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.
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