentiful and cheap to expand. Most service industries — telecommunications, finance, retailing, even transportation and health — are now creatures of the information age. Their capital stock is progressively made up of the computers and software applications that make telephone connections, price derivatives, reorder goods, process insurance claims, route airplanes and dispatch trucks, or pool and securitize receivables. The rise of these industries in the Information Age has made the entire economy more elastic on the margin.

And, in manufacturing, the level of capacity we report misses the fact that this capacity has been rearranged through corporate restructuring. Twenty years ago, capacity utilization of 90 percent in such industries as automobiles or computers meant that 90 percent of the capacity of vast, integrated value-chains was being deployed. But in the intevening two decades, those industries have been reorganized by networked production, outsourcing partnerships, and a far higher level of specialization. Chrysler is moving out of the business of making components, just as most PC makers don’t make their own chips.

Chips and auto components are now being made, therefore, and their capacity managed by, specialized firms, rather than integrated producers of the final product. The economy's manufacturing capacity has been rationalized by this type of restructuring — we're putting our capacity into the right hands. As a result, the economy is making better use of its capacity at any rate of capacity utilization. Taken together with cheap and easy service industry capacity, this allows the economy to show acceptable though unremarkable rates of growth and productivity (although slightly higher than trend once you account for biases in the data), yet truly remarkable price stability and sustained growth in profitability as well.

Then there are trade and global integration, which both play a major role in the Messianic New Economy story. There’s plenty of capacity in the world, the story goes: This output (or prospective output) forces the prices of U.S. production into submission. But the declining price of imports in this expansion probably has more to do with what's being traded than any notional higher level of competition. In fact, the price index for our durable good exports has fallen by more than its import counterpart. If trade helps inflation, it's most likely due to the fact that the products that it brings to us — computers, electronic components, telecommunications gear — are falling in price.

Moreover, the key to disciplining U.S. prices is not the level of integration but the price at which it’s experienced — the exchange rate. The good news for this expansion, now well into its middle age, is the strong dollar. So long as growth proceeds in the U.S., strong dollar “losers” will have a hard time pressing their case. But it remains to be seen whether the U.S. has the will to accept the tonic of a strong dollar should growth abate. If it can’t, then trade and global integration will seem more the conveyors of inflation than its cure.

The stickier issue is wages. The unemployment rate has fallen below most economists' guesses as to the “NAIRU.” When is the labor market going to start delivering higher real wages?

The fact is that it has, but not by enough to overwhelm the other influences on prices. Yet. Growth in hourly compensation in nonfinancial corporations bottomed out in mid-1993 at slightly less than 2 percent, stayed at that rate for about a year-and-a-half, and then doubled (to close to 4 percent) by the end of 1996. And this compensation escalation has occurred despite restructuring in the provision of health care that has allowed inflation in employer-provided benefits to fall. Wages are rising, and if profits have remained unaffected, it's because interest payments and other non-labor costs have provided some slack.

And wages are going to rise some more. Medical care inflation has declined for seven consecutive years: Will it decline for seven more? A record share of the population is at work after six years of expansion: Will the labor force continue to expand at this pace? Moreover, as the economy operates at this high level of employment, the likelihood that it will become skill-constrained increases, along with the premium that skills will demand. None of this augurs well for labor costs. Granted, some firms will have a harder time passing these costs forward than they would have in a previous expansion. But that doesn't mean that they're not going to rise, and put pressure on both prices and earnings.

Wonderful things are happening in the American economy today — a technological revolution, a sound economic policy, a wave of productivity-enhancing corporate restructuring (rather than “slash and burn cost cutting”), the vanquishing of inflationary psychology and the wage-price spiral. But that doesn't mean that we're in a Messianic New Economy in which the old rules no longer apply.

The tight U.S. labor market is going to lead to steadily rising wage gains. If the dollar falls, import-borne inflation will become a problem. And if profits growth slows, business may be tempted to use prices to catch up, no matter how much inflationary psychology has improved. The bond market is yet to build fully these prospects into its thinking.

That doesn't mean that the end of this expansion is nigh. But it does mean that we should think long and hard before buying into a New Economy Paradigm, let alone any strategy based on it. The proponents of this New Era, like the Sabbatianists, may very soon be forced into apostasy, but this time by equity and fixed income markets rather than the caliph.

An excerpt from this article was distributed by Reuters Financial as part of a series on “The New Economy” in October, 1997. The article is reproduced in its entirety for clients and friends of ESC Company.

9Jul/97Off

Rules of the Road for the Unwitting CEO in the Information Age

Over two centuries ago, James Watt invented the steam engine, unleashing the Industrial Revolution by cutting the price of mechanical work in half. Today, the price of information processing is being cut in half every two years -- the equivalent of five Industrial Revolutions every decade.

Information technology in all of its forms is transforming the economy today as surely as Watt’s device for pumping water out of mine shafts did then. We typically think about this transformation in terms of new products -- computing and communications goods and services, embedded computing in other goods, new information or entertainment products -- or as changes in the skills the economy demands (and that all too often our pre-teen age children have but our executives themselves lack).

But the transition to an Information Age economy is far more profound. To think of the computer, the microprocessor, and the digital constellation built around them as “just a technology” is like calling Watt’s steam engine “just a machine.” Cheap and ubiquitous information flows are changing the way companies are organized. They are forcing them to adopt new strategies and conceptions of what it means to be in business. They are changing our economy’s aggregate performance. And they are changing the culture of management and what the CEO is supposed to do.

To illustrate the wide ranging ramifications of this shift, consider the following five new rules for competing in the Information Age. They are not about bits or bytes, platforms or servers, or systems development -- the word “digital” appears in none of them. But while none of them are about technology per se, each of them is caused by the way epochal technological changes are reorganizing the economy. They are the new rules of business competition in the Information Age.

1. The most important thing a CEO does is to define the boundaries of his company. A generation of corporate managers was raised to see scale as a competitive ace-in-the-hole. Today, if not built on sustainable, value-creating skills, it is a potentially-fatal encumbrance.

Companies once integrated themselves vertically in an effort to control their production, meaning to manage internally all of the information associated with coordinating it. In an age of CAD-CAM, ubiquitous networks, and vibrant communications technology, why bother? Throw out everything that isn’t world-class -- or that you aren’t willing to bet will one day be world class -- and let other providers bring the rest to you.

The automobile industry is a good example. Seventy years ago, Ford opened its River Rouge plant. Iron ore and coal went in one end, finished cars came out the other. The plant produced its own electricity, rolled its own steel, stamped and milled its own parts and components.

Today, such a plant would be considered a bizarre industrial theme park. In fact, the key to successful operation in the auto industry today is dis-integration, not integration. Ford and Chrysler now produce about 25 to 30 percent of their own componentry. General Motors, in contrast, produces about two-thirds, much to its own detriment. Ford and Chrysler have wrapped their boundaries tightly around their skills in designing and engineering new product and marketing it, keeping assembly as the platform that allows them to control those activities. General Motors, in contrast, thinks of itself still as an “integrated” automobile manufacturer, meaning that it wastes its time and assets doing things that others could do better.

Here’s a prediction. In ten years, one of the leading worldwide automobile nameplates may well be Swiss -- that of Swatch, the watch manufacturer. Swatch is building an automobile production campus where it will co-locate its assembly plant with a series of component manufacturers, the logical destination of modern, network-based production. By drawing its boundaries around its true skills -- design, assembly, and marketing -- Swatch realized that it had more to offer than just watches.

The lesson of Swatch’s experience, like that of Ford and Chrysler, is that information technology has allowed every activity and every value-creating stage in every company to be subject to a market test. Drawing a boundary around what inside his company is truly sustainable and value-creating, therefore, is the most important act that a CEO performs.

2. Take a lesson from your opposite. The best service producers are those who act like manufacturers and the best manufacturers are those who act like service producers. That’s because information technology lets both of them do exactly that.

The difference between services and goods is that services can’t be inventoried. They have to be consumed when and where they are produced, as does the output of doctors, restaurants, and the kissing booth at the State Fair. This makes it hard for service producers to build scale in the way that manufacturers traditionally have, since inventories allow the timing of production and consumption to be reconciled, which gives goods producers some leeway over the flow of work.

But information technology has allowed service producers to “scale up” by allowing them to lever the service provider. The information system allows the doctor to extend himself through networked information management, remote diagnosis, and the like, just as the insurance claims processor, the loan officer, and the retail establishment can all “do more” because of the information systems at their disposal.

Have you ever noticed, in fact, how similar today’s banks and the automobile producers of the 1920's are? Both are just learning how to succeed using mass production. Henry Ford got the picture early in that decade. Banks are now just getting it. Today’s banks, thanks to the securitization of assets, an information technology trick, now make their money not by holding assets, but by originating them and then moving them to secondary markets. Their balance sheets, once fine asset residences, are now asset parking lots. Banks are financial asset manufacturing plants, producing a product of standardized and predictable quality in the most efficient way they can, just as Henry Ford did.

Meanwhile, the ability to learn more about the customer and his wants, to individualize production, and to manufacture things both faster and more flexibly is making manufacturing firms look like service companies. Consider Dell and Gateway, which now both manufacture for the customer, not for inventory. After all, a computer that sits in stock for six months depreciates about ten percent or more during its shelf life. The computer, therefore, has become manufacturing’s first perishable product. In essence, it must be consumed when it’s produced, meaning that the manufacturer must know who is buying each unit they produce, what they want, and when for each individual unit. The computer manufacturer has become the kissing booth at the State Fair.

In both cases, the capabilities of information technology drive the change. It lets service producers build scale, and lets manufacturers work more flexibly and individually. And it tells executives that they should spend some time learning about other ways of doing business.

3. Talk to capital markets. The old saw says you don’t go bankrupt because you lose money -- you go bankrupt because somebody else gets tired of your losing money. But capital markets’ perceptions are important regardless of whether a firm is going bankrupt or great guns, and need to be managed even more than ever in the Information Age.

Markets are information processing machines. They turn information into decisions. Capital markets are the cutting edge of this reality. They are deep, diverse, liquid in the extreme, and growing rapidly in international scope. And they are almost overwhelmed with information, so much so that it is becoming progressively harder for investors and their agents -- analysts, for example -- to master all of the nuances of every investment opportunity.

Capital markets, in response, are developing “brand names” -- information short-cuts, devices that provide consumers with shorthands that allow them to get the picture quickly. The word “Coke” on a can tells the consumer something important about the contents of the can. The fact that a company lists on the New York Stock Exchange tells investors something as well -- regarding the liquidity of the firm’s issues, the accuracy of the price they receive, the accounting standards the firm employs, the commitments it has made to open and honest information flows, and the like.

CEOs are becoming brand names as well. Al Dunlop, of course, is one extreme example. But the CEO who can cut through the information clutter by explaining the strategic intent of his firm, how it relates to real-world conditions, and what the next steps towards realizing it will be, turns himself and his company into capital market brand names, and will earn the returns that well-managed brands earn. Instead of focusing solely on quarter-by-quarter results -- as important as they are -- the CEO needs to build the firm’s identity as a brand name in the eyes of investors. This means taking the strategy documents that sit on shelves at headquarters and turning them into banners that explain the firm’s intent in vivid, exciting terms. The moment when the CEO starts to get sick of saying it is the moment his audience is just beginning to get it.

The moral: in the Information Age, you’ll be judged by the way you provide information.

4. Beat 'em with the clock. The hallmark of the industrial era was cost reduction. Industrial technology and organization were virtually one-dimensional, a search for new ways to amass scale in order to make things cheaper.

Information technology, in contrast, has added dimensionality to production. It has created new ways for firms to compete, to differentiate themselves and their product, and to create shareholder value.

Time is one of these new dimensions, perhaps the most important. Informated business systems make the time expended in every aspect of a business both measurable and manageable. The time from order to shipment. The time from shipment to billing. The time it takes a customer to get a response from an 800-number. Better data systems make all of these ripe for ongoing, visible improvement.

There are then the time-intensive activities that are more deeply embedded in a firm’s processes. The product cycle is an obvious example. Firms and entire industries now brag about shortening the time-to-market for their new products, as if their new-found fascination with it represents evidence of enlightenment. Is this new focus a reflection of a higher plane of managerial consciousness? Are proto-amphibian executives sprouting legs and heading up to dry land?

No. They’re just using the new tools technology has placed at their disposal. The applications of digital technology to product design, to the configuration of shop floors or service delivery systems, and even to new product market research has made it possible to shorten the product cycle and juiced the reward to doing so.

And that same pattern holds for other “new dimensions” of competition. Asset utilization, for example, has been revolutionized by a host of information technology techniques, from the securitization of receivables to automated material handling to networked production of parts and components. Customer service, from call-in help-lines to the ability to customize individual units of product, has been similarly opened up. In fact, add up time-based competition, lean asset use, and heightened customer service and satisfaction and you get what the consultants call Total Quality management. Is TQM a new insight, a higher plane of consciousness, an evolutionary advance? No. It’s just what happens when information technology is used to help business compete. The new technology has created new dimensions of competition, and it’s up to the CEO to use them.

5. The right-brained economy is upon us. In the days of vertical, pyramidic information flows, the premier players were sharp-penciled Whiz Kids who could turns scraps of data into usable information. Today, they have been supplanted by right-brained intuitors who see patterns of information that they turn into decisions.

The pyramidic organization was created earlier in this century to do precisely what computer networks now do for a pittance -- to collect, process, verify, and distribute information. Owing to the failings of human nature, of course, pyramidic organization dwellers often did exactly the opposite -- that is, they husbanded information, withheld it, and regulated it. Paperwork, routine decisions, presentation materials, and all other manners of work floated through the organization chart like Hamlet's father, searching for that elusive last act that would allow them to reach their final destination.

But today, information networks make any type of information available to anybody within a firm, and the pyramid has become irrelevant. Corporate pyramid builders now share the fate of their ancient predecessors, entombed in the rubble of their creations.

Today, armed with a single fact, you can speak directly to probably more than half the population of the Earth. That fact, of course, is their phone number. We will soon have a comparable system for data. Anybody will be able to access and manipulate almost every conceivable type of fact. "Which of our inventories have the fastest turns?" "What are the truck versus rail rates for transporting a turbine from St. Louis to Chicago?" "How do the volatility of company earnings among our competitors compare to the spreads on their paper against the London interbank rate?" Each of these questions will be as easy as "Open the pod bay doors, Hal."

The skills that this evolution in technology will reward are, of course, the skills that are most complementary with the capabilities of the technology. When we are overloaded by data, the people who succeed will be those who know how to triage the flow and create something from it, rather than those who add to the clutter. Thus, ironically, the Information Age will reward not those who have a great deal of information, or know how to manage it, or even produce it, but who know what to do once they get it.

The power of information technology is automating the analytic, data-manipulating, left half of our brains. This improves the market power of the complimentary and creative right side. The technology will favor judgment, intuition, creativity, and insight -- right-brained stuff. No less a seer than Timothy Leary agreed before his death, stating: "Computers...will replace you only to the extent that you...think like a bureaucrat, a functionary, a manager, an unquestioning member of a large organization, or a chess player." Not too long after his departure, Big Blue beat Gary Kasparov, substantiating his point.

And so, the ultimate irony -- the Information Revolution may ultimately reward the artists, poets, and philosophers. People like them will be tomorrow’s CEOs, if not today’s.

We are all now creatures of the Information Age, guided by the suite of epochal digital technologies. They are changing the way business is done in ways that have seemingly little, but actually everything, to do with technology. Regardless of whether they know their way on the Information Superhighway, CEOs need to learn these, the new rules of the road.

20Feb/97Off

Notes on a Borderless World

These remarks are taken from a speech given to an Organization for Economic Cooperation and Development conference on the “Knowledge-Based Enterprise” in Stockholm, Sweden, February, 1977. An article of the same name was awarded the Abramson scroll by the National Association of Business Economists as “Outstanding Feature Article of the Year.”

I want to thank OECD’s Directorate for Science, Technology, and Industry for their invitation to make this plenary address this morning. This week’s discussions about the global Information Age speak directly to the most important issue that our economies confront. Burgeoning digital technologies are changing not only what we produce and the way we produce it, but the way we organize to produce and the implications for aggregate economic activity. My friend and colleague Risaburo Nezu and his staff have moved DSTI and, in turn, OECD, squarely into the center of the evolving understanding of this transformation, and for that reason are entitled to our thanks.

I was watching the news accounts of Deng Xiaoping’s death in my hotel room last night when it struck me that here I was, a North American, sitting in Scandinavia, watching a news report of the death of an Asian leader. And I thought: I’m having a McLuhan moment. In fact, McLuhan’s prediction of a Global Village united by the medium of television was made over thirty years ago. In the intervening thirty years, the world has witnessed in unison a single man standing before a column of tanks in Tienamien Square, the tumbling of the Berlin Wall, and Nelson Mandella walking from captivity on Robben Island. McLuhan’s vision is being fulfilled.

The advent of digital computing and telecommunications networks has led to a comparable prediction. As computing has gotten not only smaller, cheaper, and faster, but more accessible, more integrated into daily operations and events, and more embedded in all classes of objects, we share an intuition that we are headed towards the Global Marketplace that accompanies the Village.

That it is the intuition. What is the underlying reality? Have we become a global marketplace? How has technology driven this integration? And what are the implications for both our businesses and governments?

My own view is that the Global Marketplace -- the borderless economy -- is at hand and is a phenomenon of the Information Revolution underway around us. But the extent to which these pressures have led to integration differs for businesses, capital markets, and governments.

Moreover, the unanticipated aspect of this transformation is the manner in which global economic integration is occurring. In short, epochal information technologies have “unraveled” or “dis-integrated” our firms, allowing them to act globally without having to achieve global scale. Instead, the modern firm searches the world for value-creating skills, abilities, and assets that lever its own. It is that phenomenon that is driving the “borderless economy,” and that I wish to discuss this morning.

Corporate Restructuring and Global Integration

Let’s begin with our firms.

For most of the postwar period, analysts of the transnational enterprise (both critics and defenders) have seen it as the vehicle for integrating the world’s economies. They saw the TNEs as an elite of global corporations that would make everything everywhere and would sell it to everybody. In the eyes of the French in the 1960s, the companies were going to be American. In the eyes of the Americans in the 1980's, they were going to be Japanese. But while the villains changed, the role they played did not. The industrial history of the first three decades following the Second World War is the history of the leading firms from all three regions pursuing that model: entering geographic or product markets around the world in order to ensure that rivals do not capture them, integrating suppliers and distributors into the firm to control the entire value chain, and conglomeratizing to utilize scarce managerial skills and to provide investors with diversification without their having to diversify.

But it didn’t work. Instead, this model of the firm proved to be an act of overextension and its own undoing. In retrospect, the everything-everywhere-everybody view of the transnational corporation and the integration that it would bring to the world economy was based on the premise that these organizations would ultimately prove the most effective form for organizing and managing information and decision-making. It was a bet, in essence, that global scale created more benefits by levering managerial skills and internal information and decision structures than costs through inertia and absence of focus. It didn’t work, in part, because it simply taxed the capabilities of any organization’s managerial attention, investment funds, and R&D capabilities. But the most important engine of change was the burgeoning capabilities of information technology. The ongoing improvement in the price-performance of the suite of digital technologies -- computing, communications, and other information processing -- unraveled this integrated, pyramidal model of the firm.

Cheap, fast, and accessible information processing transformed the organizational structure of the transnational enterprise from a compelling strategic advantage to an outmoded nuisance. Coordinating the various activities of the firm was no longer best accomplished by vertical structures that sent information up and down the chain of command for verification, distribution, and action. Instead, information could be shared across the boundaries of the firm as easily as within it, if not more so. Thus, each activity of concern to the firm no longer had to reside within it but, instead, could be provided externally and brought into the firm via these new networks.

The result has been the dis-integration of our largest companies across stages of production, product segments, and regions. For example, the ability to share production information -- schedules, lay-outs, specifications, designs, and the like -- has allowed companies to distinguish those stages of the production process in which its value-creating skills excel from those in which they do not. This has freed them to adjust their boundaries appropriately, and to find the skills elsewhere that complement their own. The most successful U.S. automobile producers, for example, are those that have targeted product design and engineering and marketing, leaving the development and manufacture of components to such networked “co-producers,” in the U.S. case, as Allied Signal, Borg Warner, TRW, United Technologies, or Eaton. Similarly, the leading figures in the U.S. computer industry are no longer the integrated producers -- those who produced everything from the hardware platform to the operating system and application -- but those who have specialized in one stage of the process or one component -- Intel, Microsoft, Oracle, Novell, Hewlett-Packard. Here again, cross-company partnership is being used to fill out product lines or integrated value chains, or to market to geographic regions.

Simply put, the transnational enterprise has gone from its everything-everywhere-everybody model to one that focuses on sustainable, value-creating, differentiating skills and abilities and then searches for external partners that lever them. Rather than bring new activities into the firm, modern companies now demand the highest level of competitiveness in every activity, while looking for new activities to array around the firm.

This transformation is underway in the United States, where it is often incorrectly and unfortunately referred to as “downsizing.” Signs of it are also visible in Europe and Japan, but their less open markets for corporate control have placed less pressure on their firms to adjust. As a result, they lag behind. But, in my view, these pressures for transformation are unrelenting and inevitable, and will play themselves out outside the U.S. just as they are now doing inside the U.S.

The result is global integration, but not under the command of the transnational enterprises. Instead, it is occurring through the network of partnerships, joint ventures, co-production and sourcing agreements, research collaborations, and other alliances and relationships formed under this new model.

This is an outcome to be desired. This new and different form of integration suggests more rapid diffusion of new technology, more specialization and therefore better economic performance, and a more open world economy.

This new form of organization, for example, represents a new avenue for productivity gains. Dis-integrating the production value chains in our companies means that we now have markets -- I’ll borrow from the geologists and call them interstertial markets -- where we once had organizational structures. These interstertial markets mean more competition, more price discipline, more innovation, and more specialization. Let me make my point by way of exaggeration: it is like a miniature transition from feudalism to capitalism in every firm! I believe that the growing prevalence of this approach to organization in the U.S. -- a product of our system of corporate governance -- is an important part of the explanation of the exceptional inflation performance of the U.S. during the current expansion. Growing specialization and more interstertial markets make firms more specialized and efficient, better users of labor, and help to contain cost pressures. The result is less inflation at the current stage of the business cycle than we would have imagined, if at all.

A second important aspect of this new model of networked borderlessness is that it allows greater ease of entry. More interstertial markets mean more points of access. This allows companies and their nations to find their specializations more readily, and to have the prospect of greater bargaining power than they might have had under the old integrated system. This may be a particularly good outcome for developing nations.

Capital Markets Lag

Somewhere behind our corporations in the integration process are our capital markets. Economists have long heralded the coming integration of the world’s capital markets. The technology that links the world’s capital markets already exists -- the global computing and telecommunications network. Data now circles the Earth as a representation of capital. A body of theory now exists to describe capital market integration, complete with theorems that guide us to understand the results it will produce.

The only problem with all of this preparation is that the integration hasn’t happened yet. Capital markets persist in showing a frustratingly national character. Interest rates have not yet obviously overpowered trade flows as the dominant determinant of exchange rates. “Covered parity” explanations of these phenomena are still more theoretical than actual. Currencies stubbornly refuse to converge to purchasing power parity values. And the isolation displayed by the Japanese stock market during its recent rundown (as well as the U.S. bull market) shows that the global linking of equities is also not yet at hand.

All of these results are surprising. Capital is the world’s most fungible and potentially mobile commodity. Still, it has yet to become truly worldwide in its outlook, (although, granted, the process of integration in global capital markets has not yet run its course). So while capital’s horizons are ever expanding, it still demonstrates some old-fashioned charm, preferring to stay at home when possible.
Why? Obviously, the place to start is regulation. Many nations see their capital markets as a national policy asset or preserve, even if their value as such is probably being undone by the integration in the real-economy activities they exist to finance. Others fear that foreign finance -- be it through equity listings on the major global exchanges or the provision of foreign debt -- represents a challenge as opposed to an opportunity. And some are concerned that deregulation would unveil the true state of their domestic finance or banking industry, and that the costs of ongoing regulation are less than the costs of adjustment. I have difficulties with all of these reasons, but that is another matter. They are all barriers to more complete integration.

To some extent, the absence of greater global financial integration also reflects the fact that global information networks are yet to overcome the suspicions that impede capital’s cross-border flow, be they about accounting, language, or culture. In the U.S., for example, our capital markets are integrated not only by their deep liquidity, the absence of fragmenting legislation, and a common currency, but by the free flow of good information about opportunities. Analysts provide research products that create this condition of information liquidity. If this is the case, then the prospects for further and rapid integration are clearly strong as we find new ways to create this information liquidity in global markets that overcomes divisions of language and culture. It also speaks to the importance of developing international accounting standards that allow investors worldwide to have the same reliable information about all the companies in which they invest.

But there also may be weaknesses in the underlying theory. In essence, the idea that the world’s capital markets will come together as one requires us to believe that all investors have the same reaction to inflation everywhere. If they do not, then why should inflation differentials narrow? But an investor in the U.S. is exposed to a far higher-level of U.S.-based price risk than to price risk in other nations, if only because that investor consumes untraded U.S. goods and services. And producers may view inflation risks in proportion to the nature of their markets or the structure of their costs. Investors in each nation, therefore, may not care equally about inflation in every locale, and may not, therefore, drive capital markets to produce the inflation-equilibrating result that real integration produces.

All told, our theories regarding “open economy macroeconomics,” however elegant, need to wait for underlying reality to catch up to them. But there is the undeniable feeling that, sooner or later, they will.

National “Advantage” In An Integrated World

The last group to consider is government. It is not surprising that government, a creature of borders, be the least susceptible to borderlessness. Yet what is it that governments in this new world ought to do? How should they think about borderlessness?

I see the problem as follows: when Ricardo first wrote about trade, he wrote about a world in which goods were mobile but factors were not. Today, we live in a world in which almost every factor is mobile. If it cannot travel directly, as might a blueprint dispatched via fax or management skills imparted by foreign investment, then it can be incorporated via partnership, alliances, joint ventures, or any of the other techniques by which modern corporations extend and complement their ability to create value.

If the web of plug-and-play corporations that now dominates the world economy can deliver virtually any resource to any place, then what distinguishes one economic location from another? What are the remaining determinants of economic competitiveness?

The answer and, to my thinking, the guiding framework for government economic policies, is this: in a globally-linked, information-intense, factor-mobile world, the determinants of economic competitiveness are related to the economic setting created by the interaction of public sector policies and business decision-making. That is, our economies will compete as well as the behavior of our companies allows and, in turn, the policies around them permit.

That suggests to me that the goal of policy is to improve this “economic setting.” This broad objective subsumes a wide variety of policy areas. But I wish to focus on only a few this morning, beginning with technology policy. Innovation is a hard objective to pursue, and even harder to buy. But, given its very high rate of return, it is likely that well-designed innovation programs, involving sound technical criteria, cost sharing, and broad potential social returns, will make good use of public moneys. This argument rests on the striking research result showing that the social returns to new knowledge in the economy are greater than those appropriated by the original innovator. It is clear that, absent intervention, we will not produce as much R&D as we should.

But the case for diffusion policies is even stronger. It strikes me as extraordinarily likely that a dollar competently spent on diffusing good technological practice to our firms will earn a very high return. I say this given the evidence collected from longitudinal data on plants and firms in the U.S. and other nations suggesting that a relatively small number of “heroic” firms or plants account for a substantial share of the gross job creation in the economy. Moreover, the same research demonstrates that most of the economy’s advances in productivity occur not because of general improvement in all plants or firms, but because these “heroic” high-productivity plants out-compete low-productivity ones, gaining market share from them even as they create employment.

All of our economies reserve a special place for small business. But too often the place we reserve for it is more special than the small businesses themselves. Rather than think about how to create larger numbers of small businesses, we might think about how to make more of the existing ones successful. Diffusion policy goes directly to this objective.

A second area that should be considered part of structural policy is the quality of the decision-making produced by our governments. I mean this in a sense larger than such basics as making good macroeconomic policy or liberating telecommunications for competition.

For example, is the entirety of economic policy consistent? Do we provide tax benefits for R&D but then deploy other tax features (such as foreign tax credit limitations) that work in the opposite direction? Do we examine all expenditures for export promotion and determine their relative worth? Or, for that matter, do we subsidize exports and then deploy farm policies that discourage them by guaranteeing a return in our domestic markets? Are our data collection efforts dispersed in an uncoordinated fashion using inconsistent methodologies? Inconsistent policy sends bad information, decisions, or signals to our firms and wastes the time and energy of all concerned.

Second, is government competent? The administrative aspects of government alone address a wide variety of activities. Are they effective? Are the boundaries of government involvement correctly defined? Is outsourcing used when appropriate? Do the rules for government hiring lead to the right balance between developing expertise and institutional memory in the government on the one hand and avoiding entrenched bureaucracies on the other?

Third, what is the decision-making process? This is an important issue in all of our nations. Does the system produce political latitude, does it make decisions quickly, does it make the right number and level of decisions, or does it overburden itself with too much to do? This may sound like standard “good government” rhetoric, but it is more than that. Our ability to make good policy decisions goes directly to our ability to compete. Consider the following: the first of the advanced economies to address forthrightly its major structural economic problems -- be it deregulation in Japan, the role of entitlement expenditures and health care in the U.S., or the need for more entrepreneurship and labor market fluidity in Europe -- will probably realize substantial gains in competitiveness by making their economies more efficient and creating a better “economic setting,” while their competitors will watch from the sidelines. The maturity of our political systems -- or absence of it -- goes directly to our economic prospects.

Openness As A National Competitive Strategy

A third and final area of structural policy that deserves mentioning is openness, in trade, investment, and corporate governance. Openness itself is an important national economic asset. In a globally-integrated economy, autarchy policies are doomed to fail. In a narrow way, this proposition is visible in trade flows. Our nations turn imports into exports -- using the example of the U.S., the most open of the three major regions -- from componentry that is integrated into computer systems to equipment that produces electronic media and film entertainment.

But, in a broader sense, openness is a vital precondition to building our firms’ competitiveness. Today’s corporate manager is the one who can define what her or his firm is good at doing, wrap his company’s boundaries tightly around those abilities, and then find skills and abilities elsewhere in the world that complement and lever his own. Technology’s ability to “dis-integrate” our firms means that the vertical value-creating chains that once resided inside our organizations will be reassembled as global networks of production. Our companies need to search for their place in this network. Only an open environment, one that allows trade, investment, and that promotes governance focused on adaptation and change, can promote this objective.

Policies such as these are good structural policies and important aspects of producing an economic setting that gives our firms the right incentives. In an integrated world economy, they are the means by which our economies differentiate themselves. And they provide a good backdrop for macroeconomic policy as well. They make it more likely that macroeconomic policy will work and, by liberating the forces in our economies that create new employment and foster growth, take some of the pressure off stabilization instruments.

Governments As Stewards

Finally, we must respect the simple fact that there are fewer and fewer domestic policies in our world. Technological subsidies, export promotion, and regional development all now spill over more pervasively than ever before. But the same forces of integration that led to greater spillovers also provide us with a way out. If we focus on building our nations not as competitors but as productive environments, we foster our national interests, but growth as well. If institutional competition means that we invest in skills in our people, promote R&D and both innovation and diffusion of knowledge, or adopt forms of business organization that are more productive, then the world is better off.

Alternatively, if it means that we export environmental amenities through sub-optimal internalization of environmental costs, or that we compete through direct subsidies unrelated to a growth mission, or develop lax standards for bank regulation, corporate disclosure, bribery, or other matters, then we will all pay a price.

The good news might be that the pressure to take this second road has always been with us. Greater integration seems not to have intensified the pressures to compete through policy so much as it appears to have provided us with a greater awareness of the danger and new means to address it.

Our governments are slowly but surely learning how to cooperate. The international linkages inherent in stabilization policy are now institutionalized through the G-7. Nations have learned to act in concert to perform such once-national tasks as promoting bank capital standards, eliminating dangerous chlorofluorocarbons, or beginning to address the prospect of climate change. Recent weeks have seen sometimes dramatic progress towards global agreement in the areas of intellectual property and telecommunications market opening.

The growing borderlessness found in the first two spheres I’ve discussed -- business and capital -- is increasingly forcing itself on this third one. Governments are slowly being transformed from domestic policy makers to stewards of the nation’s interests in global policy making. There is no shortage of issues that merit inclusion in this new approach to doing business. Accounting standards and, down the line, greater conformity regarding corporate chartering and governance seem likely candidates. So might be further progress regarding intellectual property, standards for competition policy, climate change, and a variety of other areas.

If we can make this transition, then a borderless world might end up fulfilling its promise of being a better one.

25Apr/95Off

Where Will Technology Take the Economy? The ‘Firm of the Future’ and the Digital Suite

Prepared Remarks of Everett M. Ehrlich, Under Secretary for Economic Affairs, U.S. Department of Commerce, Before the University College University of Denver — Denver, Colorado — April 25, 1995

My topic this morning is technology and the economy, specifically, about how the dramatic acceleration of information-related technology, or as I'll call it, the "digital suite," is going to change our economic future.

Thinking about my remarks today led me to remember other predictions about the future. Remember the Jetsons? Cars flew instead of rode. People moved about in pneumatic tubes. Robots with vacuum tubes for eyes rolled around and acted out the fantasy of homes without housework.

The Jetsons was, in other words, a picture of a life driven by the products of technology and a life unchanged from its current pattern.

Even more importantly, the Jetsons view of technology was centered around its use in the home -- the tube-eyed robot and the flying car. But, to my thinking, the most dramatic effects of the new technologies around us won't be felt most immediately in the home, but somewhere else -- in the firm. The digital suite is going to force our firms to change the way they behave, and by so doing, will change our economic lives.

Firms are the place in our society where technological and economic change occur. That's their job -- they're supposed to figure out how to use new technology effectively.

And they do that because they prosper if they do. Census Bureau research shows that firms that use advanced manufacturing technologies (and "advanced" means digital -- CAD/CAM, automated inventory handling, networked supplier relations, and so forth) hire more people, pay them more, have a lower failure rate, and have higher gross margins than their less innovative competitors.

Firms grow, in essence, because they out-innovate the competition. So if we want to see where technology is going to take the economy, we have to start by examining how it will change our companies.

When I was back in the computer industry, before I joined the Administration, a friend of mine showed me a quote that went like this: "You can tell that the computer is an epochal invention, because an epochal invention is one whose users make more money using it than its producers make producing it."

That's right on the mark. The power of today's computers has become a commodity product -- it's cheap and easy to get and use. But the things that we do with those computers are infinitely differentiable, each application unique to its circumstances, each user exploring some different possibility opened by this burgeoning capability. And this, therefore, is where the power of the information revolution -- the "digital suite" -- will find its greatest expression -- in the firm, not the home.
A few on-line services probably to the contrary, our households demonstrate a fascination, but no burning interest, in a digital way of life. But the technology is already pouring into our companies. It is driving the wave of restructurings that have become commonplace in recent years, changing our concepts of business strategy, creating new dimensions of competition in the marketplace, and by so doing, changing the way our economy behaves.

The question, therefore, is this: how will cheap and ubiquitous compute power change our productive organizations and, once they have changed, how will they change the world in turn? Forget tube-eyed robots cleaning up the "home of the future." The real question is, what will the "firm of the future" look like?

The answer begins with the fact that the price that firms pay for information is falling at a staggering rate. Let me put that in historical context. James Watt invented the steam engine two centuries ago to pump water out of mine shafts. His invention, which began the Industrial Revolution, cut the price of mechanical work in half -- that's all. But, through stunning advances in technology, we are cutting the price of information, of data processing, and of telecommunications capability in half about every two years.

How have firms responded to these changes? The first and most conspicuous change is that they have become flatter, disgorging layers of middle management that are now useless. The pyramidic organization was created earlier in this century to do precisely what computer networks now do for a pittance -- to collect, process, verify, and distribute information. Owing to the failings of human nature, of course, pyramidic organization dwellers often did exactly the opposite -- that is, they husbanded information, withheld it, and regulated it. Paperwork, routine decisions, presentation materials, and all other manners of work floated through the organization chart like Hamlet's father, searching for that elusive last act that would allow them to reach their final destination.

But today, information networks make any type of information available to anybody within a firm, and the pyramid has become irrelevant. Corporate pyramid builders now share the fate of their ancient predecessors, entombed in the rubble of their once-glorious creations. Instead of a pyramid, the organization chart of the modern enterprise looks like the seating plan for an orchestra or, perhaps more apropos, the network diagram of the enterprise's information system, because in some basic sense they are appended to it. Indeed, the "flat company" is the first visible product of the Information Age.

But a second and even more profound change has to do with the "right-sizing" of our companies, and I use "right-sizing" as an alternative to "down-sizing." Let's contemplate for a moment the following economic question: just how large should the "average" firm be? A fellow named Coase thought this through some while ago and was awarded the Nobel Prize years later for his answer. It was that the size of the "typical" firm is determined by its ability to process information more effectively than the market -- it will continue to grow so long as it can manage its activities better than a group of firms could by coordinating their activities through the market.

Let me give you a practical example of this theory in action, if only to assure you that some of the esoteric thoughts that economists have are of value. About seventy years ago, Ford Motor built its famed River Rouge plant outside Detroit. Iron ore and coal come in one end, finished automobiles out the other. Ford built a plant of this grand scale because it felt -- correctly at the time -- that it could coordinate all of these activities -- metals refining, electricity generation, parts machining, body construction, final assembly -- better than could a series of firms coordinating their activities through transactions.

Today, the successful model of automobile companies is exactly the opposite. The most successful U.S. automobile manufacturers -- Chrysler and Ford -- focus on what they do best -- product design and engineering, and mass marketing. They produce only 25 percent to 30 percent of their own components, while General Motors produces about two-thirds, much to its dismay and disadvantage.

And the reason for this dramatic -- and recent -- change in the auto industry is the rise of the digital suite. Powerful and accessible computer networks have eroded the distinction between what is inside and outside the firm. Parts suppliers no longer need be within the organizational boundary of the enterprise: they can now be part of a "virtual company" that shares information and acts on it in concert, sending computer-designed parts specifications over networks, changing them in real-time fashion as appropriate, and controlling the flow of parts and components better than the pyramidic model ever could, all because the digital suite allows them to do so.

In Coase's terms, the ability to process information cheaply has shrunk our companies. And, by so doing, it has increased the economy's productive potential. If a firm can coordinate most -- if not all -- of its processes with other firms, then each of its stages of production, each of its product lines, each of its market segments is subject to a market test. If they are not "best in class" in that stage, or that product, then they can build a networked relationship with somebody who is.

As a consequence, the new technology is a wake-up call for those firms that thought that their size was a sustainable competitive advantage. Cheap information networks allow partnership and specialization to substitute for size or scale. Thus, the companies most shaken by the forces of corporate restructuring -- GM, Sears, IBM -- are those who thought that their size would sustain them. To their surprise, they're being challenged not by other integrated Goliaths, but by a network of specialized Davids.

Thus, just as it is creating "flatter" companies, the new technology is producing more specialized, or "focused," companies who are winnowing themselves back to their true value-creating skills, where their "best in class" competence lies. Our productive system is evolving into a constellation of such companies bound together by flows of information. And as is true of the heavens, to be in such a constellation, every company must be a star.

The trend towards more specialized competitors does not always mean smaller ones. Paradoxically, information technology has finally provided a basis for achieving greater scale in many service industries, for precisely the same set of reasons that it appears to be dis-integrating the production of goods.

The problem in service industries is that their product is consumed at the moment it's produced. When you go to the doctor, that moment happens in the examining room; at the store, it takes place at the cash register. Inventories, the part of the system that makes scale-based production possible, don't exist. How then do we lever the service provider -- the doctor, the store clerk, the banker -- at this point of consumption in order to achieve scale and productivity growth?

The answer is -- through information-based administrative and logistical systems. The ability to process information cheaply now makes a large health care provider better able to manage its operations than a series of smaller competitors, as it does for banks, or even for retailers -- witness Wal-Mart, Dillard, Toys 'R' Us, or any of the other new giants of retailing, all of whom are little more than sophisticated computer networks with stores appended to their nodes. Just as the falling price of information is creating vertical dis-integration in the production of goods, it is creating opportunities for horizontal integration in services with the same effect -- greater specialization and potential productivity growth.

So, technology is making our firms flatter and more focused, and -- one more "f" -- faster. Information systems have allowed firms to compete on the basis of time, not only because they allow firms to act more rapidly, but because they make time more visible, whether it be the lag between product design and manufacturing, or order and shipment, or between claim processing and payment, or between proposals and approvals, or the time it takes for a customer to call an 800 number and get a satisfactory response.

Time-based competition is only one example of an answer to the following question: if I could know everything about my company in a real-time fashion, then what would I do? Shortening up my company's cycle time is only one of the possible answers.

Another answer is better customer service, particularly through customization. Customization means changing the information that goes into the production of every unit of output -- be it a good or a service -- it provides. Which auto company is the one that says "Let us build one for you?" In the future, they're going to mean it. Mass production will give way to mass customization. Moreover, as the economy rises to a higher level of specialization and competition, margins and profits are going to come under pressure, and the ability to compete on the basis of time, customer responsiveness, and product customization will be an important way to maintain earnings -- in essence, they are all ways to add a value-added service layer to a more commodity-like manufacturing product.

Yet another new dimension of competition is the higher level of attention paid to a very old objective -- asset use. Information networks allow our companies, perhaps for the first time, to have a meaningful, real-time handle on where their working assets are -- receivables, parts and components, works in progress, even cash and liquid assets. Balance sheet engineering is now a vital business practice -- the equivalent of keeping the sail perfectly positioned against the wind -- because we now have the means to do it.

In fact, if you put all of these precepts together -- asset management (or, more generally "lean production"), time-based competition, and customer response, you get what we've come to call TQM -- Total Quality Management -- which is little more than working quickly, smartly, and efficiently to create value through customer satisfaction.

Does anybody really believe that these weren't business goals before TQM became popular? Are today's managers really that much more insightful than their predecessors? At the risk of challenging this hubris, it's no wonder that TQM and the re-engineering revolution it has unleashed have become the business fashion of choice in recent years. They are in vogue today because they call up aspects of business practice that are only now being brought to the fore by the capabilities of the digital suite.

This, therefore, is my outline of the "firm of the future" -- the ways that firms will be driven to reconfigure and reorient themselves in order to manage the remarkable possibilities that the digital suite is creating: in other words, how they will change in order to survive. They will become more atomistic, specialized competitors, that continually redefine their boundaries in order to focus on their most formidable value-creating skills and let others do the rest. They will compete on their ability to respond quickly to changing conditions and customer preferences or, in essence, their ability to use information. Their transactions will take the form of partnerships that stretch across their organization boundaries, and will resemble embraces rather than handshakes.

I've taken a good amount of everybody's time talking about these changes in the firm. But I've done so because these changes have repercussions for how every other aspect of economic life will be organized. The digital suite is more than just "technology:" calling it "technology" is like calling Watt's steam engine a "machine." For just like the steam engine, or the invention of interchangeable parts, or the assembly line system, the digital suite will not only reorganize production, but the world around it.

Let me give you three examples from three different areas. The first concerns how our people find opportunity and security in our society.

In every corner of the industrialized world, we have gradually moved the firm into a loco parentis relationship with its employees. In the U.S., we've come to view the firm as the vehicle for delivering much of our social well-being. Our firms train us, promote us, and provide us with health care, sometimes child care, and finally retirement incomes. And a career with one such employer was the ideal, if not the norm.

But that bargain looks ever harder to fulfill. As firms continually redefine themselves and adjust to more rapidly changing competitive conditions, and as job content changes in response to technology, it seems likely that a higher level of job turnover will become a fact of life. And that means that the entire system by which we provided our workers with security and advancement is going to come under stress.

The Administration's health care proposal was in part a response to this trend. It allowed small and large employers equal access to delivering health care to their employees, and it allowed workers to move from job to job without losing their benefits. In essence, it separated the provision of health care from a worker's tenure with any one workplace.

Health care isn't the only example of our need to deliver security and opportunity in the context of a career based on moving from job to job. For example, we need to consider ways to shift gradually to a more portable retirement income system based on defined contributions instead of benefits, partly to encourage labor force mobility, partly to highlight the need for individual saving, and partly to assure greater consistency in funding. We should consider, for example, whether to allow employers with fully funded defined benefit plans to retire those plans and allow the assets to revert to participants' IRAs, for example, as such a transition device.

And if we are going to develop a new model of security in a world of constant change, then we need to give our workers assets equal to the challenge. One exciting possibility is national skill standards.

What if we had a set of truly national skill standards -- something that established a common definition of a "class C systems engineer" or a "level 4 laboratory technician" everywhere in the U.S.?

I think that a variety of things would happen. First, the existence of a "standardized" product could induce new private sector providers into the market for adult skills training. For if we believe that the pace of technology is going to continue to accelerate, then there are going to be millions of mid-career adult workers in need of such skills development. The government alone can't do it -- private sector providers will have to be a major part of the answer.

But even more important, skills standards would give the worker an asset that would assist in their mobility -- standards would grant them a credential that turned the skills they had acquired in their worklives into a portable asset. Thus, it would help to insure them against the de-skilling that is too often associated with leaving a job. It would be a credential that preserved the value of their skill, and therefore provided exactly what the system will be forced to provide -- security in the face of change.

A second interesting aspect of the "firm of the future" and the digital suite concerns their implications for the prospects for the American economy in the years ahead.

Let me ask you another economics question -- what makes an economy distinct in today's world? We live in a world of cross-border alliances, joint ventures, and partnerships, transnational firms, cross-border capital flows, and increasingly significant migration. When you get right down to it, the rising level of global economic integration allows any company in any leading nation to get its hands on almost any resource around the world -- any skill, any material, almost any technology, and so forth. So in one sense, the world's economies are becoming more alike.

I think that the answer is this: the last remaining national economic attribute is, in a broad sense, our "system." We are defined by our macroeconomic rules, our corporate governance, our business culture, the beliefs of our managers, executives, and suppliers of capital, and our view of individuals and organizations. After all, if markets can bring you "anything" -- any factor, almost any technology, any resource -- then our "competitiveness" will be determined by the way in which we put together what markets offer us.

If this is the case, then our economic future looks strong. The "firm of the future" is one that can redeploy itself to fit changing conditions and demands. It is one that digs out entrenched bureaucracies and reorganizes itself to live without them. It is able to redeploy its boundaries to take advantage of excellence in its partners and suppliers. And our economy has a system that gives executives precisely this free hand. Our executives have every incentive to adjust their boundaries expeditiously, and our capital markets have the depth and liquidity to facilitate these rearrangements.

There was a time when these aspects of the system were condemned as myopic. And perhaps that tendency is the price we pay for the benefits of the way we do business. But those benefits cannot be denied -- they are the reason why our economy looks vibrant, and our competitors' listless by comparison.

And there is one aspect of our "system" that receives special mention -- openness. Economists have long preached the theoretical virtues of open trade. It's time that we endorsed it as a competitive strategy. We add engineering to foreign memory devices and produce computers. We add design to foreign componentry to produce automobiles. We add imagination to foreign video equipment to produce filmed entertainment. As Japanese firms are learning as they watch U.S. firms emerge from their restructuring -- and as they are relearning as they dispose of U.S. entertainment properties -- a great deal of time and money can be wasted by denying the value of what markets already bring to you. Our system's opposite inclination will be an even more important strength in the future.

In this regard, the wave of restructurings in corporate America, as it races towards this new model, stands in stark contrast to our major competitors. Japanese keiretsu-style relationships look rigid and unyielding by comparison. And they will look even more so as Japan inevitably becomes a more open economy and these firms compete in a global market in which each practitioner exists not because they are "in the family" or "on the board" but because they are "best in class." European state enterprises or co-determined companies also seem to lack the footwork needed to navigate these changes.

That's not to dismiss these regions as competitive failures. But it is to note that they face formidable challenges as they try to do what our system is designed to do -- to change. And that ability may be the reason to be confident that the restructuring process in the U.S. contains the seeds for a long term positive economic transformation.

A final phenomenon I'd like to discuss goes to a precept of our business culture. One important aspect of the digital suite is that it's easy to use -- the more sophisticated it gets, the less you need to know about it. In that sense, computing and networks are more like automobiles, as opposed to televisions. That is, as automobiles got "better", they became simpler to operate. Televisions, of course, are the opposite, or so it occurs to me as I stare blankly at my VCR. The more capability, the harder they are to figure out.

Computing is going the automotive route -- as its embodied technology becomes more powerful, the easier it is to use and the more accessible it becomes. "Point and click" computing has taken this to a new level: voice recognition promises to advance it even further, and it is not that far away.

The gating item is database management. Today, armed with a single fact, you can speak directly to probably more than half the population of the Earth. That fact, of course, is their phone number. One day we will have a comparable system for data. Anybody will be able to access and manipulate almost every conceivable type of data. "Which of our inventories have the fastest turns?" "What are the truck versus rail rates for transporting a turbine from St. Louis to Chicago?" "How do the volatility of company earnings among our competitors compare to the spreads on their paper against the London interbank rate?" Each of these questions will be as easy as "Open the pod bay doors, Hal."

The skills that this evolution in technology will reward are, of course, the skills that are most complementary with the capabilities of the technology. When we are overloaded by data, the people who succeed will be those who know how to triage the flow and create something from it, rather than those who add to the clutter. Thus, ironically, the Information Age will reward not those who have a great deal of information, or know how to manage it, or even produce it, but who know what to do once they get it. The technology will favor judgment, intuition, creativity, and insight -- right-brained stuff. It will be the ultimate triumph of the liberal arts majors. They will be tomorrow's CEOs.

There is a certain gleeful irony in this "right-brained economy." The power of information technology is automating the analytic, data-manipulating, left half of our brains. This improves the market power of the complimentary and creative right side. No less a seer than Timothy Leary agrees, stating: "Computers...will replace you only to the extent that you...think like a bureaucrat, a functionary, a manager, an unquestioning member of a large organization, or a chess player."

And so, those are my messages today. Yes, technology will allow us to have intelligent software agents to find us the best prices for ski weekends, and we might well be able to take a virtual walk down the beach one day with our sister, Winston Churchill, or Sophia Loren. Our living rooms may yet become shopping malls and amusement parks.

But we will first see a restructuring of our private sector, the advent of the "firm of the future." And the ways that they change will have implications for all of us. For in the final analysis, technology changes more than the things we have -- it changes the way we do things. And the "firm of the future" will reflect that basic tendency.

A last point that I'll make this afternoon relates to the following. Consider the topics we just discussed. We talked about how individuals will find security in society. We talked about our nation's economic prospects. And we talked about the emerging aspects of our culture.

They're all important items, but they all came up because they are all related to how the firm of the future uses technology. The way firms use technology is big stuff, that the innovative process in our private sector will have a great deal to say about the kind of society we become. We have to pay attention to that process, to nurture it, and to frame it in a partnership with the public sector that moves us all ahead.

Thanks very much for your attention.

14Sep/94Off

The Economics of Signal: What’s Ahead for the Information Superhighway?

Remarks of Everett M. Ehrlich, Under Secretary for Economic Affairs, U.S. Department of Commerce, before the Computer and Communications Industry Association — Chicago, Illinois — September 14, 1994

I appreciate having the opportunity to be here this afternoon and to speak to my colleagues at the CCIA about my views on the economics of the information superhighway. It's a topic to which I bring several perspectives.

First, my organization, the Commerce Department, is the lead agency of the federal government charged with bringing that superhighway into existence. Commerce Secretary Ron Brown chairs the Administration-wide Information Infrastructure Task Force that will implement this mission.

Second, as the Under Secretary for Economic Affairs and, therefore, the executive of interest in the Department for economic policy, I have the specific mission of analyzing the structural changes underway in the U.S. economy and their implications for our economy's future. And the information superhighway -- I'll call it the network -- is the most active source of change in our economic lives today.

Third, and by no means last, as a former executive of Unisys Corporation, I've seen first hand changes in the hardware and software industries, and, most importantly, I've seen users both succeed and fail using information technology to transform their organizations.

I'm going to talk about three basic issues today:

  • the changing "balance of power" within our industries;
  • the "theory of our business" -- what is it that we're selling when we further extend the network into the marketplace?; and
  • government's role -- what government can and should -- and will -- do to advance this agenda.

THE BALANCE OF POWER

Computing traditionally has been measured by the dimension of smaller, faster, and cheaper. Each successive generation of hardware is compared to its predecessors along these lines. The compute power that sent a man to the moon is now dwarfed by what's on your desk. The compute power of the first Univac is in your wristwatch.

But a second dimension of computing now dominates its application -- not just smaller, faster, and cheaper, but more open, accessible, and flexible.

And so it is with the network. Just as the compute power of hardware inevitably overwhelmed the user's ability to do things with it, so it will be with the growing functionality of the network.
Today, all you need to know about anybody in the world is one fact and you can find them and speak to them in less than a minute. That fact is their phone number. One day, we will be able to contact data in the same fashion. Any fact, any image, any sound, any document, any data product or exchange will be available in the same fashion.

When that day comes, what data will people want to call up?

We do not yet know the answer. Our success to date is frankly poor. On-line services -- correct me if I'm wrong -- have catered to date to enthusiasts for the technology more than offering any newfound functionality.

Greater compute power, greater connectivity, will not solve the problem, because the problem is not technological. The problem is anthropological. Our software engineers were the right people to write applications that apply compute power to doing specific tasks. They are the wrong people to develop computer-driven ways of living and experiencing.

Who will solve this problem? Disney. Spielberg. Diller. Geraldine Laybourne. The world's premier signal creators. And a next generation whose names we don't know, but our kids surely will. They will show humankind the ability of the compute power and the connectivity to touch something within us. And that is lesson number one: the network will spread not by its ability to carry more signal, but by the signal it carries.

Compute power plays a role. Voice recognition will one day -- I'd guess in a decade -- be where point and click computing is today, and will result in a similar order-of-magnitude leap in accessibility. Computers are in this sense like cars and not like televisions -- that is, greater technological sophistication has made them simpler rather than harder to use. The question then becomes: what do I do with it? Computing and connectivity penetrate the market because of the applications that rationalize the compute power and the technological capability.

In short, hardware is trash, and signal is cash. Technology is not the product. Signal is the product.

Let me tell you a story about a friend of mine, a cinematographer named Steve Poster. Steve was hired by Sony to make a demonstration film of their HDTV system. Steve was a good choice -- he's both an artist and a thoughtful student of technology.

Sony so liked Steve's work that they brought him to Tokyo to talk to their engineers about the system. Picture Steve -- he's a light meter type, you know? -- in front of hundreds upon hundreds of Sony engineers in a massive auditorium. He tells them this: the first time Arnold Schwarzenegger turns into a stream of molten silver, people will pay seven bucks to see it. The second time he does it, people will want to know how he's going to catch the bad guy. The technology is not the movie, not the product, not the story. The creativity is.

They stood up and applauded. They got it.

One day, capital intensive, fixed-cost systems will compete in a business defined by market penetration. In the last several years, I have seen articles that say that cable will beat telco because its infrastructure is more modern, that telco will beat cable because it's the known medium, that satellites will beat both because they don't need expensive infrastructure on the ground, or that low-power microwave and other esoteric possibilities that I really don't understand will emerge as the technology of choice. There are all sorts of possibilities.

What do these articles mean, taken together as a group?

  • First, they tell us that the technologies are going to compete. Households will have the ultimate A/B switch.
  • Second, they tell us that technology will not differentiate carriage providers. Everything will be breathtaking -- breathtaking won't differentiate. Ease of use might, but technology makes ease of use a moving target.
  • Third, pressures to price to gain share will be unrelenting -- quite the opposite of today.

Perhaps I'm too driven by the shifts in the composition of the computing value chain that I experienced, but this suggests a profound shift in value-creation -- the "balance of power", because in markets, value creation is power -- to signal providers.

Carriage will be a commodity product, a platform on which value-creating products will be delivered. Integrated carriage and signal providers will be forced to one end of the "stack" or the other. Signal producers -- Disney, Viacom -- will consolidate their signal "brand names" as a way of cutting through the inevitable signal clutter. Signal carriers -- be they cables, telcos, Sky TVs, or whatever -- will be forced to innovate continually to cut costs and support their drive for share. And by competing, they will extend the market for signal and their own need for it.

WHAT ARE WE SELLING?

There's a wonderful article by Peter Drucker in Harvard Business Review this month on his notion of the "theory of the business". Any business is founded on a set of premises about where its sustainable advantages lie and how it creates value for the customer. What's the theory of our business? What are we selling?

My answer is drawn from my experiences at Unisys. Smart information technology users were re-engineering before they knew the term. They used the technology to rewrite the script, to change business process. Some thought of it as "cleansheeting" the enterprise. Those who didn't bought an expensive paperweight or door stop. It was a real-life demonstration of what Shoshanna Zuboff saw as the difference between "automating" and "informating".

And that's what I believe we're selling: change.

For business, we know this story. The informated business environment has given us concepts about business that are part of a new conventional wisdom about being in business. Process re-engineering. Time-based competition. Networked production. Smaller minimum scale. Customization as a competitive norm. Close to the customer. Faster product cycles. Better asset use. New dimensions of competition, new types of strategic advantages. Our productive base is literally being transformed -- technology is driving an epochal reorganization of the way we do business.

Households are going to have a parallel process -- but we've not yet cracked the code. When we have the tools that allow compute power and connectivity to change their lives, they will respond. The industry will be commanded by those who can conceive of how to change our customers' way of life, their use of time, their range of experience, they way they are amused, the way they navigate the world, the way they manage daily affairs. It will have to be simple, accessible, basic, and experiential.

Because that's what we're selling -- a new way of life. The product isn't the information -- it's what the information allows you do, how it allows you to feel, what it allows you to experience. Better cars led to more vehicle miles travelled not because people got in those cars and went places, but because they gradually changed their living patterns in a way that integrated those cars into their daily routine. It won't be different for us. We need to sell change -- to show our customers how to change their routines and let that integration take place. And we're not there yet.

WHAT ABOUT GOVERNMENT?

I've come to tell you about your business. I hope I'm right. And I hope, whether I'm right or wrong, that you're right.

This Administration knows that your industries are agents for profound change. The digital revolution is an epochal event. We welcome its changes -- and if we didn't, we'd have to learn to tolerate them anyway, because they're inevitable.

And like many of you, we intend to be in the business of social change. And so, we're obliged to have a vision of what that change should look like.

We've articulated such a vision. First, we see the network as a vehicle for improving our economic growth, productivity, and potential for a rising standard of living. We see it as a vehicle for greater international competitiveness, as a way of developing and levering the great assets of the American business environment -- its flexibility and adaptation, its emphasis on entrepreneurial action, its ability to reconfigure itself quickly.

But we also see the network as a tool for improving the quality of life, and as a way to promote social coherence and unity. It can be that -- it can be a new shared social thoroughfare. But it can also be a line of demarkation -- a "walled city" that separates forever those on the inside from those on the outside.

I would encourage you to think of the government's posture in terms of a seven point agenda.

First, we need to pass telecommunications reform legislation. The industry shares two precepts that must move it in this direction. First, we must recognize that competition is the best way to enlarge our market and the potential gains of each producer, whether telco, cable, or anybody else. Second, we need to accept that FCC and judicial review are not the way to build our new industry. The momentum for deregulation is there. If we follow through, a good result will follow.

Second, we need to promote openness and interoperability. The problem is that these words mean different things to different people. To me, "open" and "proprietary" are not contradictory. UNIX was open despite AT&T's interest in it. In fact, it was even more open because it was proprietary: in the absence of some accepted steward for UNIX, it would have degenerated into eight different versions that would have left users with no clear standard.

That doesn't mean that open must equal proprietary. It means that "open" is not an institution or a property relationship, but a quality that we assign to the relationship between the users of a standard and its stewards. We're looking for new ways to create an environment that drives us towards that end.

Third, we intend to search for international opportunities in our industry -- we've got a winner. Overseas information technology equipment sales totalled $62 billion in 1993. And that doesn't count billions in software and services.

Part of the strategy for exporting our gear and services is to push for the GII based on private investment, competition, open access, universal service, and flexible regulation. As he has taken U.S. businesses to China, Latin America, the Soviet Union, and elsewhere, Secretary Brown has championed this cause in the name of American firms and workers.

Fourth, we are rationalizing spectrum use. We've transferred spectrum from the feds to private sector. We know that spectrum is the resource that will support an entirely new "portability" industry. Larry Irving, our Assistant Secretary for Telecommunications, tells me that world has already seen the sale of a billion walkmans! And PDAs are on their way. In the face of this flux, spectrum allocation is not just a revenue-raising device. It's an exercise in building new institutions that allow spectrum to be best used in a changing and deregulated world.

Fifth, we need to pursue demonstration projects for public purposes -- schools, hospitals, libraries, universities, police and fire protectors, and the like. We need to teach the value of what we sell, and expand the constituency for what it represents. Vendors won't put boxes in schools -- teachers will. Doctors will in hospitals. We need to enter into coalitions with these groups of users to introduce not only the new products and technology, but the new ways of doing things that they entail.

Sixth, we need strong intellectual property protection for signal producers. The integrity of software and other data products must be defended, because that is where value will reside, and because that is where America has unique and sustainable advantages. To do otherwise is to undermine our greatest strength in this new economic era.

And last, we need to come together to determine the right approach to the issue of universal access. What will it mean in practice? The reality is that we don't know. But you can help us figure it out. After all, it will happen with or without you. Your insights and imagination can help move us to a resolution that truly serves everybody well.

A good speech offends one person in the audience, puts one person to sleep, confuses one person, and, of course, gives at least one person a good idea. The good idea is the point. The rest is to make sure that you've fully tested your audience's range. I will stop here, therefore, and hope you'll allow me to clarify what I said, apologize for whatever it was, or wake you up.

Many thanks for your attention.