Microchips, Not Potato Chips

The Gang of Eight (Bill Clinton, John Major, Jacques Delors, Robert Reich, Laura D'Andrea Tyson, Mickey Kantor, Ira Magaziner, Lester Thurow) pleads not guilty to Paul Krugman's charges that it is grossly exaggerating the importance of international competitiveness.

Krugman asserts that, economically, nations have "no well-defined bottom line." Wrong! Nations seek to raise the living standards of each citizen. Higher living standards depend on rising productivity, and in any economy the rate of productivity growth is principally determined by the size of domestic investments in plant and equipment, research and development, skills and public infrastructure, and the quality of private management and public administration.

I have written articles referring to strategic trade policies as the "seven percent solution." Ninety-three percent of economic success or failure is determined at home with only seven percent depending on competitive and cooperative arrangements with the rest of the world. My book, The Zero-Sum Solution: Building a World-Class American Economy, contains 23 pages on competitiveness issues, 45 pages on the importance of international cooperation and 333 pages on getting things right at home. The centrality of domestic invention and innovation is precisely why I agreed to lead the Lemelson-MIT program in invention and innovation, one part of which is a $500,000 prize for the American inventor and innovator of the year. The corpus of writings, speeches and actions of the rest of the Gang of Eight contains similar quotations, proportions and actions.

But remembering this sense of proportion, what is the role for competitiveness? Clearly something is wrong with Krugman's arithmetic that shows international trade cannot make much difference to American productivity. If his arithmetic were correct, then it follows that a lot of American protection might be quite a good thing.

Today 6 million Americans are working part-time who would like to work full-time, and almost 9 million are unemployed. In the last 20 years the bottom two-thirds of the male work force has taken a 20 percent reduction in real wages. The American work force could use a few million extra high-wage jobs. Suppose the United States were to impose quotas on manufactured imports so as to bring American imports (now 14 percent of gross domestic product) down to the 10 percent of GDP currently exported, that is, increase the domestically produced GDP by $250 billion. According to the U.S. Department of Commerce, if one divides manufacturing output by manufacturing employment, every $45 billion in extra output represents one million jobs. Production of current imports would absorb more than 5 million of those 15 million underemployed and unemployed people.

Since more Americans would be working in a sector with above-average productivity, national output and earnings would rise. The losses to the American consumer in the form of higher prices would be smaller than the gains to American producers in the form of higher earnings unless American producers were less than half as efficient as those abroad (an unlikely event). But even if that were the case, the economic burden of their inefficiency would be trivial relative to American GDP of $6.5 trillion. The gains to workers would be well worth the loss in output. But certainly none of the Gang of Eight advocates such policies, although they would seem to be called for by Krugman's simple arithmetic. Why?

WELCOME TO THE REAL WORLD

The simple arithmetic of what economists call "comparative statics" is technically right but economically wrong. If the domestic economy is to succeed in moving to higher levels of productivity and income, it must first compete successfully in the global economy. Foreign competition simultaneously forces a faster pace of economic change at home and produces opportunities to learn new technologies and new management practices that can be used to improve domestic productivity. Put bluntly, those who don't compete abroad won't be productive at home.

Although he denies saying it, Michael J. Boskin, chairman of President Bush's Council of Economic Advisers, will go down in history as the man who said, "It doesn't make any difference whether a country makes potato chips or computer chips!" The statement is wrong because wages and rates of return to capital are not everywhere equal.

The real world is in a perpetual state of dynamic disequilibrium where differentials in wages and rate of return to capital by industry are both large and persistent (these above-average wages or returns to capital are technically called disequilibrium quasi-rents). Within manufacturing in 1992 there was an almost four-to-one wage gap between those working in the highest- and lowest-paid industries. The industries at the top and bottom have changed little since World War II. Rates of return to capital similarly ranged from plus 27 percent in pharmaceuticals to minus 26 percent in building materials.

Pharmaceuticals top the rate of return charts every year. The market is always eliminating the high rates of return on existing drugs, but disequilibrium quasi-rents are always being created on new drugs. Because every successful pharmaceutical firm requires huge amounts of time and capital to build physical and human infrastructure, those already in the industry find it relatively easy to stay ahead of those who might seek to enter.

PUTTING PEOPLE FIRST